For many years people have questioned whether property or a pension is better when saving for retirement. The argument was given new life when one of the Bank of England’s top economists, Andy Haldane, recently claimed buying property is a better investment than saving into a pension. Perhaps now is the time to consider the myths about property and pensions, and look at the numbers to work out which has been the better way of investing for retirement over the past 25 years.
How Property and Pensions compare over 25 years
|Cost of home in 1991||Avg. monthly mortgage payment||Mortgage interest rate||Home value after 25 yrs||Profit mortgage and other costs|
|Started paying into pension in||Avg. monthly payments||Annual investment growth||Pension value after 25 yrs||Profit after contributions and charges|
House prices have soared by 300%
The growth in property values has meant startling returns for some, with house prices up almost 300% over the past quarter of a century. But all is not what it seems. According to analysis by researchers, you should not risk your retirement on property – although house prices have risen dramatically, savers have had to devote a huge amount of their income to paying the mortgage. In many cases, by the time you have cleared your mortgages, you will have handed over three times the original cost of the property. Let’s consider a case study: In 1991 John was earning £18,000 and had started to save when he was 22. In 1991, a typical property cost £54,903, according to Nationwide Building Society, some £151,030 less than now. To buy a typical property John would need a deposit of £10,981. At the time, savings interest rates were higher and salaries lower than now. Mortgage interest rates in the early Nineties were typically around 14%, so the property would have taken about a third of John’s salary. It is true that interest rates fell over time, however they remained at around 7 to 8% for much of the next 15 years. All of the interest paid adds up and this is money John won’t see again in retirement, unlike pension savings. If John took out a mortgage with a 25-year term in 1991, he would have paid £86,400 by the time the loan was paid off this year. This is £31,497 more than the price paid for the property! There are other costs that eat into the return John actually gets from his investment:
- Maintenance and insurance costs would have added up to an estimated £30,000 over the 25 years.
- Stamp duty of around £200.
If we add up the costs, John’s £55,000 property has cost more than £127,600. After house price inflation, this leaves a profit of around £78,300.
How do you cash in on your property?
Having paid off your mortgage, how can you get to the money tied up in your property? If the property is your home, you will still need somewhere to live.
You could sell your home and move to a smaller, cheaper property
The only problem is that it’s not only your property that has risen in value — they all have. This means that the new home you need to buy will be more expensive and reduce the profit you are left with.
- If John got £205,000 for his property and then bought a £150,000 house to live in, he would have just £55,000 left in cash to support him through his retirement.
- There would be stamp duty to pay on the new property costing around £500.
You could take out an expensive mortgage that allows over 55s to fund retirement by using the equity in their property
Known as equity release plans, these arrangements are a bit like mortgages:
- Interest is charged on the money you borrow.
- How much you get is based on your age and how much equity you have.
- The money you borrow, plus the interest, is repaid when you die or go into care.
- This provides the advantage that, unlike selling up, you stay in your original property.
Equity release plans can help older property owners, who may be unable to get a traditional mortgage from a bank due to their age, however they can be very expensive and in many cases the debt typically doubles every decade. This means that if you take £100 out of your property today, in ten years your estate will owe £200,000.
Despite concerns, Pensions have soared
In the UK the reputation of pensions has been blemished by misselling and more recently the scandals surrounding “Pension Liberation” Scams. Despite this, if you have a pension scheme, you could be better off than you may think. In the past, the real retirement winners were savers with generous final salary deals paying a guaranteed income for life. Over time these have fallen away, being horribly expensive for employers to provide and indeed many schemes do not have the funds they need to keep the promises that were made. Today, for most pensions what you will get back depends on investment performance and over the years, despite the extra risk, they have done well. An analysis of stock market performance over the past 25 years shows that saving a modest amount of your income each month into a pension invested globally would have built up a sizeable sum, especially when you consider tax relief and the power of compound interest. So back to John. If John started saving in 1991 at the age of 22 and contributed 4 per cent of his salary each year, he would enjoy a £168,663 pension pot over 25 years*. A key reason John’s pension grows quickly is pension tax relief. In the UK, personal pension contributions receive a refund of income tax at your marginal rate (20, 40 or 45%).
- It costs a basic-rate taxpayer 80p for each £1 added to a UK pension (with 20p from tax relief added to his pension pot).
- For Higher (40%) and Additional Rate (45%) tax payers the £1 costs even less at 60p and 55p respectively.
This means it will cost John only £65,419 over 25 years to build up a pension worth £168,663. There are fewer fees and costs when taking your money out of a pension compared to realising money from a property. In April 2015 new rules came into force allowing you to spend your pension in any way you wish. Once you are 55, or older, you can keep the money invested and draw down funds as and when you want to. It is important not to draw down too much in one go or pay more tax.
- If John takes the full £168,663 in one withdrawal, he could end up paying tax at 45% on a significant amount.
- This is because John could be classed as a higher earner with taxable income of more than £150,000.
Don’t forget a pension is designed to last you throughout retirement so, whilst £168,663 is a reasonable sum, you should ensure you take a sensible amount each year to make sure the pension lasts for your lifetime.
Today it is harder to profit from property
Using property to fund your retirement is much riskier today than in the past.
- Ballooning house prices mean you need to save a much bigger deposit to get on the property ladder.
- A 10% on an average £205,000 home is £20,500.
- With interest rates at an all-time low, saving this deposit can be more difficult than it used to be.
- With savings interest rates below 1%, if you save £200 a month, it would take more than eight years to have enough for your deposit – and property prices continue to rise making the deposit you need larger and larger.
Is Buy to Let a better Retirement solution?
There are no guarantees that house prices will rise as rapidly as they have in the past, indeed there is no guarantee that they will rise at all. Many who already own homes have been buying rental properties to provide their retirement incomes, however recent taxes introduced by the UK Government mean that property has become far less profitable. To buy a second property you must pay an extra 3% Stamp Duty on the total price of the property on top of the Stamp Duty normally paid, so now stamp duty on a £150,000 property costs £5,000, compared to £500 under the old system.
- The amount of tax relief landlords can claim on their mortgage interest repayments is being reduced steadily over the next 4 years.
By contrast, pension savers are paying less today than in the past
The UK Government, over recent years, has acted to limit charges on workplace pensions and is taking action to limit fees payable for moving your pension elsewhere.
What about when you die?
Although there has been a nod to property passing to descendants, in the form of a small additional Inheritance Tax allowance, property remains at a distinct disadvantage compared to pensions as:
- Property values, in excess of the Nil Rate Band, are taxed at 40% on death with the tax being payable before probate can be granted.
- Pensions by contrast:
- Suffer no tax if you die before age 75
- Are taxed as income of the beneficiary, only when drawn, if you die after your 75th
As we age we tend to develop a strong attachment to the home where we have lived most of our lives, making it very hard to consider moving from a house to a little flat that may be far away from our friends, family and grandchildren. This makes the plan to downsize impractical for most. The attraction of Buy to Let has all but been extinguished by UK Government legislation which has eaten into returns and, in some cases, resulted in more tax being paid than profit is made! Planning for retirement requires access to money in retirement to pay for your lifestyle as your employment income stops. The illiquid nature of property makes it generally unsuitable as you can’t take a few bricks to the Supermarket. The attractiveness of pensions has grown through successive reforms and, for now, the attraction of tax relief provides superior returns to property whilst maintaining all important liquidity and flexibility.
In this article we have compared UK Property to Pensions, however the lessons learned hold true for retirement planning in many countries, including Australia. Pensions not property provide the best way of providing for a secure retirement, however it is vital to ensure you have the best, and most suitable pension, to match your needs coupled with an effective investment strategy. You should have a Pension Audit to take stock of your retirement plans and make sure that you are on track for the retirement you want. To arrange your no obligation Pension Audit contact your AAM Financial Planner or email firstname.lastname@example.org now.
Ian Black Head of Wealth Solutions AAM Advisory Pte Ltd
Note: *In our example, we assume the worker’s salary rises over the 25 years from £18,000 in 1991 to £52,000 and that they increase their contributions gradually to 12 per cent. The figures also look at global stock market performance over the whole quarter century, which include years when investments rose by 27 per cent and those when they fell by 6 per cent. We also include charges of 0.5 per cent a year.
Land Registry, Registers of Scotland, Land and Property Services Northern Ireland and Office for National Statistics
Disclaimer: This article is an op-ed piece by Ian Black. The views expressed in this article are those of the author’s and do not necessarily reflect the views of Financial Advice SG or his current employment. This document/article should not be construed as an offer, solicitation of an offer, or a recommendation to transact in any securities/products mentioned herein. The information does not take into account the specific investment objectives, financial situation or particular needs of any person. Advice should be sought from a licensed financial adviser regarding the suitability of the investment product before making a commitment to purchase the investment product. Past performance is not necessarily indicative of future performance. Any prediction, projection, or forecast on the economy, securities markets or the economic trends of the markets is not necessarily indicative of future performance. Whilst we have taken all reasonable care to ensure that the information contained in this document is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness. Any opinion or estimate contained in this document is subject to change without notice. The above report may contain data obtained from third parties and as such we cannot guarantee the accuracy of this data.