Pension or Property?
2nd December 2016
Pensions have many advantages: Pensions allow you to spread the risk and also offer you many other benefits as well. It seems a real shame that so many people, apparently even those who have the most valuable type of pensions of all, fail to understand how much they are worth. I would like to explain just how valuable pensions are and why they would normally be the best way to save for retirement – even better than property.
You can more than double your money with a pension: The first thing to say is that, if you are in a workplace pension and you opt out of it to rely on property, you will lose free money from your employer. Many employers will match your own pension contributions. So, if you earn £25,000 a year and you put 8% of your salary into a pension, that amounts to £2,000 each year. £400 of this, however, will come from basic rate tax relief, so your own actual investment in your pension will be £1,600. And, if your employer offers a matching 8%, then you have another £2,000 going into your pension fund too.
You put in £1600 and it can become £4000 straight away: In other words, £1600 of your money has gone into the pension fund and you have received an extra £400 from taxpayers and another £2000 from your employer. So, on day one, your £1600 is worth £4000. That is more than double your money.
Even if property prices double and pension investments make no return, you could do better in pensions: If you pay £1600 a year into a pension you will have £4000 more each year in your fund. By contrast, if you put that £1600 into a property and even if the property price doubles, you will still only have an investment worth £3200 (and that is ignoring the costs of buying, selling and managing the property). So even if your pension investments do not perform brilliantly, you will have extra money you would not have had when buying a property. If your pension fund makes no returns and your property investment doubles in value, you could still be better off in the pension.
Property gains are magnified by borrowing: The big difference, of course, is that you will usually put more money into a property in the first place and also borrow a huge amount extra with a mortgage. So, if the price of the property increases, your gains can be magnified because the amount you have invested is much larger. That works well when property prices rise, but there is no guarantee they will keep on going up and there is also no guarantee that the interest on your borrowings will stay low.
Pension funds can invest in property as well as other assets: It’s also important to remember that a pension can invest in many different assets — including property funds and commercial property. So if you think property will do well, you can include property investments in your pension fund but you can also invest in other assets as well.
Don’t put all your eggs in one basket: When investing for the long-term, it’s not usually sensible to put all your eggs in one basket. Unless you are an expert in one particular area and have ‘exceptional’ knowledge, that you believe is not available to the rest of the market, then relying only on one type of investing means you run huge risks. A more broadly spread portfolio can reduce these risks for you. If you already own a home, its value depends on the movement in property prices. If you then buy another property, you are doubling up. That’s fine when the property market is strong, but there are periods when property doesn’t do well.
Property market may be in a bubble which could burst: Quite frankly, property does have some of the characteristics of a bubble right now – the housing market has been stoked by the Bank of England pushing down interest rates to encourage people to borrow more cheaply, and there aren’t enough homes being built. If borrowing is artificially cheap and there is a shortage of supply, then property prices are bound to rise, but this cannot last for ever.
Investing in property is very expensive: Keep in mind, too, that the costs of buying and managing property can be quite high. You have to pay stamp duty, and you will usually have solicitor, surveyor and estate agent’s fees too. If you let the property, your tenants may not look after it, you will have costs of repairs, you may have periods when it is empty and you could even face court fees if your tenants prove difficult.
Pensions are the most tax efficient way to save for the long-term for most people: You can get tax relief on your pension contributions at your highest marginal rate but you invest in property from taxed income. Any rental income and capital gains from property are taxed, whereas pension investments are tax free. Your pension investments pass to the next generation free of inheritance tax and there is no income tax until the money is taken out (and if you die before age 75 there will be no tax to pay at all). With property, all income and capital gains are taxable and when you pass away your property goes into your estate and is subject to inheritance tax (although there are exemptions for your own private residence).