Property vs pension – what investment is right for you?

Investing in property or deciding to solely rely on a pension is a big financial decision and many find themself learning how to buy a property in the later stages of life in order to set themself up financially for the future. 

The truth is, both pension and property have the potential to bring you long-term financial security and freedom, but it can be hard to work out which option is best for those approaching retirement. 

Throughout this article, we will be comparing the pros and cons of investing in property versus saving in a pension. So, you can make the most of the money you have as you plan for your later years.

Key terms such as return on investment and risk management will all be considered as we understand that someone’s requirements and tolerance are all unique and individual to them.

So, prepare to be equipped with the knowledge you need to make a smart and informed choice about your future investment.

Is it best to invest in my pension or buy a property?

There are a lot of ways to determine if a property or a pension is the right thing for you. This includes going over the return of investment that can be expected for each as well as the pros and cons of other investments too.

You can read our article on alternative property investments for some ideas on how this may work and read also how to buy a property with no money if you want a more aggressive property investment strategy.

Can you use a house as a pension?

While a home does go up in value, using it as a pension may not be the best idea for most people. For one, it only works if you own the home and aren’t paying a mortgage on the property.

Alternatively, you should at least have most of the equity on the home paid off if you’re going to use it as a pension but either way, because you’re living in your own home, it could be hard to realise the true potential of the investment you have.

One of the options you have is to sell the property you own at retirement age and move into a property with less value. This gives you some extra money you can use as an investment again or you could use the money directly for living expenses.

Another option you have is using your house as a pension is to go to a lender and ask for an equity release. This is where they give you some money up front for your pension.

However, after you die, the house is sold and the lender is able to recoup the money with interest from the asset you have left behind. In order to do this, you’d need to make sure your inheritance is well planned out.

This is something that must be done with the right professional help to make sure the residential valuation is correct and you’re following the right laws when it comes to inheritance tax on your property. 

Do you need a solicitor to make this decision?

It is advised to seek out help from a solicitor who has dealt with similar cases to yours as there could be parts of the law you don’t understand and there could be the option to perhaps buy a second home if you gain access to the right knowledge.

Everyone has different goals so it is important that you find specialist advice for you. There are also different tolerances for risk that people have and unique features about a retirement plan that could inspire a different decision.

Is it worth taking out a buy to let mortgage?

Depending on the deal, it could be worth taking out a buy to let mortgage for some extra income throughout retirement. This is because you could find a deal that is great on a short term deal.

Does a pension or property give the best ROI

Table of house price returns compared to a pension return

In the UK, the return on investment for a pension is calculated by looking at how it performs in the equities market. Typically, this results in around a 4 or 5% return on investment every year as the value of the pensions appreciates.

As you can see however, when the two are compared, there is very little difference in the change in value of both assets. House price is slightly more.

However, this is not a complete picture as it doesn’t take into consideration the rental income collected over the years and the additional risk that comes with owning a property.

This table should only be a reference to go by rather than conclusive evidence that one performed better than another.

Tips for choosing a property with the best return on investment

In order to find a property with the best return on investment, there are a few things you should be aware of which should help you make a good decision.

These factors are listed below:

Focusing on the area

The area is perhaps the biggest factor in determining if the property will be a good deal with a great return on investment, This is because the area impacts if a property is likely to appreciate in value the most.

For example, properties that are in London have the biggest chance of increasing in value because capital appreciation is highest in the capital. Since 2000, property prices have increased by five times!

As well as this, looking at the more localised area is also a good idea. Things like low crime rate, good schools in the area and jobs nearby all make the house price of an area creep up.

In general, the more desirable an area is, the more likely it is that a property’s value will go up.

Maximising the rental yield

In order to maximise the rental yield of a property, there is a lot that you can do to make sure the finances work in your favour as an investor.

First of all, finding the right mortgage is the first step in making sure your expenses are low before you buy a house. Putting down more of a deposit, negotiating with lenders and waiting for the right time in the market are all methods.

It may not seem like much but the interest rate on a house mortgage makes a huge difference in how a properties rental yield performs. For instance, a mortgage with a 2% interest rate compared to 4%.

If the rental income of the property is 5%, the property with the 2% mortgage will have a 3% rental yield whereas the property with the 4% mortgage will have a 1% rental yield.

This simple change in numbers produces three times the income in this case and shows the importance of having a property where the mortgage is secure.

Other Than, this, you could be able to increase the rental yield of  a property by maximising the rent that you’re charging as a landlord by raising rents every year and adding value to a property to extract as much rental income as you can.

In order to find out what in the UK has the higher rental yield for you, check out the house for sale data base below that shows all of the properties that you should be aware of in the UK.

Doing the right tenant referencing

Tenant referencing is a process that should be done carefully as bringing in the wrong tenant to a property can severely impact rental yield. For instance, if a tenant leaves a property, these void periods can reduce rental income.

What are the pros and cons of pensions compared to property

Pensions are there for the majority of people who have worked in the UK. This is because it is the responsibility of employers to contribute to the pension of people in the UK.

Pros

Below are the main advantages of a pension for those who want to use a pension as a strategy to retire. There are a lot of advantages and in general, the more familiar you are with property the better.

For example, you may have a lot to learn for very little gain if you only have one house that you’re using towards your retirement. However, if you have a second home, you’ll likely just be solving the same problems you did in the purchase of the first.

In other words, the learning curve for investing in property is harsh but once you know what you’re doing, accumulating a larger portfolio isn’t too hard and before you know it you could own an entire build to rent development.

Contributions

If you contribute to a pension, there is a tax relief that comes with it. For instance, the contributions to a pension can go towards child benefits and the personal allowance of people who are looking for tax relief.

On the other hand, the rental income from property is taxed before there is the opportunity to contribute towards a personal allowance or benefits for a child.

Taxation as a benefit

The rent received from a buy-to-let property is taxed at the investor’s individual tax rate. Prior to the 2017/18 tax year, landlords were able to fully deduct mortgage interest costs from their property income.

However, this has changed and is now subject to certain limitations. For more information, please see our article non section 24 highlighting this.

Advantages of pension when you die

Pension funds are accessible for those who are beneficiaries of someone when they die. If someone dies before 75, they will have all of their funds transferred but if they die over 75, funds will be transferred at a marginal rate.

No void periods

In a property, there is no guarantee that the property will be rented out consistently throughout the duration of the tenancy. This is a big factor in making sure the predicted rental yield comes into fruition.

As a result, whenever you are making a calculation to see if the rental yield or the return works for a property, you should consider there will be a period with no tenants.

However, with the right tenant referencing, you should be able to gain rent guarantee insurance which will mean there are no void periods in a tenant and rental income is more predictable.

If you sign up below at lofti, we are so confident in our tenancy referencing process which is embedded in the software that you will be eligible for rent guarantee insurance too 

Costs that occur on the sale of a property 

Whenever a property is in the process of being sold, stamp duty must be paid. In addition to this, capital gains tax is paid by the seller. This means a lot of profit is removed from the deal.

In the case of pensions, once you have reached retirement age, pensions can be accessed completely tax free. However, property doesn’t have to be sold and an investor can avoid costs by simply collecting rental income instead.

Cons

Costs of having a pension

In the process of taking out a pension, there are legal fees involved that a property will not have. Nonetheless, there are still costs associated with the sale of a property such as stamp duty and land tax.

For instance, a pension that you want to extract will cost anywhere between £500 and £2,000 to process once all of the legal fees are considered.

Whether it remains more or less expensive to withdraw a pension as opposed to getting paid from a property is up to the individual property deal but it is worth noting there are costs with withdrawing a pension and it isn’t free.

No ongoing costs

When it comes to property, there are maintenance costs associated with property that don’t exist whenever there is a pension such as home insurance. This is because there are tenants in a property that need managing.

In difficult cases, there could also be tenants in situ that have to be managed as the ownership of a property is transferred from one landlord to the next.

As well as the financial costs that are ongoing, there are also the added stresses of analysing a property to make sure it is a good investment. A good landlord would want to ask the right questions when buying a house.

Also, legal issues like deciding whether to open a limited company or convert a mortgage if you’re dealing with a help to buy property during a new build purchase all need to be thought about in detail.

Pension property funds

Pension property funds are where you can use the pension contributions to purchase a property in the future as an investment. This must be done through a pension scheme that is private.

As a result, this will often require a fair bit of future planning so you’re able to accumulate enough money in the fund before your retirement. Nonetheless, it is an option for those who want to stay prepared.

So pensions aren’t the best in this sense because you have to plan ahead and you may run out of time to effectively and adequately invest in a property pension fund if you forget about it or have circumstances that delay the process.

No rental income only dividends

In general, dividend payments are less than the highest rental yields you can receive from property. As a result, rental income is preferred when it comes to establishing an income stream that will be able to benefit you throughout retirement. A good rental yield on a property is considered 7% – 9% in a location with a high rental yield.

On the other hand, when you consider a pension over the course of decades, the average pension growth is around 2% – 3% per year. Over time, this can certainly compound. However, property investments made in the right way will always be superior.

For instance, a property bought at auction for a great deal will always have a better return both on rental yield and capital appreciation than a pension. As you invest in a pension, everyone gets the same return in the market.

No level or expertise, asking the right questions access to the right checklist when viewing a property will help you when it comes to investing in a pension like it does when it comes to property.

Do property or pensions have the best tax benefits?

What type of retirement setup has the best tax benefits, property or pension, is up for debate and will differ depending on who is investing and what your goals are. 

For instance, a great return on investment that comes with a lot of risk may not be preferred to someone who wants to take minimal risk and is okay with having a lower return on their retirement pot.

Inheritance tax is better for pensions

Inheritance tax is arguably a lot more beneficial for those who use a pension for retirement rather than invest in property. This is because assets must be continually gifted to relatives in order to have tax benefits over years.

If not, a property portfolio would likely have to pay inheritance tax which can be up to 40% if inheritance tax isn’t considered in the will of someone who has passed away. 

So, a pension can be passed on and accessed by a loved one when they reach retirement age in the event of a death. However, property will still be taxed fairly heavily if you die unexpectedly through inheritance tax.

In this sense, it could be argued that a pension has superior tax benefits to property in the event of someone’s death.

Personal income tax can be reduced in a pension

Whenever a pension is paid into by someone earning a conventional income, they reduce the amount they have to pay in income tax. What’s more is some employers will be able to pay more into your pension if you increase your own contribution.

This is therefore a great way to avoid tax and plan for the future.

Expenses can be reduced in property with a limited company

As a buyer invests in property on a larger scale and perhaps using a buy to let mortgage, they can begin writing off a lot of expenses they would usually have as a business expense.

For instance, petrol miles can be included as part of a tax bill and any renovation that is necessary for a property to be continued to rent out can also be written off.

In the long term, this can benefit an individual because they aren’t using their personal income that is already taxed to pay for necessities. However, tax write offs must still be used within reason, read more about them here.

What is better overall?

In conclusion, choosing between property and pension investments is a complex and personal decision that requires careful consideration of your financial goals, risk tolerance, and overall financial situation. 

In addition, while most people contribute to a pension for their whole lives, many still don’t quite understand how they work, where they’re stored and what kind of return you can expect. So, read more about them here.

It is fair to say that property doesn’t benefit from the same tax incentives as pension. As a result, you have to make sure you make up for the additional returns you can make on a property investment to make it worth your while.