Property investment or pensions savings – how to prepare for retirement?

Make the best decision for the most important time in your future

There's a continual debate about property investment versus pension savings as the best vehicle for your retirement. It's one that everyone should take notice of, and understand.

How you invest for your retirement will dictate the type of retirement you have. It will determine how much income you benefit from to support your retired lifestyle. Without enough money coming in, you can wave goodbye to your dream retirement of foreign holidays, more time with the grandchildren, and have a second home in a warmer climate.

This article describes the major pros and cons of both investing in property for retirement and using traditional pension funds.

How a pension fund works – advantages and disadvantages

When you invest in a pension fund, there are several benefits. Most of these are centred on tax. For example, all your contributions are exempt from income tax. If you are a basic rate taxpayer and pay £80 into a pension fund each month, the taxman will add another £20. That's like having a 25% investment return overnight.

It gets better. The income and capital growth in your pension fund grow largely tax-free. And your employer can contribute to your pension plan, too. If all this sounds too good to be true, it is. There are some serious disadvantages if you invest in a pension fund for retirement.

For example, you can only save a maximum of £40,000 in any single year. If you save more than this, you could face a tax charge. Further, if you are a high earner who is earning more than £150,000, for every £2 more you earn you will lose £1 of pension contribution allowance. It is not a straightforward calculation. You must first work out your ‘threshold allowance' before calculating how much tax relief you can claim.

In addition to the annual pension savings allowance, you are also subject to a lifetime allowance. It is the maximum amount you can have saved in your pension pot and is currently set at £1 million. If you go over this level, you'll be subject to extra tax payments of as high as 55%.

Professionals will manage the funds you chose for your investment. It sounds a great idea until you hear that 80% of funds underperform their benchmarks. Mind you; this underperformance might be seriously influenced by the way you are charged on pension funds. The fund manager takes a management fee (of usually between 1% and 2%) of the value of your fund. It is paid irrespective of its performance. You may also be charged transaction fees and switching charges.

When you retire, you can take 25% of your fund as a tax-free cash lump sum. You'll probably be recommended to do so. Why? Predominantly because you can probably get a better return on it elsewhere!

With the remainder of your pension fund, the traditional method of creating retirement income is to purchase an annuity. These will pay on average around 4% to 5% of the invested amount. Once you have bought an annuity, the money is gone. You'll be paid an income until you die, but that's it. Most people take a level annuity as this pays out more at the beginning, but does not increase to protect you against inflation. It means your lifestyle will be deteriorating from day one because of the effects of any increase in the cost of living.

How property works as a retirement vehicle – advantages and disadvantages

Unlike saving in a pension fund, any investment you make does not benefit from many tax advantages. For example, if you want to invest £100,000 in property for your retirement, you will need to have £100,000 to invest.

Having said this, there is no limit to how much you can invest in property, either. So, you are not restricted to a £40,000-per-year limit. Nor are you restricted to a lifetime limit of £1 million. If you want to build a £20 million property portfolio to pay for your desired retirement lifestyle, you can.

While you won't benefit from tax relief on your property investment, you can benefit from using other people's money to invest – an advantage not available to the majority of pension fund arrangements. It is called ‘leveraging' – investing with a buy-to-let mortgage. It can be much more powerful than tax allowances on pension contributions, as you'll see in a moment.

Property investment is also more flexible than pension saving. Even though pension rules have been relaxed, you can't access your investment like you can with property investment. If you start investing in property in your twenties, you could have a property portfolio that is profitable enough to support retirement within ten or twenty years. You can't access your pension fund until you are at least 55 years old; and even then, you could be taxed up to 55% because you are taking benefits before 60.

Of course, if you want to take a lump sum, you'll need to sell a property to do so. You'll be charged capital gains tax on this, of up to 28% (on any gain after your tax-free capital gains tax allowance).

Now, to income in retirement. Unlike a level pension annuity, the income you receive from rent is likely to rise each year. Why? Because you decide what to charge! So, rental income is likely to protect you from the rising cost of living, thus maximising current and future rental income.

Equally importantly (perhaps even more so, for some people), when you die your property will outlive you. It doesn't die with you like most annuities. The income from it is unlikely to reduce. Investing in property builds a real and tangible legacy for your family to enjoy and profit from for generations to come.

The effect of leveraging when you invest in property for retirement

Earlier, I promised to explain the power of investing using other people's money. It's probably easiest to do so using a hypothetical example of two twin brothers:

Let's say, for example, that the first twin invests in a property worth £200,000 with a £40,000 deposit. Let's consider that the property rises in price by 10% in one year and that he pays mortgage interest of 4%. Rental income covers his mortgage interest of £ 6,400. The gross capital gain will be £20,000, or 50% on the original investment.

Now let's say that the twin brother invests a gross amount of £40,000 into a pension fund. Net, he will have paid in £32,000 and the government £8,000. Now let's say that his fund grows by 10%, just the same as his twin's investment property. After one year, his pension fund is worth £44,000. He just made £12,000 on his investment of £32,000, or capital growth of 37.5%. Let's see how these investments perform over 10 years, assuming 10% capital growth per year every year:

Year Value of Property Investment Value of Pension Saving
0 £200,000 £40,000
1 £220,000 £44,000
2 £242,000 £48,400
3 £266,200 £53,240
4 £292,820 £58,564
5 £322,102 £64,420
6 £354,312 £70,862
7 £389,743 £77,948
8 £428,717 £85,743
9 £471,589 £94,317
10 £518,748 £103,749


Leveraging pays off. Even taking into consideration the £160,000 buy-to-let mortgage, the gross profit from property investment in this example is £318,748 on the original investment of £40,000. Meanwhile, the twin's pension fund produced a profit of just £71,749.

The bottom line

Whether traditional pension saving or property investment is the best retirement vehicle for you depends on many factors personal to you. Whichever you decide, don't do so without consulting experts. Contact one of the Gladfish team today on +44 (0)207 923 6100. Let us help you get your financial goals into perspective, and discover how property investment could positively impact your lifestyle in retirement.

Live with passion,

Brett Alegre-Wood

Brett Alegre-Wood
August 3, 2017

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