Should I invest my pension lump sum in property?

How to decide if property investment is best for your tax-free cash lump sum

We recently had a client ask if he should invest his pension lump sum in property. While the advice for you might be different and is dependent upon your circumstances, this article should give you the information you need to consider before you spend or invest your tax-free lump sum.

Should I take the tax-free cash lump sum?

When you decide to take benefits from your pension savings, you are entitled to take 25% of the fund as a tax-free cash lump sum. For most people, this is the sensible thing to do. While the rules on what you can do with your pension have been relaxed, it only has the cash in your pocket that gives you complete flexibility and freedom of choice.

Options that are open to you include:

  • Save it in ISA accounts (dependent upon the lump sum amount, ISA limits, and what ISA savings you have made)
  • Buy an annuity to provide income
  • Invest it into the stock market
  • Spend it
  • Pay off your mortgage

You could also invest in property, perhaps with the aid of a buy-to-let mortgage.

My lump sum is £100,000, here’s what I want to achieve

Nigel is 60, and he’s considering taking benefits from his pension plan. His total pension pot is valued at £400,000, so he could take £100,000 as a tax-free cash lump sum. He also wants to go on the trip of a lifetime – he has promised his wife for the last 20 years that he would take her to visit Australia and the United States. He’s budgeted £10,000 for this.

Nigel has recently finished paying off his mortgage, and so his monthly finances are in much better shape than they have ever been. However, he also wants to put £10,000 of his lump sum in a cash ISA as an emergency fund.

He’d like the balance to do several things. His major concerns are:

  • Provide some income
  • Have the potential to build a valuable inheritance for his grandchildren (upon their death, he and his wife will be leaving the family home to their two children)
  • Protect against inflation
  • His income to outlast him

What options can be ruled out immediately?

Given his main objectives, there are some options that Nigel can cross off immediately. For example, Nigel wants the lump sum to provide an inheritance for his grandchildren. If he buys an annuity, the money will be gone – you get an income for life in exchange for the capital you use to purchase it.

He could bank or invest the income and spend it over a number of years. A popular rule is the 4% rule. It says that you should take 4% of your capital every year, and this should last until you die. Effectively, Nigel would receive £3,200 per year for 25 years. But what if he lives beyond these 25 years? Plus, taking money out of the capital means that his grandchildren might receive no inheritance.

If he invests his money in the stock market, it might grow and last longer than 25 years. But what if the stock market goes down? He’d have to cut the amount of money he is taking – that’s no hedge against inflation.

Nigel doesn’t have a mortgage to pay off, so he could invest in ISAs. But, he can only invest £20,000 per tax year into an ISA. It will take him four years to fully invest his lump sum. However, when it is fully invested, he will benefit from tax-free income. The asset in which he invests inside the ISA will determine his income and the risk to his capital.

So, we come to property – an option that his financial advisor hadn’t considered.

The benefits of investing your pension lump sum into residential property

Nigel could use his lump sum as a deposit on a residential investment property. Let’s say that, after research and discovering the best places to invest in property UK; he decides to buy a property valued at £200,000. He will need a buy-to-let mortgage of £120,000 – or 60% loan-to-value.

Nigel is borrowing money to invest in property. It means he’s going to be making money on other people’s money and taking advantage of the benefits of leveraging in property investment. For example, let’s say that Nigel’s investment property produces a gross rental yield of 8%, and he pays mortgage interest of 5%. On his investment of £80,000, Nigel would make £10,000 in gross rental income (£80,000 x 8% + £120,000 x 3%). That’s a gross income yield of 12.5% on his invested capital! (Of course, he may have tax to pay on this income, and there may be other costs to take into consideration, such as investment property management fees).

In addition to this benefit, Nigel’s rental income is likely to increase. It will offer him protection against inflation. Being residential property, over the long-term, its value is likely to increase. Residential property in the UK is one of the most stable assets with consistent growth available to investors.

When Nigel dies, the property will be available to leave to his grandchildren. If he has protected it with life assurance, they won’t even have the mortgage to repay.

Investing a pension lump sum into property could meet all your objectives

As you can see, investing his pension lump sum into property ticks all of Nigel’s major financial objectives:

  • It provides an income
  • It allows him to leave his grandchildren a valuable inheritance
  • It protects against inflation, both to his income and the capital value
  • The income will last way beyond his death – it doesn’t run out like using the 4% rule

Should you invest your pension lump sum into a residential property?

Whether investing in property is the right decision for you depends on several factors. You’ll need to consider your financial and lifestyle objectives, and your tax position. You may need to consider your family, health, and other investments and savings, too.

When you have that lump sum available to you, do always take advice from as many knowledgeable people as possible. To have an informed decision about whether property investment could provide your desired lifestyle benefits and meet your financial objectives in retirement, contact one of the Gladfish team on +44 (0)207 923 6100.

Live with passion,

Brett Alegre-Wood

About the Author

Brett has over 20 years experience in all facets of property, he owns various companies centred around property and is the driving force behind the education and training at Gladfish. His companies have sold over £850 million in UK and London property and he manages over 1200 properties through his estate agency chain. Today he shares his time between UK, Australia and Singapore. He is married to Arlene and together they have 4 kids.

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