House prices have been on the rise for many years, and it's no wonder why so many people are turning to property as an investment option. However, investing in a pension or increasing pension contributions can also be incredibly beneficial as they are supported by government tax relief. So, which one is the better investment – pension or property? Let's find out!
Choosing Between a Pension and Property
Pension and property are unique in the way they can help you save for retirement. With a pension, you get access to tax relief and employer contributions, whereas with property, you have the potential to generate rental income and benefit from capital appreciation.
Let’s look at some of the factors that you should take into consideration when choosing to invest in either a pension or property.
Investment growth
The average annual percentage change for UK house prices ranges from 5% to 7%, showing that the property market experiences significant capital growth. If you had invested £50,000 in 2017, you could have seen it grow to over £63,000 by the end of 2022. The consistency of returns and rising house prices in the UK make property investment an attractive option for retirement planning.
On the other hand, pension investments have different growth potentials, and their performance will depend on factors such as your age, type of pension, and risk appetite. If you have a SIPP account that allows you to invest in financial assets like bonds, stocks, and funds, your returns would vary based on the performance of these assets over the years.
Nonetheless, you can still achieve consistent growth in your pension plan if you stick with a workplace pension that receives contributions from your employer. The advantage that property offers here is that you can earn steady returns from things like rents and leases, unlike pensions, which are paid in lump sums.
Rental income vs dividend income
Yields on property can vary depending on demand, location and other factors. Generally, a good rental yield tends to be around 5%. Rental income from property can be more reliable than dividend income from shares which are affected by things like changing market conditions.
However, you must factor in costs such as mortgage payments and maintenance of the property when looking at rental income returns.
These costs can be covered in a variety of ways. You could opt to pay them from your own income, or you could use the rental income generated to pay off mortgage repayments and other costs.
But, if you have a pension plan that invests in stocks and shares, you could benefit from regular dividend payments. Dividends can be paid out quarterly or twice a year and these depend on the performance of the company.
Both rental income and dividends have the benefit of consistency in that they can generate returns that you can rely on over time. However, rental income is often higher than dividend payments and also has less volatility in terms of how much you receive.
One way to earn stable dividends is to invest in blue-chip stocks and balance your SIPP portfolio such that you get a range of dividend payouts over time.
Inheritance tax
One of the main things to consider when investing in property is the effect it can have on inheritance tax. As property prices rise, so does your estate’s value. And if you hold multiple properties, the total value of your estate could be subject to inheritance tax. Pension payments are exempt from inheritance tax, so this may make them a more attractive option for those looking to avoid such taxes.
While pension payments are exempt from inheritance tax, they can come with income tax liability. If you take taxable income out of your pension pot this will be taxed at your marginal rate in the same way as other forms of earned income.
Capital withdrawals are also taxed at the same rate, depending on how much you withdraw each year. However, most pension plans are tax-exempt up to a certain percentage withdrawal, usually 25% of your total pension pot.
Risk levels
Both pension and property come with risks, so it is important to understand the risks associated with each before investing.
Property prices can be highly volatile and are based on market conditions such as local demand, interest rates and economic uncertainty. Property investments are also subject to stamp duty, and you have to pay capital gains tax when you sell a property, so these need to be factored into your decision-making process.
Pensions, on the other hand, have varying risk profiles depending on the type of pension plan you have or what assets your plan is invested in. If you want a low-risk, low-return investment then a traditional pension plan (investing in bonds) might be suitable, whereas investments in stocks and shares may offer higher returns but also involve more risk.
However, one way to reduce risk is to choose low-risk pension plans or invest part of your pension into property.
Costs
Property costs include stamp duty, estate agents’ fees, legal fees and surveys. You should also consider the cost of maintaining a property in terms of repairs, insurance and taxes.
Pension costs include fees for setting up a pension plan and ongoing management fees. Overall, these costs can vary depending on the type of plan you have – for example, workplace pensions typically have lower charges than SIPPs due to economies of scale. It is important to compare charges between different pension providers as some may offer better value for money than others.
If you are looking for an alternative investment option that offers a balance between risk and return then stocks and shares ISAs or ETFs could be suitable.
These products come with the added benefit of tax-free returns, so any profits from your investments will not be subject to capital gains tax. Additionally, ETFs are often cheaper than other types of investments as they are traded in bulk and so benefit from lower commission costs.
What if the home you live in is your pension?
For many people, the home they live in is a part of their pension. Selling up and downsizing can be a great way to free up capital for retirement and this option should certainly be considered if it’s viable.
This involves selling your home and moving to a smaller property, freeing up equity that can be used for retirement. It is different from having investment properties which are separate from your home, as the proceeds from a sale of your home would be used to fund retirement rather than being reinvested into more properties.
Whichever option you decide, it’s important to ensure that you have sufficient provision for retirement. Although property investments can provide an opportunity for growth over time, you should at least consider having a workplace pension in order to ensure that you’re financially stable at the point of retirement.
Pension vs Property: Advantages and Disadvantages
Now that you understand the factors to consider when deciding between property and pensions, let’s look at the pros and cons of each option:
Investing in a Property
- Opportunity to build long-term and consistent wealth
- Potential for capital growth over time
- Leverage your assets to raise capital by selling the property at anytime
- Potential for rental income in addition to capital growth
- High upfront costs (mortgage) and ongoing maintenance fees
- Subject to stamp duty, legal fees and other taxes
- Time consuming to manage multiple tenants/properties
Investing in a Pension
- Safe investment with low risk
- Tax advantages for income and capital withdrawals
- Easy to access and manage your investments
- Option of investing in a variety of assets such as bonds, stocks, ETFs etc.
- Reduced flexibility compared to property investment
- Returns may not be as high
- Long-term investment horizon to achieve best returns
The Bottom Line
Pension or property investments can both offer long-term returns, but the suitability of each will depend on your individual circumstances and risk appetite. Pension plans offer a range of tax advantages and allow you to access a portion of your money before retirement without incurring any penalties.
However, they may involve higher fees than other types of investments. Property investment also comes with its own risks and rewards, with the potential for large returns but also the possibility of capital losses if market conditions deteriorate. Ultimately, it is important to carefully consider all factors when deciding which type of investment is right for you.
FAQs
Is it a good idea to use my pension to buy a house?
Is a pension an investment?
Can I take money out of my pension before I retire?
Can I use my home as a pension?
- Your child might be decades away from retiring – but helping them build their pension early on will help them have a sizable pot once they reach retirement age. With the ability to deposit up to £3,600 per year without paying income or capital gains tax, a junior SIPP account is an excellent way to do so.
- Are you looking for a flexible and controllable way to invest your pension savings? If so, you might want to consider a self-invested personal pension (SIPP). Unlike traditional pension plans, SIPPs give you the freedom to manage your investments in a hands-on manner and invest in a variety of assets, including stocks, bonds, and mutual funds.
- According to the Pensions and Lifetime Savings Association, the average UK pensioner needs at least £12,800 a year to meet the minimum living standard.
- A limited company pension provides a tax-efficient way for the company to build your pension pot for retirement. According to the latest data, most companies in the FTSE 100 channel between 7.5% and 11.5% of the director’s salary to their pensions.
- When you leave an employer, any benefits that have been accrued in your pension will not be lost, as the fund actually belongs to you. This means that even though you are no longer working with that particular company, you will remain a member of their pension scheme and your money will stay invested as it was prior to leaving.
- If you have held different jobs from multiple employers, this thought might have crossed your mind how many pension pots do I have now? How do I combine them? The term pension consolidation is just that – it’s the process of combining, or consolidating, all your pensions into a pot that rules them all.
- Starting a personal pension is a good way of saving for your future without relying on an employer. If you’re self-employed, keeping money back in preparation for retirement might seem a long way off, but you’ll be glad you did it when you reach pension age.
- What is (hopefully) one of the cheeriest of occasions, retiring abroad, can and often is soiled by an endless amount of paperwork and one big question: whatever will happen to my pension? It seems daunting, but once you understand the process, you'll see it's not rocket science. Here, we explain how it works.
- It's generally possible to transfer your pension to another provider and this could be a great way to save more money and get the most out of your pot. In this guide, we'll look at how you can transfer your pension, your eligibility to do so, and any other factors to consider before taking the plunge.
- The key to successful retirement planning is understanding the options available and finding one that works for you. Whether you're an employee or a self-employed individual, having a pension plan is a secure way to ensure you will have a steady stream of income during your retirement years.
- Private pensions are retirement savings plans that savers set up, and contribute to, by themselves. They are one of the most popular ways of securing a comfortable life in retirement, and most financial institutions offer some kind of private pension scheme.
- A drawdown pension can come in handy during retirement as it allows the holder to draw money from their pension pot as and when they need it. With the right drawdown pension plan, it’s possible to achieve maximum long-term growth with minimum risk. In this guide, we will be looking at the best-performing drawdown pensions available to help you make the best decision for your financial future.
