Which is better - property or pension?
12 July 2017
Question by Paul
Which is better - property or pension?
Answered by Holly Mackay
This is a very common question and the answer could run for pages and pages, but I will try and stick to the main points.
I am assuming you mean a rental / investment property rather than somewhere for you to live and so a good starting place is to look at the relative benefits and risks of each.
Let’s start by looking at residential property. Perhaps the most obvious advantage is that you can actually see and touch a property. This can be reassuring to some as it makes your investment tangible.
With a tenant in place the property should provide you with a steady stream of income. To a certain extent you can vary this by adjusting the amount of rent that you charge. This income can be used to cover any borrowing you may have taken out to buy the property and also supplement your other income.
If house prices grow, you may be able to sell in the future and benefit from this increase in value.
Now onto the disadvantages. By sinking all of your money into a property you are potentially concentrating your financial future on a single asset. The housing market has good times and bad times and if you need to sell during a bad time it can take a long time to get your hands on the money.
There is actually some work involved in owning a rental property. You may end up getting calls at 3am telling you the boiler has broken down for example, you can employ an agency to take care of things like dealing with tenant queries but this increases your costs and so the amount of income you get will be reduced.
If the boiler does break you will need to cover the cost of the new one.
The rental income is not guaranteed; you may have periods of time when the property is empty and so any mortgage payments will still need to be made. Your income is therefore restricted to whatever the market will pay. You can’t take out part of the value if you need a lump sum and you can’t take a few bricks down to Tesco to pay for your weekly shopping!
The income you receive is likely to be subject to tax, although you can offset some of your costs against this. If you are fortunate enough to sell at a profit you may also pay tax on that profit. The property will form part of your estate for inheritance tax purposes so there may be more for the tax man there as well!
If you are looking to take out a mortgage it is worth considering, not just if you can afford the payments now, but if there were to be an increase in the mortgage rate that you are still able to meet this obligation.
When buying a rental property ensure that you are aware of the additional costs that come along such as legal costs, mortgage arrangement fees, stamp duty and factor that into your equations.
This is extremely rare but there is also a risk that the tenants decide to just stop paying the rent, trash the house and refuse to move out. You then have the emotional and financial pain of going through the courts to get them evicted.
Now onto the advantages pensions and despite what you may read in the press, there are some.
When you make a payment into a pension you receive tax relief on that payment, this is effectively the government giving you some money. If it is a pension that your employer pays into as well, the actual amount going into your pension is far higher than the cost to you.
Once it is in the pension you can spread your investment over a wide range of different ‘asset classes’ i.e. stocks and shares, Government and Corporate bonds etc. This means you are able to spread your risk.
If the funds grows, it does so tax free and under current legislation at the point you access what is called your ‘pension commencement lump sum’ (often referred to as your tax free cash) 25% of your accumulated fund can be taken by you free of tax.
You then have complete flexibility over how and when you take your income. You can buy an annuity (a secure income for the rest of your life) if you want security of income, although annuity rates can often be seen as poor value because people are living longer.
If you die before you reach age 75, the pension fund can be passed on to whoever you want (assuming you’ve filled out the form) free of any tax. If you die after your 75th birthday you can still pass your pension on, but any income taken will be taxed like employment income.
There are also some disadvantages to pensions and the main one is that you are not able to access your money until you reach age 55. Due to the tax advantages outlined above you are also restricted on the amount you can pay into a pension each year. This is linked to your earnings but is still very generous at £40,000 per annum.
In addition, you are restricted on the amount you can build up in pensions without suffering a tax charge. This is known as the lifetime allowance and is unlikely to affect the vast majority of us as it is set at £1m!
We mentioned above that you are able to spread your risk but any investment involves the risk that you won’t get back as much as you put in. Some investments carry very high levels of risk and can involve a roller coaster like experience with values going up and down.
You can reduce risk by spreading your investment around, but it is important to understand these risks and feel comfortable with them before investing.
Overall there are advantages and disadvantages to both and my only advice (with a small ‘a’!) would be to make sure you fully understand the risks associated with each option and that you have considered the overall purpose of what you are trying to achieve before making a decision.