Andrew Megson: Property or pension investment?

Property can be an extremely fruitful route to retirement, but individuals should be fully aware of the risks involved before committing to an investment, writes Andrew Megson

In the current economic climate, many individuals might be left feeling short-changed.

In an environment where high inflation and low interest rates is chipping away at the buyer power of savers’ cash, many prospective retirees would be forgiven for looking elsewhere when it comes to saving for retirement.

Increasingly, many individuals turning to property investment, rather than a traditional pension, with data from the ONS back in 2020 revealing that 25% of Britons believe that investing in property is the best and safest way to provide funds for their retirement.

Although the economic landscape has changed since then, savers are not alone in thinking this way. Indeed, one such person who holds this view is none other than ex-Bank of England chief economist Andy Haldane, who suggested back in 2016 that the housing market is “on fire”, and that “property is a better bet than pension”.

Controversial guidance indeed – but is there any truth to this statement?

The advantages of property investment

It is difficult to dismiss the benefits that savers can gain from investing in property. As I have already mentioned, the current high inflation, low interest rates environment makes it difficult for savers to achieve profitable returns with more traditional investments. On the contrary, property investment may provide an attractive alternative, allowing individuals to achieve a rental income, as well long-term capital growth after they retire.

Adding to this is the fact that house prices have surged since the first lockdown, after the property market came to a standstill in the beginning stages of the pandemic. Now, demand for buy-to-let property has been thriving, and has increased in value by 5.8% year-on-year. As such, it is unsurprising that so many individuals are re-considering their options.

A viable alternative?

However, it is important to note the fact that property investment can come with a whole host of unexpected costs, which may eat away at an individual’s retirement finances.

Put simply, property prices do not always continue to head north. During a recession, for example, or any period of economic upheaval, it is typical to see the market slow. In some more extreme cases, the market can even grind to a halt entirely, causing properties to fall in value. Not only can this leave investors vulnerable to capital loss, but it can also make negative equity a possibility – meaning that investors may have paid more their property than it is worth.

Troublingly, there is a multitude of other associated costs that come with running a property, which can accumulate, leaving a significant financial burden for prospective retirees. Costs such as landlord’s insurance, maintenance fees for wear and tear, property management, letting fees, and decorating and furnishing the property can be particularly onerous. On their own, letting fees typically land somewhere in the region of 15%, and landlords will also need to factor in periods where the property is vacant, as this is highly likely to occur somewhere down the line.

Together, these costs can leave pension planners with far less in the way of retirement income than they might imagine, particularly if their retirement plan relies solely on the income from their property. Although property can constitute a profitable addition to a person’s income in retirement, it is advisable to consider these plans in the wider scheme of a pension plan for some added security.

Taxation charges and liquidity risk

Unfortunately, the added costs of property ownership do not stop there.

Given that individuals usually enjoy some tax relief on their pension, taxation should be high on the list of things to consider when planning to invest in property to fund retirement. As a result of legal, stamp duty, and survey fees, landlords and those who own a second home usually end up footing a higher tax bill, so this is something to bear in mind. In terms of stamp duty, there is a 3% surcharge for second homes, whereas landlords can also expect an increase capital gains tax.

Above all else, liquidity risk may be one of the greatest concerns to pension planners. As selling a house can often take a significant period of time, especially when difficult economic periods are factored in, it can be difficult to retrieve the funds on schedule, so to speak. Even though an individual might wish to retire on a certain date, there are no guarantees that a property will sell – sometimes, sales can fall through, and the markets can crash, so it is wise for individuals to have a back-up plan in mind to fund their retirement.

An advised retirement

Clearly, there is a lot at stake when looking to property to fund retirement, and this can be a high-risk strategy. As such, individuals should ensure that they have sought advice from a registered independent financial advisor (IFA) before they decide that this is the right option for them.

An advisor should be able to make a rigorous assessment to determine whether the individual in question is in a good position to take such risks, while considering whether additional payments and tax penalties will be viable for them. After these discussions, naturally, some individuals will decide against making property the sole provider of their retirement income, while others may consider investment alongside another more traditional pension investment. In any case, individuals are likely to be offered a range of options that will suit their individual circumstances best.

No doubt, property can be an extremely fruitful route to retirement, but individuals should be fully aware of the risks involved before committing to an investment. Likewise, individuals should be wary of putting all their eggs in one basket, as doing so may be extremely detrimental to their retirement income.

Andrew Megson is executive chairman of  My Pension Expert