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Ten reasons why investing in a pension fund can be better than investing in property

4 September 2016

  PENSION PROPERTY
1 You get free money from employer – often a matching contribution to double your money No employer help with your property purchase
2 You get extra from tax relief – on top of an employer contribution can more than double your money No tax relief on money you use to buy property
3 No income tax to pay on income earned in a pension fund All rental income taxed
4 No capital gains tax to pay on assets that rise in value in pension fund All capital gains taxed on second property
5 No inheritance tax when passing on pension assets Property assets subject to inheritance tax
6 Inherited pension assets stay tax free until money is taken out Inherited property income will be taxed
7 Costs of buying pension are controlled Costs of buying property can be significant
8 Costs of managing pension usually around 1-2% a year Costs of managing property can be significant – agents’ fee, repairs, empty periods etc.
9 Pensions can invest in property funds and commercial property to spread risk Buying one or two properties has more risk than buying many properties
10 Pensions can also invest in other assets to spread risk Relying only on property is putting all your eggs in one basket

 

So what is better when saving for your retirement – property or a pension?

Pensions have many advantages:  Pensions allow you to spread the risk and also offer you many other benefits as well.  It seems a real shame that so many people, apparently even those who have the most valuable type of pensions of all, fail to understand how much they are worth.  I would like to explain just how valuable pensions are and why they would normally be the best way to save for retirement – even better than property.

You can more than double your money with a pension:  The first thing to say is that, if you are in a workplace pension and you opt out of it to rely on property, you will lose free money from your employer.  Many employers will match your own pension contributions.  So, if you earn £25,000 a year and you put 8% of your salary into a pension, that amounts to £2,000 each year.  £400 of this, however, will come from basic rate tax relief, so your own actual investment in your pension will be £1,600.  And, if your employer offers a matching 8%, then you have another £2,000 going into your pension fund too.

You put in £1600 and it can become £4000 straight away:  In other words, £1600 of your money has gone into the pension fund and you have received an extra £400 from taxpayers and another £2000 from your employer.  So, on day one, your £1600 is worth £4000.  That is more than double your money.

Even if property prices double and pension investments make no return, you could do better in pensions:  If you pay £1600 a year into a pension you will have £4000 more each year in your fund.  By contrast, if you put that £1600 into a property and even if the property price doubles, you will still only have an investment worth £3200 (and that is ignoring the costs of buying, selling and managing the property).  So even if your pension investments do not perform brilliantly, you will have extra money you would not have had when buying a property.  If your pension fund makes no returns and your property investment doubles in value, you could still be better off in the pension.

Property gains are magnified by borrowing:  The big difference, of course, is that you will usually put more money into a property in the first place and also borrow a huge amount extra with a mortgage.  So, if the price of the property increases, your gains can be magnified because the amount you have invested is much larger.  That works well when property prices rise, but there is no guarantee they will keep on going up and there is also no guarantee that the interest on your borrowings will stay low.

Pension funds can invest in property as well as other assets:  It’s also important to remember that a pension can invest in many different assets —  including property funds and commercial property. So if you think property will do well, you can include property investments in your pension fund but you can also invest in other assets as well.

Don’t put all your eggs in one basket:  When investing for the long-term, it’s not usually sensible to put all your eggs in one basket. Unless you are an expert in one particular area and have ‘exceptional’ knowledge, that you believe is not available to the rest of the market, then relying only on one type of investing means you run huge risks.  A more broadly spread portfolio can reduce these risks for you.  If you already own a home, its value depends on the movement in property prices. If you then buy another property, you are doubling up.  That’s fine when the property market is strong, but there are periods when property doesn’t do well.

Property market may be in a bubble which could burst:  Quite frankly, property does have some of the characteristics of a bubble right now – the housing market has been stoked by the Bank of England pushing down interest rates to encourage people to borrow more cheaply, and there aren’t enough homes being built.  If borrowing is artificially cheap and there is a shortage of supply, then property prices are bound to rise, but this cannot last for ever.

Investing in property is very expensive:  Keep in mind, too, that the costs of buying and managing property can be quite high.  You have to pay stamp duty, and you will usually have solicitor, surveyor and estate agent’s fees too.  If you let the property, your tenants may not look after it, you will have costs of repairs, you may have periods when it is empty and you could even face court fees if your tenants prove difficult.

Pensions are the most tax efficient way to save for the long-term for most people:  You can get tax relief on your pension contributions at your highest marginal rate but you invest in property from taxed income.  Any rental income and capital gains from property are taxed, whereas pension investments are tax free.  Your pension investments pass to the next generation free of inheritance tax and there is no income tax until the money is taken out (and if you die before age 75 there will be no tax to pay at all).  With property, all income and capital gains are taxable and when you pass away your property goes into your estate and is subject to inheritance tax (although there are exemptions for your own private residence).

3 comments

1 Terence P. O'Halloran F.C.I.I. Ch FP { 09.06.16 at 10:57 am }

Ten reasons why investing in a pension fund need not be better than investing in property
6 September 2016
PENSION PROPERTY
1 You get free money from employer – often a matching contribution to double your money If you are employed and you lose the utility of your resources if you are.
2 You get extra from tax relief – on top of an employer contribution can more than double your money No tax relief on money you use to buy property, but access to the utility of that property.
3 No income tax to pay on income earned in a pension fund All rental income taxed. Unless it is your own home or the property is in a SIPP and you are the tennent.
4 No capital gains tax to pay on assets that rise in value in pension fund All capital gains taxed on second property unless the property is your home or in a SIPP.
5 No inheritance tax when passing on pension assets Property assets subject to inheritance tax if your estate is over the now complex rules. Most individuals are not in this position.
6 Inherited pension assets stay tax free until money is taken out Inherited property income will be taxed. True but the utility is maintained.
7 Costs of buying pension are controlled Context is everything in financial planning. This is an inadmissible distortion.
8 Costs of managing pension usually around 1-2% a year Costs of managing property can be significant – agents’ fee, repairs, empty periods etc. This appears to refer to ‘buy to let’. Context is important.
9 Pensions can invest in property funds and commercial property to spread risk Buying one property within a pension environment when your business can be the tenant, or tenants introduced is the best of all worlds.
10 Pensions can also invest in other assets to spread risk Rely on ‘fund managers’ and invest in fixed interest for safety? Really?

So what is better when saving for your retirement – property or a pension?
Pensions have many advantages: Pensions allow you to spread the risk and also offer you many other benefits as well. It seems a real shame that so many people, apparently even those who have the most valuable type of pensions of all, fail to understand how much they are worth. I would like to explain just how valuable pensions are and why they would normally be the best way to save for retirement – even better than property.
You can more than double your money with a pension: The first thing to say is that, if you are in a workplace pension and you opt out of it to rely on property, you will lose free money from your employer. Many employers will match your own pension contributions. So, if you earn £25,000 a year and you put 8% of your salary into a pension, that amounts to £2,000 each year. £400 of this, however, will come from basic rate tax relief, so your own actual investment in your pension will be £1,600. And, if your employer offers a matching 8%, then you have another £2,000 going into your pension fund too.
This is so true, if the employee works for the state or a substantial organisation. But, is it true of those employees working for the largest employment grouping the SMEs? Employers can only distribute their largess as income or pensions contributions, they are not mutually exclusive. Currently all firms with Auto enrolment will be paying 25.8% combined NI which nets down to circa 22% of gross earnings after taking out the LEL and UEL limits. Add to that 2% Auto Enrolment.
In 2018 that 22% (some 16% of which goes to PAYG pension provision) will have a 7% Auto Enrolment addition. An expert will then convince, what is the expression Henry used, ah! yes, the intellectually challenged, that a 31% contribution of a substantial portion of their income (and their employer’s resource) is great value for money in a pension who’s activation date moves ever farther away.
You put in £1600 and it can become £4000 straight away: In other words, £1600 of your money has gone into the pension fund and you have received an extra £400 from taxpayers and another £2000 from your employer. Dream on. So, on day one, your £1600 is worth £4000. That is more than double your money.
The reason that valuable tax relief is given is to compensate for the fact that the contributor hand over the utility of their resource (cash in hand) to a third party, often fixed interest and therefore for government use; at poor rates of return. Where NI is concerned it funds today’s pensioners.
Even if property prices double and pension investments make no return, you could do better in pensions: If you pay £1600 a year into a pension you will have £4000 more each year in your fund. By contrast, if you put that £1600 into a property and even if the property price doubles, you will still only have an investment worth £3200 (and that is ignoring the costs of buying, selling and managing the property). However you may have the utility of the property. I am not arguing for property incidentally, although these arguments have credibility, they are academic and lack humanity. The following sentences prove my point. So even if your pension investments do not perform brilliantly, you will have extra money you would not have had when buying a property. If your pension fund makes no returns and your property investment doubles in value, you could still be better off in the pension.
Property gains are magnified by borrowing: The big difference, of course, is that you will usually put more money into a property in the first place and also borrow a huge amount extra with a mortgage. So, if the price of the property increases, your gains can be magnified because the amount you have invested is much larger. That works well when property prices rise, but there is no guarantee they will keep on going up and there is also no guarantee that the interest on your borrowings will stay low.
Here lies the rub. In 1978 new legislation introduced THE STATE EARNINGS RELATED PENSION SCHEME – SERPS. This was a triumph for modern government thinking with cross party approval to benefit higher earners to balance their income in retirement with those of their working life. I use ‘those’ because earnings vary year on year throughout our working lives. What has happened to SERPS since is a travesty, because, just when it became ‘fully funded’ in 1997 the rules changed dramatically and that extra income in retirement differential is watered down, eventually to disappear, but the contribution remains the same.
Pension funds can invest in property as well as other assets: It’s also important to remember that a pension can invest in many different assets — including property funds and commercial property. So if you think property will do well, you can include property investments in your pension fund but you can also invest in other assets as well.
I wrote Hindsight the Foresight Saga to inform my client base (some 2000 souls) of my rational where property, in particular, and equities, fixed interest and cash fit into our everyday world. Those that work for the state are ‘fixed interest’ in and of themselves. To balance their portfolio they need ‘risk’ that is equities and property; their income whilst working, and in retirement, is assured.
Those that comprise the other 2/3rds of our 34 million, or thereabouts, workforce will constitute a broad church of changing circumstances and probably employment, requiring personal guidance to match their personal profile. That is why this type of generalisation is so dangerously misguided. It is an academic analysis that reflects the same naivety that those who foretell the outcome of an election suffer from – a lack of understanding of people, their thinking and their aspirations.
I dealt with ordinary, and we are all ordinary, people, day in and day out for 44 years. Not high flyers; yes some, but mostly folk on median earnings of £26,000 per household. 31 % ,or even 22%, NI which constitutes a loss of current utility of that money from current use may well be better utilised in buying a property to live in , or work in, or if the individual has the time and discipline required, to let out.
Don’t put all your eggs in one basket: When investing for the long-term, it’s not usually sensible to put all your eggs in one basket. So why is so much diverted to pension through NI , auto enrolment and other personal contributions, ending up in fixed interest or the future hope of a PAYG state scheme?? Unless you are an expert in one particular area and have ‘exceptional’ knowledge, that you believe is not available to the rest of the market, then relying only on one type of investing means you run huge risks. A more broadly spread portfolio can reduce these risks for you. If you already own a home, its value depends on the movement in property prices. If you then buy another property, you are doubling up. That’s fine when the property market is strong, but there are periods when property doesn’t do well.
For most people the value of their home is of little importance unless, or until, they are selling it. Timing is of the essence at that point but otherwise, as my own investment in a business property proved, is irrelevant. The utility of the property as a home or workplace and the rent saved all prove worthwhile offsets to the asset.
After 12 years saving in a pension I was able to sell my property to my pension fund, remain a tenant and pay tax efficient rent to my pension. I invested the capital from that sale into my business. When the pension fund sold the property some 30 years later, with no tax of any kind, my pension fund had made a 3.7 fold gain tax free (£86,000 became £230,000). Coincedentally My original purchase of that same property in 1973 cost £13,000 as my office and sold to the pension fund for £86,000 in 1985.
Property market may be in a bubble which could burst: Quite frankly, property does have some of the characteristics of a bubble right now – the housing market has been stoked by the Bank of England pushing down interest rates to encourage people to borrow more cheaply, and there aren’t enough homes being built. If borrowing is artificially cheap and there is a shortage of supply, then property prices are bound to rise, but this cannot last for ever.
This is not a true analysis, the O’Halloran Curve reflects the fact that foreign money and cash purchases of London properties since 2007 (reportedly some 70% of transactions) allowed sellers to buy in the provinces, sometimes multiple purchases (too much to go into pensions because of imposed caps and relevant earnings) and inflate the housing market in a progressive ‘pebble wave’ across the country which is still taking place. Commercial property has also benefited from the perceived safety of the UK’s property status. There are trends, ups and downs as there are in any market – just consider ‘fixed interest’ yields as a case in point.
Investing in property is very expensive: Keep in mind, too, that the costs of buying and managing property can be quite high. You have to pay stamp duty, and you will usually have solicitor, surveyor and estate agent’s fees too. If you let the property, your tenants may not look after it, you will have costs of repairs, you may have periods when it is empty and you could even face court fees if your tenants prove difficult.
This is a very true and relevant statement for the ‘buy to let’ brigade to take heed of. As a property versus pensions topic this really does highlight a pitfall that few acknowledge and many learn the hard way.
Pensions are the most tax efficient way to save for the long-term for most people: You can get tax relief on your pension contributions at your highest marginal rate but you invest in property from taxed income.
This is a truism that needs to be balanced in analysis and action with the retention of utility and the foresight of reality to give a practical application of a very complex and ever changing set of circumstances. It is a truism but does not necessarily reflect the truth as my own example above adequately proves.
Any rental income and capital gains from property are taxed, whereas pension investments are tax free. Your pension investments pass to the next generation free of inheritance tax only if you die before drawing on the pension fund before age 75. and there is no income tax until the money is taken out (and if you die before age 75 there will be no tax to pay at all). With property, all income and capital gains are taxable and when you pass away your property goes into your estate and is subject to inheritance tax if your total estate exceeds the IHT limits, which, north of Watford, it may not do (although there are exemptions for your own private residence).And of course trusts can be used to great effect by the well advised.
I hope that my analysis of Roz Altman’s analysis will be accepted as a contribution to the debate and a reflection based upon differing points of view from an academic standpoint and a practitioner perspective. I was the National pension spokesperson for the FSB for 31 years on their NI committee and endeavour to be constructive in a very important and far reaching debate.
The Federation for Small Business was the author and designer of STEPS which it gave to the Government Actuary in 1999 as a suggestion to replace SERPS with a funded substitute that appears to have morphed into Auto Enrolment as an addition to the original SERPS integrated level of NI.

Terence P. O’Halloran

2 Terence P. O'Halloran F.C.I.I. Ch FP { 09.06.16 at 11:04 am }

unfortunately for me and any interested reader my responses to Ros’s assertions are not highlighted as intended. This is such an important topis to debate. Perhaps some will print the original and my response to compare the two differing points of view.

3 Stephen Tiley { 09.06.16 at 11:55 am }

All good sense Ros, as usual.
As Henery Tapper has said, there is a matter of Trust. Either trusting yourself in managing a property and all its complications, or trusting professionals that seem to make more money from pensions than looks reasonable or fair.

Then of course we have thousands of people who paid into personal pensions in the 1980s and 1990s for a relatively short period (before joining a company scheme perhaps) and lost all value in charges. The likes of Allied Dunbar, Abbey Life, General Portfolio and various others pushed expensive products on people which had such huge upfront charges that all value was eroded.

The regulated charging structures that now exist are helping (for default funds at least) but there remains a ‘once bitten…’ mentality.

The TV programmes (e.g. Homes under the hammer) bombard us with dozens of success stories of ordinary folk renovating and benefiting from their efforts in a tangible way. Yes, leverage is often the key, and they don’t show many failures, bit you can’t blame Joe Public for following what looks like an investment that you can influence and control to a much greater extent – if you trust yourself!

Better to have both if you can – and many can only invest in property in later life because they have pensions to fall back on and may have used tax free cash to fund a deposit on a property venture.

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