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.
