Would you rather invest in property or in a pension?
- colinslaby
- Feb 25
- 8 min read
In the UK, property ownership is a thrilling goal that many aspire to achieve! Over the past 20 years, becoming a 'Landlord' has been celebrated as an exciting path to securing a future retirement income.
For countless individuals, the ups and downs of financial markets make property investing an appealing choice for a secure retirement, often more so than contributing to a personal pension.
While both property and pensions promise great investment returns, they are fundamentally different at their core.
Most people have a grasp of property, but few truly understand pensions. Property is straightforward and tangible – we can see it, touch it, and live in it. Pensions, on the other hand, are more abstract.
This might involve building a portfolio of buy-to-let properties or simply owning a home.
But is this strategy genuinely beneficial? How does property investment stack up against personal pension contributions when all factors are considered?
Investment Growth
Since 2004, house prices in the UK have typically increased more than inflation by about 3% each year.
According to Land Registry data, the average price of a UK home at the beginning of 2004 was £150,633.
By October 2024, the average price of a home sat at £292,059. So, ignoring mortgage interest and maintenance costs your house will have returned 95% return (4.75% per annum) in 20 years.
In contrast, the S&P 500 has averaged 8.393% return per year over 20 years (ignoring dividend reinvestment).
Keep in mind that these figures don't include earnings from renting properties or dividends from stocks or tax. If you invest in rental properties, you can earn both from the property's value increasing over time and from the rent you charge.
Buy-to-let properties typically produce rental income of between 2 – 6% per year, depending on location. So, let’s go straight down the middle with 4%. A £250,000 buy-to-let property will typically produce a rental income of around £10,000 per year.
On the other hand, investing in stocks can provide growth in share values plus income through dividends.
If we look at the S&P 500 index again over 20 years but this time includes the dividend yield this has averaged 10.475% return per year over 20 years.
When it comes to pensions, there's an added benefit if you’re part of a workplace scheme: your employer is required to contribute as well—at least 3% of your qualifying earnings. This can really help boost the amount of money you save for retirement over the years.
Pensions also offer tax advantages. For the money you contribute to your pension, you can receive tax relief—20% for those paying basic tax, 40% for higher-rate taxpayers, and 45% for those at the highest rate, up to a certain limit.
Essentially, if you contribute £100, it will only cost you £80 if you’re a basic-rate taxpayer. Plus, when you reach 55 (or 57 from April 2028), you can take out up to 25% of your pension as a tax-free cash lump sum.
Rental Income vs. Investment Dividends
If you buy rental properties, your goal is often to achieve the best rental yield possible, which is the return from rent compared to what you invested in the property. A good rental yield is usually considered to be over 6%. This yield needs to be enough to cover your mortgage, potential repairs, taxes, insurance, and any agents’ fees while still allowing you to profit.
If owning property sounds like a lot of work, you might consider investing in dividend-paying stocks through a pension instead. You could invest in a low-cost fund that tracks the top dividend-paying companies in the UK, like the Fidelity Moneybuilder Dividend, which pays out a typical income yield of around 4-5% quarterly.
Another option is to buy individual shares of dividend-paying companies to create your own portfolio.
Inheritance Tax (IHT)
When someone passes away, their estate—including properties and investments—may be subject to inheritance tax (IHT). With property prices rising, many more people are finding themselves affected by this tax. Currently, the IHT threshold is £325,000 for a single individual, meaning that assets over this amount are taxed at 40%.
Pension pots do not currently incur inheritance tax, with a few exceptions. However, this will change in April 2027 when unused pension savings will count toward your estate for tax purposes.
Risks with property investing
When considering property investment, it's important to be aware of the main risks involved:
1. Property Value Fluctuations: There's no guarantee that the value of your property will appreciate over time.
2. Income vs. Costs: Your rental income may not cover the expenses incurred, leading to potential financial losses.
3. Regulatory and Tax Changes: Current and future changes in regulations and tax policies could reduce the profitability of buy-to-let investments.
4. Void Periods: Periods when the property sits vacant between tenancies can impact your income negatively.
5. Tenant Issues: Problems with tenants, such as property damage or failure to pay rent, can pose significant risks.
To mitigate these risks, consider hiring a trusted property management agent. This will allow you to avoid the day-to-day responsibilities of being a landlord while ensuring that tenant issues and repairs are handled professionally.
It's crucial to carefully analyse the financials related to buy-to-let investments and determine if the potential benefits outweigh the risks. Additionally, planning an exit strategy is essential. Think about your property’s future resale value, its location, desirability, any value-added improvements, and whether it will attract dependable tenants. This thorough evaluation will enhance your chances of success in property investment.
Investing in a pension also comes with its own set of risks:
1. Investment Returns: There may be instances where you receive less than what you initially contributed, although this is uncommon given the typical long-term nature of investment in financial markets.
2. Inflation Impact: If returns on your pension fund fail to outpace inflation, particularly in times of high inflation, this could result in a negative real return.
3. Legal Changes: Future changes in legislation may affect when and how you can access your pension funds, such as increased pension ages.
To mitigate some of these pension risks, consider allocating a portion of your pension savings to purchase an annuity. This can provide you with a guaranteed income for life, offering a layer of financial security.
Costs
Both pensions and property ownership entail various associated costs that individuals should consider.
· For pensions, some common costs include:
· Management fees associated with the funds you hold
· Transaction fees related to buying or selling assets
· Platform fees for the service provider you use
· Fees for a financial adviser, if you choose to work with one
One of the benefits of pensions is the tax relief available on contributions. However, it's important to note that any withdrawals exceeding the 25% tax-free threshold may be subject to income tax.
· On the other hand, property ownership incurs its own set of fees, which may include:
· Conveyancing and other legal fees involved in the buying process
· Ongoing maintenance costs and agent fees for managing the property
· Taxes such as income tax on rental income and capital gains tax when selling the property
Additionally, it’s important to be aware of the stamp duty land tax, which is set to undergo changes in April 2025. Finally, upon passing, the property you own is included in your estate for income tax calculations, making it subject to inheritance tax
ISAs as an alternative
Another way to save for retirement could be to save into ISAs, which are tax wrappers that don’t lock your money away until a certain age. However, the ISA allowance is lower than the pension annual allowance at £20,000 for the 2024/25 tax year, so you can’t put away as much.
Should you view your main residence as a pension?
Your home can be an appreciating asset, although it’s important to remember that there are no guarantees that property values will continue to rise indefinitely, especially if house prices begin to decline. While living in your home limits your options for accessing the value of that asset, you do have a few alternatives.
One option is to sell your home or downsize, which would allow you to use the proceeds. However, it's essential to consider that some of these funds may need to be allocated for your later-life care, as local authority care home fees are means-tested.
Another possibility to explore is equity release. This involves a financial provider offering you a lump sum in exchange for a claim on the future sale of your property after your passing. However, it’s crucial to note that interest rates on this kind of borrowing can be quite high. Additionally, if you don’t choose a reputable provider, your estate might end up owing more than the home’s value when you pass away.
Equity release may work for some individuals, but it requires careful consideration. Using your home as a form of pension is feasible for certain people, but it’s advisable to seek professional, impartial advice to determine whether it is the right option for your specific situation.
So, which should you invest in? Property or Pension
When considering retirement planning, both pensions and property investments present distinct advantages and disadvantages. Property can be an appealing option for some individuals, but it may not suit everyone’s needs. It’s important to understand that property does not necessarily provide passive income, especially when managing rental properties. Even with the assistance of a real estate agent, there will still be time and financial resources required for effective property management.
In contrast, pensions offer several benefits, including employer contributions, government tax relief, and the potential for compound interest to grow your savings over many years. However, a notable drawback is that individuals usually have limited control over their pension funds, and access typically begins in the mid-50s, which may be extended as the minimum pension age increases.
In summary, while pensions are often more straightforward and convenient, investing in property can provide an opportunity to diversify your investment portfolio. This approach may also allow for greater control over retirement timing, making it a viable option for those who choose to pursue it.
Advantages and disadvantages
The advantages of investing in a pension | The disadvantages of investing in a pension |
You get free money from the government in the form of tax relief on your contributions | Your money is locked away until at least age 55 (rising to 57 in 2028) |
If you are employed, your employer has to pay into your workplace pension (subject tauto-enrolment rules) | There’s no guarantee when it comes to investment performance – your investments could fall in value meaning you run out of money in retirement |
Your money is invested in a diversified portfolio of assets (including property if you like), spreading your risk | You have to pay fees and charges on your investments |
If you start saving early, the power of compound interest means your pot could grow significantly | Some schemes have limited investment choices and poorly performing funds |
Your pension is protected if the FCA-regulated provider goes bust | You pay income tax on anything you withdraw above the 25% tax-free lump sum |
Contributions are flexible and you can start small | |
You can time withdrawals to reduce your tax bill, as part of tax planning |
The advantages of investing in property | The disadvantages of investing in property |
You own a tangible asset | You pay capital gains tax on a rental property when you sell, income tax on your rental income, and inheritance tax when you die |
Property values have been on a long-term rising trend so you could benefit from capital growth | Property is an illiquid asset so your money is tied up for a long time |
In some areas you can get rental yields of 7% or more | You may not be able to sell when you want to, at least not at a price you’re happy with |
You could "retire early" if you build a large enough portfolio; you can't access your pension fund until your mid-50s, but no such restrictions exist with property | You could end up with negative equity |
You pay more in tax now as a buy-to-let landlord because, for example, you can no longer claim tax relief on mortgage interest payments | |
You may have to pay stamp duty when you buy a property. Higher amounts if it’s a second property | |
Costs can be high, such as repairs, maintenance, legal fees, surveyors’ fees, agents’ fees, insurance, and you could lose money from non-paying tenants or void periods | |
You can spend a lot of time and effort managing a property yourself, and you have legal responsibilities as a landlord | |
Mortgage payments tend to be fixed and inflexible |
