A Pension Not Property Is best For Retirement
When it comes to planning for a retirement, the choice between a pension or property investment has persisted in the UK for such a long time. Such conversations are littered with sentiments, emotions and ultimately behavioural biases.
What if we let the numbers do the talking and thinking, I wonder where we would end up.
My curiosity was roused again when I came across the statement in the image below.
The advocates for property who I’ll call Team Property from here on are quick to point out that
House price growth over the last twenty years have been fantastic and those sort of growths could be experienced in future ( it is important for all investors to note that past performance is not a guide to future performance)
I can see their rationale to an extent, given the structural issues around land and property generally in the UK. Let’s be clear, the discussion is around property investing (so not your residential property) vs pensions.
Headwinds for Property Investing
Property investing has had a couple of challenges over recent times such as.
Changes to tax treatments for mortgage interest outside an incorporated company structure
You would think that these changes would definitely end such a debate and hugely favour an increase to pension investing. Yet these debates still persist. Would a practical example change investors views? Let’s give it a try.
Liam wants to invest in a Buy-to-Let
Liam has saved a bit of cash over the last few years. Instead of contributing to a pension he opted to save to then purchase a property which he expects will give him a steady stream of income when he comes to retire in twenty years’ time. The numbers are set out below:
Liam has saved £45,000
Property price and location: £150,000 in Southampton
Deposit: £37,500 (25% of £150,00)
Stamp duty: £5,000 (allowing for 3% additional stamp for purchasing second property)
Other costs: £2,500 (solicitor, survey, land registry and bank arrangement fees)
Once the property is bought then there are other costs which will be incurred in renovation, furniture purchase and other bits to get it ready for tenants to move in.
Maintaining the property and receiving income
This is the bit that gets most investors excited. Achieving significant growth in property price, income and retiring comfortably. Let’s explore the numbers once again.
Monthly rental income: £850
minus mortgage interest payment (interest of 4% a year): £375
minus management charge at 10%: £85
minus building insurance: £20
minus allowance for repairs: £85
minus allowance for void period: £68
Equals rental income of £176 a month (allowing for 19% corporation tax)
Nice bit of income to receive every month. This is where the conversation tends to end for Team Property especially when the income would then grow once the mortgage is paid down!
To be truly able to compare this with a pension arrangement we have to fast forward to twenty years’ time to see what the property investment looks like.
We also need to make certain assumptions about the future and I will aim to be consistent in my assumption for property and pension.
Assumption 1 - Property price expected to grow at 3% a year over the next 20 years. It has been 3.5% per annum over the last 12 years to January 2017 which has been a phenomenal growth period.
Assumption 2 - Rental income grows by 1% a year. It has been approximately 0.9% a year over the last seventeen years according to ONS (see figure 2)
Assumption 3 - Increase in cost of expense of 3% a year
Assumption 4 - Net rental income is invested in financial markets at a rate of 5% per year for twenty years (5% per year will also be applied to pensions to maintain consistency)
Team Property - The result
Once the above assumption is applied to the property over a twenty year period, then the equity in the property plus growth in rental income equates to £228,000. We will compare this to the outcome for pension investment.
What if Liam invested in a pension for retirement
I truly understand why emotionally most people would go for Team Property instead of Team Pension. The complexity, the continuing regulatory changes are two major obstacles to most. Especially when the Chief Economist of the Bank of England also comes out and states that Property is a better bet than a Pension.
Let’s explore how Liam would fair if his £45,000 went into a pension pot instead. We will keep things simple and adopt auto-enrolment contribution rates for pension.
So his £45,000 saved over the last couple of years is 3% of his salary after tax
Tax rebate which is then added to his pension of £30,000 (Liam pays tax at 40% rate)
Also assuming his employer pays contribution of 2% of his salary over the years. This would gross up to £30,000. His employer actually pays at a higher rate but i have decided to keep contribution at the statutory level.
Therefore the total to invest is £105,000 today
The one assumption is that the pension grows at 5% a year which is equivalent to the value used for the property analysis
Team Pension - The Result
Assuming the starting investment of £105,000 grows at 5% a year over a twenty year period. Then we end up with £279,000. Allowing for his actual employer contribution of 3% a year then the end value is expected to be £320,000
Brining it all together
So there you have it. In this comparison, Liam is actually over £50,000 better off investing in a pension compared with property investing where I have actually ignored a lot of minor expenses which easily add up to quite a lot.
The pension option is always worth considering especially with the FREE Money you get from tax exempt nature of pension contributions and your employer contribution to support your original contribtutions.
As for Liam, I gave my opinion about seriously thinking of putting a pension arrangement in place for his retirement. However, the property experience is just too tempting for most to resist.
Good luck with whichever path you choose Team Property or Team Pension. Let me know your thoughts in the comment section below. If you ever want to chat about your options then drop me a line