With interest on savings still painfully low, are you better off banking on bricks and mortar?
Savings ain’t what they used to be. A series of rate cuts by banks and building societies was followed last week by news that National Savings & Investments is slashing payouts on accounts and Premium Bonds for its 25 million customers. In the background, the Bank of England has maintained a painfully low base rate of 0.75% — still, incredibly, the highest it has been for nine years.
All this adds up to an inhospitable environment for savers. Investing in bricks and mortar to fund a comfortable retirement is a time-honoured British tradition, and for many it looks like a foolproof way to make money. For others, pensions are lower-risk and much less work. But what do you need to know before you decide where to put your hard-earned cash?
How much money can I make?
It is true that property is profitable — if you know what you’re doing. House prices in the UK have risen by 34% on average over the past 10 years, according to Savills estate agency, but when inflation is taken into account, they are down by 0.3%. Buyers who invested in a second home in Aberdeen, for instance, lost 8% over the decade, but those who bought in Waltham Forest, northeast London, saw their investment double.
Over the long term, prices rose by 117% in the 2000s, 21% in the 1990s and 180% in the 1980s, which illustrates the fluctuations buyers face. It all depends on what and where you buy, when you buy it and when you choose to sell up.
Savills predicts that property values in the UK will grow by 15.3% by 2025. In comparison, the average pension fund grew by 14.4% in 2019 alone, although annual growth over the past five years is 7.5%, according to the Moneyfacts UK Personal Pension Trends Treasury report.
“Being successful in property is about buying at the right price in the right location,” says Stephen Moss, managing director of Sourced Capital, a peer-to-peer property investment company. “We’ve seen investors’ mentality shift from London to the north.” The Savills forecast predicts that values in London will rise by only 4% over the next five years, while in the northeast of England they will increase by 24%.
“When I hear about growth that high, that makes me nervous,” says Romi Savova, chief executive of PensionBee, a website where savers can manage their pensions online. “High return usually means high risk, so I would question what is driving that rate of growth.”
One of the great advantages of owning a second property is that you can let it and receive a monthly income on your investment. Again, rental yields can vary; landlords in Scotland can expect a return of about 5.8%, while those in Wales are seeing only 3.6%, according to Sourced Capital.
With property, you’re arguably relying on research to get the most out of the housing market, which itself is subject to economic winds and government legislation. With pensions, the scheme you’re automatically enrolled in via your employer is likely to be invested in a relatively low-risk diverse fund — and the company contributes as well. In addition, the government puts in £25 for every £100 for basic-rate taxpayers.
“Spreading your eggs across many baskets can insulate you from one-off shocks to the market,” Savova says. “These are harder to avoid in property, particularly when you consider recent flooding.”
How much will I be taxed?
House prices may have gone through the roof, and you might be making a decent amount on the side in rental income, but when it’s time to sell, you will have to pay capital gains tax on the increase in your property’s value, even if it’s overseas. Basic-rate taxpayers pay 18% and those in higher bands pay 28%.
From this April, you won’t be able to deduct mortgage expenses from your rental income, either. Instead, landlords will have to make do with a tax credit equal to 20% of the mortgage interest payments on the property.
Another factor that could make a significant dent in your profit is a rise in interest rates. If your buy-to-let is financed with a tracker mortgage, then this could lead to a hefty reduction in your monthly income. Pension-fund growth is tax-free, provided you don’t hit your annual or lifetime allowance. If your entire pot is more than £1.055m, you can be taxed up to 55%. If you save more than £40,000 in a single year, you will also be taxed at a marginal rate. The cap can be as low as £10,000 for the highest earners.
What happens when I want to take money out?
When you start to draw down your pension, the first 25% is tax-free and the rest is treated as income. There are ways to withdraw your pension in stages that are more tax-efficient. You can only start to access a private pension once you are 55 years old, while the state pension kicks in at 65, for now (with exceptions for a change in circumstances such as a terminal illness).
This makes it far less flexible than a second home, which you can sell if you want to give your child a home deposit, for example, or remortgage to start a business. “Property isn’t seen as a liquid asset, but if you need to get your money back, you usually can in about six to eight months,” Moss says.
What happens if I die?
If you die before you sell, any properties you own will be subject to inheritance tax. Second homes can qualify for the residence nil rate band (up to £175,000 from April, on top of the standard tax-free allowance of £325,000) if left to a child or grandchild, but your executor can only nominate one property in your estate to receive it. If it is a second home, you need to have lived in it at some point.
If you die before the age of 75, your pension can be passed down tax-free to any nominated beneficiary as a lump sum. Should you die at 75 or older, however, the beneficiary will have to pay income tax on any money they receive from your pension.
How much work is involved?
Lifestyle is an underrated factor in the property v pension debate. Aside from inheritance tax, older or retired investors may not be able to take on the work of being a landlord. A raft of new licensing and immigration legislation has increased the paperwork involved, and the Tenant Fees Act 2019 means you can’t charge the tenant for your time or impose administration fees on them.
Attending to repairs and queries can also be time-consuming, and any amount you spend paying an agent to handle them will reduce your yield.
Conversely, Brits persist with bricks because pension funds are seen as too “hands-off”. Having money squirrelled away in a fund you can’t touch for decades, invested in companies you don’t have time to keep track of, is unappealing to many.
“Property is a love story,” Moss says. “It has made money for generation after generation. If the market crashes, you can still park in the driveway and there’s a house you own. That’s quite a big safety net for a lot of people.”
Savova believes it doesn’t have to be this way, and her business, PensionBee, attempts to demystify pension pots by uniting all of an investor’s old pensions in one place online. The idea is, once you can see all the contributions and top-ups, you’ll be empowered to take a more active role in managing your pension.
“You need to take a balanced approach,” Savova says. “Both your home-ownership ambitions and your pension are important, and it makes sense to allocate capital to both.”
NEED TO KNOW
The Private Landlords Survey from MHCLG shows that landlords in England earn £15,000 a year on average before tax and other deductions
The average amount sitting in a pension pot after a lifetime of saving is £61,897, according to the FCA. This will give you an income of £2,500 a year — even adding on the state pension, that’s below the minimum wage
If the value of all your pensions exceeds £1.055m, you could be taxed up to 55% when you try to draw down the money. In 2017-18, HMRC took £185m from people who exceeded the lifetime allowance
The typical sum paid into a pension in 2017-18 was £2,700, according to HMRC
45% of landlords surveyed said they owned one buy-to-let property; 59% of landlords said they are 55 or older
Source: Sunday Times February 23 2020