Should I buy a property or invest in my pension?
Whilst property and pensions both offer the potential for good investment returns, under the bonnet, they couldn’t be any more different.
Although most people understand property, few people understand pensions. Property is easy to understand, it’s all around us – we can see it, touch it, live in it. Pensions – not so much.
What gives the best return on investment?
Let’s start with how much your property or pension could have grown over time.
The below table assumes that you invested £100,000 back in 1984.
- For property prices, we’ve used the Halifax Residential House Price index, which represents the average house price nationally. Of course, if you invested in London, you would be laughing. But hindsight is a wonderful thing.
- For pensions, we’ve assumed you invested in the FTSE 100, which represents the largest 100 companies in the UK. Of course, if you invested in Apple/Microsoft/Google, you would be laughing. But hindsight is a wonderful thing.
So, what would you get? The table does the talking.
What about income?
Ah yes, income! As anyone self-respecting landlord will tell you, it’s the income you want to focus on, not capital growth.
But don’t forget that investments in a pension also provide an income, in the form of dividends.
Unfortunately, the industry doesn’t track rental income, which makes it hard to compare So we’ll need to make a few assumptions.
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%.
Which kind of makes sense when you think about it. A £200,000 buy to let property will typically produce rental income of around £8,000 per year.
It’s pretty much the same figure for investing, with the average dividend yield being around 4% per annum.
Importantly, these figures are gross, meaning they don’t take into account any costs or taxes.
How about tax?
It’s no secret that the Government hates buy to let property, but loves pensions.
We know that because they apply an extra high rate of tax on property and provide tax relief on pensions.
The below table summarises the differences for a higher rate taxpayer. Suffice to say, pensions destroy property from a tax standpoint.
1 Mortgage tax relief is being phased out for higher rate taxpayers.
Tax relief is an interesting one and something that very few people understand. It basically means if you put £60 into a pension, the Government puts another £40 in (assuming you’re a higher rate taxpayer).
Tax relief should be renamed ‘free money’, but that’s a subject for another day.
Aside from tax, there are a couple of other things you need to consider. Things like costs, liquidity and leverage. These are the critical details that most people overlook.
Liquidity – it’s bloody damn hard to sell a property, particularly if you’re in a hurry. Pensions, on the other hand, are fairly easy to sell, you can get your money out in a few weeks at most.
Leverage – investing in property comes with the special privilege that the bank will lend you most of the money. It’s like playing poker and betting with house money. This has the potential to magnify your returns, in a big way – although it can also magnify your losses. Generally speaking, borrowing money to invest is not available in pensions.
Hassle – property is seen as the classic ‘passive income’ but ask anybody who’s rented one out and you’ll hear a different story. You’ll need to maintain it, deal with estate agents, missed rent payments, etc. Pensions are less hassle, but they also need to be maintained, you can’t just set and forget and expect everything to be hunky-dory.
Charges – buying, selling and renting out a property doesn’t come free. Every person in the chain will want their fee, whether that’s the solicitor, mortgage adviser, estate agent, etc. Pensions also come with fees, but they’re generally much lower (typically less than 1% per year).
So, what’s best – property or pension?
Property has delivered fantastic returns over the last 30 years, as have pensions. But when it comes to the critical details, it’s a mixed bag.
Property comes with leverage – which is your friend in a rising market but your enemy in a falling market! Pensions, on the other hand, are more liquid, less hassle and lower cost.
As always, neither is right or wrong, it will depend on your circumstances.
The best of both worlds?
I should say that this isn’t an ‘either-or’ decision. Few people know it, but you can hold property in your pension.
To some extent, this gives the ‘best of both worlds’, it gives the potentially higher returns of property with the tax efficiency of pensions.
All the best,
James Mackay, Independent Financial Adviser in Bristol