The debate between the virtues of investing in a pension, or in a property when planning for retirement has raged fiercely recently. The Bank of England’s chief economist, Andy Haldane, fanned the flames of the discussion by suggesting that the best way to save for a retirement “ought to be pension but it is almost certainly property”.
It is fair to say that in the past, pension planning was a complex issue, and employees, such as the Bank of England’s chief economist, can still be daunted by the prospect of understanding their retirement planning. Organisations are investing heavily to boost this understanding. This research shows that in the last year alone, 73% of respondents have undertaken communications exercises around pensions.
However, workplace pensions are not inherently complex for the majority of employees. Ultimately, employees need to understand that in a workplace pension scheme, employers deduct a proportion of their salary, which is paid to their chosen pension provider each month, and invested along with an employer’s contribution and additional tax relief. On retirement, this is then able to be taken out.
Significant returns
Pensions are designed to be a tax-efficient long-term investment vehicle, and with the benefit of exposure to financial markets, returns can be significant. For instance, since 2002, market movements alone have benefited younger pension savers, who typically favour a higher risk portfolio more weighted towards equities. According to xx, this is boosting their pots by 168% without even factoring in contributions. The long-term benefit of compounding, and taking on the right level of risk is clear.
That said, with house prices rising 8.3% in the past year, according to the Office for National Statistics’ House price index, September 2016, and rising house prices a constant source of media attention, it is unsurprising that property investment is popular in the UK. For many, it seems to be a tangible, easy-to-understand investment that has produced well-documented returns historically. Yet it too has its fair share of complexity that should not be underestimated.
First, it has high start-up and ongoing costs, with fees required for solicitors, surveyors, mortgage companies, and letting agents.
Second, the cost and complexity of selling the asset too should be considered, especially when capital gains tax is factored in. Given the time and cost of selling a property, it is very illiquid. For those who consider their own property, in which they live, to be the key component of their retirement fund, it is vital they have a plan for when they access this equity. After all, not only will they need somewhere to live in retirement after accessing equity, but the equity must cover the cost of everyday expenditure and costs such as later life care.
The tax treatment of property is changing too for those using finance to purchase properties to let. From April 2017, the ability to offset buy-to-let mortgage interest against rental income for tax purposes will gradually reduce, with no offset at all from April 2020. By contrast, pensions get tax relief at the highest marginal rate, meaning retirement saving via a pension is substantially subsidised by the state.
Making an informed choice
There is room for both property and pensions in a retirement strategy, but it is important employees understand all that is involved so they can make the most informed choice when deciding. Pensions are set to remain the simplest and most efficient tax wrapper for the majority as they make these decisions. This is where financial education from employers, and indeed, specialist financial planning advice, is crucial.
To ensure their retirement is built on solid foundations, Individuals need careful planning and regular reviews when saving, at the point of retirement and throughout the retirement years. Once individuals understand what steps they need to take for retirement, the progress they are making, and what income they can expect in retirement, it will improve their sense of financial wellbeing as employees.
Andy Cumming is head of advice at Close Brothers Asset Management
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