The Bank of England’s chief economist Andy Haldane drew ire from the pensions industry for the second time this year, when he claimed that property was a better investment option for retirement than a pension in an interview with The Sunday Times this weekend.
“It ought to be pensions but it’s almost certainly property,” Haldane said. Experts and commentators have jumped on his remarks, given that he stands to benefit from a pension which will pay him almost £84,000 a year when he retires. Former pensions minister Ros Altmann said the comments were “irresponsible” and “divorced from reality”. But are they?
Buy-to-let has boomed in recent years, and many people coming up to retirement accept the fact that they will have to downsize to avoid poverty in old age. But which is better: buying a property or saving into a pension?
Up and up
On the face of things, Haldane may have a point. House prices in Britain have soared over the last two decades for a number of reasons. Banks are eager to offer home loans because they provide a large and long-term source of income, and government subsidies to get new homeowners on the ladder have fuelled a price spiral. Asset-rich baby boomers have been hoovering up second homes as buy-to-let investments, while the UK’s population has increased and house-building has not kept up with demand.
For those who have invested in property, this has been very good news.
According to the Global Annual Property Index, compiled by property data company IPD, UK property enjoyed an annualised return of 5.7 per cent in the decade to December 2015. Growth has been even greater in recent years; with property in Britain providing a 10.5 per cent annualised return from 2011 to 2015, and 13.1 per cent last year alone.
Loss of confidence
As house prices have ballooned, savers have stopped seeing property and pensions as complementary and more as alternatives.
Indeed, the buy-to-let boom is symptomatic of a loss of trust in the pensions system more widely. Since the financial crisis, the Bank of England has held interest rates at historic lows in an effort to buoy economic growth. Annuity rates have dropped off a cliff.
When the Bank announced earlier this month that it would be expanding its QE programme to provide the UK economy with a post-Brexit boost, Altmann herself decried the fact that “pensioners relying on their savings to deliver a decent income are earning virtually no return.”
The buy-to-let boom is symptomatic of a loss of trust in the pensions system
Faced with an inhospitable savings environment, many have taken advantage of cheap mortgages to fund a buy-to-let investment. Between 2007 and 2016, buy-to-let doubled its share of the mortgage market from 8.5 per cent to 17 per cent.
Not the whole story
However, a simple comparison of buy-to-let yields with returns of other investments does not tell the whole story. “Buy-to-let landlords have to pay income tax and national insurance on every penny they earn,” points out David Smith, director of financial planning at Tilney Bestinvest. For higher or top rate taxpayers, this will eat significantly into returns and they will have to pay capital gains tax on capital growth above the tax-free threshold for second homes. All gains within pensions meanwhile are tax-free.
Even if you’re relying on your main property for retirement, downsizing alone is unlikely to be enough to support yourself. Research by Royal London found that the average person downsizing from the average detached house (£310,000) to the average semi-detached house (£197,000) would receive an annual income of just £13,700, once the state pension has been added. The figures will obviously be much larger in London.
The benefits of a pension
Tax relief also still makes pensions a no-brainer, particularly for higher earners, who can gain 40 or 45 per cent relief on contributions. A deferred tax, it incentivises long-term saving by taxing savers when they withdraw money from their pension pot, rather than when they put it in, allowing more of their capital to appreciate over time. You are also able to take 25 per cent tax-free.
“Property can be a capital investment, but it’s not designed as a savings vehicle,” says Fiona Tait, pensions specialist at Royal London Group. Not only can you put a range of assets into your pension (some of which may even outperform residential property), with the advent of pension freedoms last year, you are no longer limited to purchasing an annuity. “With a pension, when it comes to take money out, there are income options – annuities, income drawdown and a combination of the two. With property, you either have to rent it or sell it.”
Tax relief still makes pensions a no-brainer, particularly for higher earners
And for young people kept off the housing ladder because they cannot scrape together a large enough deposit, pensions look like an unbeatable savings alternative. Indeed, most of the money which flows into pensions comes not from individual saving, but from employer contributions, notes Fidelity’s Richard Parkin.
Moreover, if stock market returns have been inconsistent over recent years, young people have the time to ride out such volatility. With more of their working lives ahead of them, they enjoy longer savings horizons and can benefit from compounding interest and reinvested dividends. Figures by Fidelity show that someone who invested £100 a month in the FTSE All Share index over the last 30 years would have amassed £132,368.12, more than twice the amount of someone who had taken their dividends as income (£65,723.41).
Read more: Brexit shines a light on pensions timebomb
Safe as houses?
While pensions allow for diversified investments, property is a gamble. If you invest a lot of money in a single house, your capital is at more risk. “Over 20 to 30 years, things change,” says Tait. “With a pension, you can move your assets easily. With a house, you have little option but to sell.”
Question marks hang over the UK’s house market, and whether its upwards momentum is sustainable. “A lot of house price growth is inflation related,” says Smith. “And while rising prices in London have brought up the national average, homes in Newcastle, for example, are at the same level as 2009. That’s a much better barometer for the vast majority of the UK.”
A lot of house price growth is inflation related
Indeed, for the last two decades, homeowners have sat back and ridden a wave of asset price inflation, thanks to limited supply and cheap lending, “but you have to question how long this will continue,” says Parkin.
And there are myriad other risks facing homeowners. Buying a residential property requires a lot of cash up front, and replacing the roof or boiler can eat into any rental return. Brexit has stoked fears that the UK housing market will be hit if the government’s negotiations don’t go well.
Bursting the bubble
On top of agents’ fees and mortgage costs, and periods when the property might not be occupied, buy-to-let landlords have faced extra taxation since the government stepped in to halt the frenzy. On top of restrictions on mortgage interest tax relief, buy-to-let purchasers now face an extra 3 per cent stamp duty surcharge, and aren’t able to benefit from cuts of 8 per cent in capital gains tax.
At the time, David Cox, managing director of the Association of Residential Letting Agents, described the changes as “an outright assault on the sector”, and sentiment on buy-to-let has since soured. Data from Equifax Touchstone shows that buy-to-let mortgage lending this July fell by 39 per cent, compared with the same month last year.
Pensions may often be described as a “political football”, but few politicians will be tempted to get rid of savings incentives entirely if the result is more people relying on the state in their old age. Former chancellor George Osborne abandoned plans for a flat rate of tax relief in fear that the decision would be unpopular.