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Property as a Pension

Today an increasing number of people planning for retirement are considering investing in property. This is a result of lower than ever pension annuity rates and a volatile stock market that threatens to leave pensioners with difficulties maintaining their standard of living during retirement. To bridge the funding gap, investors are increasingly looking to property to fund them through their old age.

One of the benefits of investing in property is that it is a tangible asset that can be passed down to surviving relatives, unlike many pension schemes. The property market has also provided attractive investment yields in the last decade to 2012, with property data company IPD reporting an annualised return of 11.2%, compared to 5.1% from equities and 7.6% from bonds. In addition property offers two revenue streams: capital growth linked to the (hopefully increasing) value of the property which can be realise when sold, and rental income from letting the property, which can be accessed in the short term.

If investors can clear the mortgage on an investment property before retirement they can choose to live on its rental income or sell the property to release a lump sum as a pension pot. If they wish, pensioners can invest any lump sum they receive from the property sale in an annuity or other pension scheme to provide a regular income for the long term.

Buying to Let

shutterstock_76160656The buy-to-let market has been particularly strong in recent years, with rising rents and an increasing percentage of the population living in rented accommodation. Research from buy-to-let lender Paragon found the average rental yield for buy-to-let landlords from June to September 2013 was 6.4%. In addition, the market for buy-to-let mortgages continues to grow, with the value of Buy to Let mortgages around £25 billion in 2014, up from £20.7 billion in 2013.

The strength of this sector has boosted the property market overall and rising prices mean that buy-to-let remains an attractive investment option, with values 11% higher than the last market peak of 2007. While investors need an equity stake of at least 25% to enter the market, buy-to-let mortgages currently enjoy low interest rates, with lenders such as Virgin Money offering a 2 year fixed rate deal for 2.64% with a 35% deposit.

Equity Release Schemes vs. Downsizing

An increasingly popular way to take advantage of property ownership for those without cash to invest is to take part in an equity release scheme. Among the over 50s, 52% plan to use the cash in their properties to fund their retirement, with 75% of that age group owning their own home outright. Equity release schemes can enable pensioners to remain in their own homes and maintain their standard of living despite low pension annuities.

The schemes work a bit like a mortgage, allowing retired homeowners to raise a lump sum or monthly income by selling all or part of their homes to an equity release company. Once all surviving partners have passed away the property is then sold in order to pay off the homeowners benefit (including interest). The scheme can have a significant effect on any inheritance passed down to family and sometimes equity release plans do not offer as much value as a straightforward loan or downsizing. Homeowners should consult an independent financial advisor to determine whether this option would benefit them.

Downsizing can be a viable alternative to equity release schemes, where pensioners move to a smaller property with lower associated outgoings and costs. The profits from the sale may release a significant lump sum if the property is large or the market is favourable, but bear in mind the usual costs associated with moving, such as legal fees and stamp duty. Consider that moving can be a very stressful experience, so it is worth thinking about all the aspects of downsizing before committing to it.

Know the Risks

shutterstock_11875582As well as benefits, there are some risks when investing in property. The market crash of 2008 has shown that property prices can go down as well as up and that investing for the short term is especially risky. If pensioners rely on selling their investment property when they retire they may find that a low market means they do not achieve the return they were hoping for. Investments made for the long term are more likely to be successful, as short-term dips in the market are cancelled out by long-term growth.

Another aspect to consider is that property is relatively tax-inefficient when compared to pension schemes because tax relief is available for pension contributions. This is a significant advantage for investors who pay the higher rate of income tax, as they can secure 40% income tax relief on pension contributions, while they will be taxed at the higher rate on annual rental income and will have to pay capital gains tax if the property is sold. Furthermore, pensions can be easier for investors to access. It can take an unpredictable period of time to sell a property, which means that any capital investment cannot always be recouped quickly.

In addition, if the mortgage on an investment property has not been cleared before retirement pensioners will not be able to benefit from rental income and may also find unexpected maintenance bills cause financial pressure. The worst-case scenario would be that a second property’s rental income no longer covers the mortgage repayments and a drop in the market leaves investors with negative equity. In this case, relying on property investments for a pension would be disastrous.

Creating a Diverse Retirement Portfolio

One of the best ways for investors to ensure a financially secure retirement is to create a diverse retirement portfolio that includes, but does not rely on, property income. It is important to consider other sources of retirement income, such as pension annuities, working longer or investing in bonds or gilts. Although other investment yields may currently be lower than those associated with property, it is better not to put all your eggs in one basket. Investors should consult an independent financial advisor to decide which options would work best in their situation.

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