In our bi-weekly series, readers can email in with any question about their finances to be answered by our expert, Charlotte Ransom. Charlotte has 30 years’ experience working in financial services and wealth planning, including 10 years as a partner at Goldman Sachs. She co-founded Netwealth, which specialises in low-cost investing and financial planning advice. If you have a question for her, email us at money@inews.co.uk.
Question: I’ve recently received an inheritance of £55,000 and as I won’t retire for around 20 years, I might put down a deposit on an investment property to generate rental income. But I’ve also read that putting money into a pension will produce better long-term returns. Can you help me discern the facts so I can secure the best route for my retirement?
Answer: You should evaluate whether you are on track to secure a comfortable retirement at various stages in your life. It is therefore worth carefully assessing what to do with a lump sum which could potentially move the dial in your favour and establish which route is more suitable for you to achieve your goals: a buy-to-let property or a pension.
Property ownership has traditionally been viewed as a dependable route to build wealth and generate income in retirement, yet the landscape has shifted somewhat in the past few years. If you are currently renting out property it’s important to recognise this and potentially adapt to the new reality.
While both property and pensions have historically rewarded those with a long-term outlook, pensions have now emerged as a potentially better option for an income in retirement. There are several reasons why this is the case: both from a financial standpoint and because managing a pension is likely to be far less stressful than navigating the hassles that can arise from maintaining a buy-to-let property.
First, let’s look at the financial benefits. It’s hard to beat a pension for being a tax-efficient home for your money. For every £1 you contribute to a pension scheme, the Government adds an extra 20 per cent for basic-rate taxpayers. Through their tax return, higher-rate taxpayers can claim back a further 20 per cent to 25 per cent. Over time, this tax relief significantly boosts your pension pot, potentially helping it to grow faster than investments in property.
A financial advantage can also extend across generations since a pension is typically exempt from inheritance tax. This can have profound consequences for those who may benefit from money you leave behind when you die.
You can nominate who you want to receive your pension through a simple Expression of Wish form. Conversely, property investments may be subject to inheritance tax, plus other taxes such as capital gains tax and stamp duty.
Managing risk should also be an important consideration for your retirement. We are keen advocates of the benefits of diversification at Netwealth, and for good reason since spreading risk across a range of assets classes such as stocks, bonds and commodities, is acknowledged to be a powerful way to reduce overall investment volatility while driving positive long-term returns.
Investing in property alone means you rely on a single-asset class for returns and growth – a potential challenge as the latest figures from Nationwide show that property prices have fallen around 4 per cent since the summer of 2022.
Furthermore, the cost of servicing property loans has been cited as a factor in this decline. With mortgage interest rates having soared (and in no hurry to come down), it’s no wonder that estate agents Hamptons stated last year that most people would lose money if they used £100,000 to put a 25 per cent deposit on a new property to generate an income. And this was when interest rates were 1 per cent lower than they are now – at 4.25 per cent versus the current 5.25 per cent.
Other costs are not trivial: the fees to buy a property, plus the considerable yearly outlays such as property management fees, maintenance bills, insurance and allowing for vacancy periods – these can set you back thousands a year. Hamptons estimate that 500,000 landlords are expected to sell up in the next five years – many because of changes to taxation and regulation, the persistent escalation of costs and because they simply don’t want the hassle.
Setting aside the potential anxiety that comes from keeping a number of plates spinning, we can objectively examine which of the two routes – property or pension – might be a better choice for you to invest your £55,000 inheritance.
With a property investment pot of £50,000 (to be used as a deposit on a buy-to-let flat), after 20 years a property’s value would have increased to £83,354 on average. Over the same 20-year period, if someone had a £50,000 pension, this would have compounded and grown to £147,406, some £64,052 more than a property.
We arrived at these figures taking into account the initial and ongoing costs and fees for both types of investment, and the potential returns, over that period. We used the following parameters:
- Purchase Costs – Solicitors, Surveys, Furniture
- Letting Costs – Letting agent fee, rent collection, maintenance, referencing, credit checks, EPC certificate, Gas certificate, registrations, landlord insurance, deposit protection
- Sale Costs -Estate Agent fees, Solicitor
Of course, these figures are a reflection of where things stand now. Property prices may rise more than expected, but the challenges in the market, increasing regulation and the cost (and trouble) of maintaining a property are unlikely to abate.
The above is a raw assessment of the figures and takes into account that you would likely need a mortgage if you are to invest in property with around £50,000. Yet, as always, I would encourage you to consider your own specific circumstances when investing for the future. In this case, you may have a specific interest in property, and potentially the time and willingness to do a lot of the landlord work yourself.
On the other hand, if you simply wish to explore the best route for your inheritance, with considerable tax advantages which compound over time, it’s hard to beat a pension.
