No investment should ever be taken lightly, but when you’re literally making decisions with your life savings, decisions should be thoroughly assessed and scrutinised.
Anyone aged 55 and over is able to access their defined contribution pension and use those savings as they choose. We’ve outlined all the options available to you so that you may make an informed decision that is right for you.
Property and your pension options
Annuities allow you to swap your pension for a guaranteed regular income, for the rest of your life. The amount you receive is determined by the annuity provider and the rate they offer.
Before the changes to pensions in April 2015, annuities were the sole option for most people with a defined contribution pension, now there is more choices, but opting for an annuity will still be right for some.
Withdraw with full pension access
If you are over 55 you can withdraw cash from your pension pot as a lump sum. The first 25% can be tax free. Should you wish to withdraw anymore then you’ll be subject to tax payments between 20 and 45%.
Lump sum example:
If you have a £200,000 pension pot, you will be able to take £50,000 (25%) as a tax-free lump sum. Then you have further options:
- Take out the remaining £150,000 immediately and pay income tax at your marginal rate: 20%, 40% or 45%
- Buy an annuity with the £150,000
- Leave the £150,000 invested and drawdown income as and when you need it.
Income drawdown – also known as pension drawdown, income withdrawal, drawdown, pension fund withdrawal – keeps your money invested, as it was during the building of the pot while you were working. Your money is managed by your pension provider and invested on your behalf. If you are familiar with this fund management, then the basics of drawdown are relatively simple and you just withdraw money from the contract – as opposed to swapping it for a fixed income, as is the case with an annuity. This means your money always stays invested and consequently, your retirement fund will grow (or shrink) depending on the performance of your provider. The best-case scenario is that your pot will grow, making more money available for your retirement. The worst-case scenario is that stocks underperform and you are not left with enough money to support your retirement.
More information about drawdowns
- Most people who opt for drawdown will either have their money in a self-invested personal pension (SIPP) or a personal pension. There are two types of drawdown – capped drawdown and flexible drawdown.
- Capped drawdown limits your income to 150% of the amount you would have received each year if you had bought an annuity.
- Flexible drawdown allows you to drawdown as much money as you want each year.
What happens to your pension fund when you die?
• If you die before the age of 75, your family can take the pot tax free.
• If you die after the age of 75 and your family want a lump sum, they’ll pay 45% tax.
• If you die after the age of 75 and your family want to take the remaining pot as income, they’ll pay income tax rates.
•A joint life or dependant’s annuity can be paid tax free to anyone after you die, subject to any restrictions of your annuity provider.
Transferring a final salary pension
Most people with a final salary pension are able to make unlimited withdrawals if they transfer to a defined contribution pension. However, if you do this you could lose valuable benefits. Seek independent financial advice first.
Alternative pension plans
Shares are an investment fundamental. Most drawdown portfolios will feature up to 50% equities investment. It’s an option for those who know they can lose significant amounts of their retirement fund overnight, but returns can be high. If you are not confident, you can pay for your fund to be managed. Although capital growth can be substantial and dividends are on offer, income will be
This is your life savings that you are dealing with so most people will shy away from non-mainstream investments. However, if you feel you have the requisite knowledge of the art, classic cars, whiskey, racehorses or stamp markets, funds can be invested. Bear in mind, many of these assets require you to buy and sell for capital returns rather than offering a regular income.
Although cash savings are an important part of a diversified portfolio, lower-than-inflation returns have hampered cash’s appeal in recent years. In September 2016 inflation jumped to its highest level in two years. However, both the Fed and the Bank of England are assessing the possibility of rising their base rates, so whether money is invested in savings accounts or ISAs, within a few years’ cash returns may rise above inflation once more.
Annuities offer market-leading levels of surety. The vast majority are conventional and pay a risk-free income that is a guaranteed for life. The amount you receive depends on how long the annuity provider expects you to live (i.e. how many years you’ll need paying).
Prominence of property
For years’ savers have voiced their concerns over the large sums locked in their pensions, believing they could generate better value by investing the money elsewhere.
Simultaneous to this disgruntlement, property investors have been seeing their own returns increase as the UK’s buy-to-let sector goes from strength to strength.
Why is this the case?
Logical economic factors suggest the potential for growth in the buy-to-let sector will continue. The country’s growing population is easily outpacing the supply of new homes. There is now a structural undersupply of accommodation and consequently the UK’s private rented sector (PRS) has expanded to 5.4 million households, and by 2025 it is estimated 7.2 million will be living in the PRS.
While rising property values have presented a barrier to home ownership, there is also a more fundamental shift underway in the PRS: an increasing number of tenants and affluent renters are now actively seeking the flexibility rental accommodation provides. This preference for transient tenure in a growing PRS is driving the demand for more rental housing.
A history of strong performance
Since its introduction as a distinct investment class, buy-to-let has left other assets in its wake. Specific buy-to-let mortgages became available in 1996 and over the past 21 years every £1,000 invested in the asset class has matured to be worth £13,048 – a compound annual growth rate of 16.3%.
How would buy-to-let work for your retirement?
It is your decision whether you want to use your retirement fund, or a proportion of that fund, to purchase a buy-to-let property. On the face of it, the returns available in the buy-to-let sector seem far more appealing than past annuities.
Five reasons buy-to-let can be a favoured pension plan
- Surety of the UK property market – one of the world’s safe haven asset classes
- A growing PRS – demand for your property could be high
- Regular income – rental yields in the UK are at record highs
- A capital safety blanket – property values rose by 7.7% in 2016 and are predicted to rise 28.5% by 2022
- Flexibility – the asset can be sold to generate funds or passed on to family
Can buy-to-let support your retirement?
Property has been a staple of pension funding for many years. Institutional funds own large swathes of commercial property and use the yields and capital gains to make annuity payments. The high asking prices of commercial property makes this impossible to replicate on a smaller, individual scale. Many people approaching their retirement see residential property as a more manageable alternative. In fact, a third of people aged between 45 and 64 with a pension are considering using some or all of their retirement funds to buy property.
Should you be one of them?
Just because you have new freedom to spend your entire pension fund, doesn’t mean you should. Most pension experts would say that while funds are still invested with the provider, they offer greater tax efficiency. Withdrawing your pot as a lump sum would negate this. The first 25% is tax free, the rest will be subject to income tax at your marginal rate. Similarly, should you wish to draw down your money over time, each withdrawal will be 25% tax-free, with the remainder subject to income tax at a marginal rate. Most people would hesitate to push their rate to the 40% boundary without thorough consideration.
Points for consideration
You will lose money
You are almost certainly going to lose some money to tax if you take a lump sum or draw down. There should be a compelling reason to take the money from your pension pot and you should assess whether your investment has the capacity to make up this shortfall.
The average life expectancy in the UK is now in the early 80s and increasing consistently. Therefore, your period of retirement is likely to be as long as your period of employment if you use all your pension fund at 55. Research suggests that people retiring at 65 will need the state pension plus a savings pot of £121,000 to fund a 20-year-long retirement.
Take a new perspective on your purchasing power
Inflation will affect purchasing power in retirement in a much more dramatic fashion than when you were earning a salary. It is particularly important to factor in medical care and energy costs, as these tend to have a disproportionate impact on older people.
If you decide that you want to use some of your pension to purchase an income-generating buy-to-let asset, how do you choose the right property? Will any property provide you with the money you need? Will the investment be suitable for both your budget and your lifestyle?
If you purchase a property, it will not be covered by Financial Conduct Authority or Financial Services Compensation Scheme protection.
Before parting with your life savings you should do your due diligence and take professional advice. Below is some preliminary information on some of the criteria you should assess any potential buy-to-let investment on.
Supply and demand
In order for your property investment to provide a regular retirement income in the same way that an annuity would, a house needs to be tenanted. Like every other buy-to-let investor, you’ll need to assess yield potential and compare this income to what you’d get from an annuity, a fixed-rate savings account, or the return on a drawdown pot.
Do some research into the most in-demand market to buy in, and the type of property that will be popular in that particular market.
The wider PRS is performing well. Average UK residential property has yielded between 4% and 5% for a sustained period. More people are opting to rent, tenant finances are ever improving and arrears falling. A little research into geographic markets however, can vastly improve your chances of increasing your yield.
The number one reason tenants leave their home is for a property of greater quality and you don’t want your retirement income being interrupted by void periods during which your buy-to-let investment is empty.
Therefore, after finding a market, you need to assess the quality of your property compared to other accommodation options in the market. You want people to live in your investment so you need to provide them with a home. Although clean internal areas and good general upkeep are very important to tenants, you should consider these the minimum requirement when you come to let your property.
You should also contemplate making life easier for your tenants and readying utilities, Wi-Fi and security. Your target market should always dictate the style, quality, facilities and finish of your property.
You can buy and furnish a property that is very appealing to a specific tenant market you have researched. However, if it is not in a desirable location then people will be reluctant to live there.
The specifics of location will depend on the market and 38% of tenants state they are prepared to pay extra rent for a convenient location. Proximity to public transport is crucial for most tenants, with three-quarters stating they wanted to live within ten minutes of their nearest link. Only 30% of tenants are prepared to travel an hour – in peak traffic – to get to work, compared to just 30% of other respondents.
Off-plan or complete
Another investment decision you’ll need to make is whether to buy an existing property or an off-plan asset. You’ll probably be most familiar with the idea of buying an existing property – after all it is the tangible nature of bricks and mortar that most people find reassuring about property investment. If you are retired and have no source of income, an existing property is probably the most appropriate option. This is because you can buy it and tenant it in a relatively short space of time, allowing you to enjoy income at the earliest opportunity.
Off-plan property means buying a property that doesn’t exist yet. If you are around 55, still working and approaching retirement this could be a more suitable option. Off-plan investments represent a great chance to capture strong initial capital growth, as the value can rise sharply between purchase and completion. This is especially useful if trying to offset any funds you may have lost to tax payments. However, you will have to wait until completion for the funds you invested to
generate income for your retirement.
Landlord or fully managed
This is a major consideration if you are approaching retirement. Running a buy-to-let property as a full-time landlord is a substantial commitment. Not only do you take full responsibility for letting the property – and ultimately driving your income – but you also have to factor in maintenance costs and management time.
One available option is a lettings agency. These companies can remove much of the stress of being a landlord, but will eat into your rents and reduce your retirement income. A more recent and perhaps more appropriate option is a fully managed investment. If you purchase one of these types of investments, a company will tenant, maintain and manage your property on your behalf. It is a totally hands-off process. Furthermore, many fully managed investments offer assured income for a number of years.
How to choose a fully managed provider of property
Choosing a provider who can manage all of your investment for you, while still providing you with high yields, sounds like an ideal retirement option. However, a simple boast of future returns will not pay your bills for you. Like any investment, you need to be comfortable with the deal before handing money over.
Research a company’s track record
You want to see that your fully managed investment provider has a history of generating returns for other investors.
Do the investment criteria add up?
Just because a company says it can provide assured returns doesn’t mean it can. Ask to see its research, and compare it with other independent research to see if their supply and demand criteria is credible.
Ignore the gimmicks
Be wary of discounts and other gimmicks that are packaged into an investment. If products are discounted, it’s usually because they are not selling.
Because you could lose a significant amount of money to the taxman by taking a full pension lump sum, you may not have enough funds available to purchase a house outright.
However, that doesn’t mean that buy-to-let is not an option.
A significant amount of existing buy-to-let investors purchase their property using mortgages.
With increasing numbers of buy-to-let loans being made available, competition within the market is leading to more favourable lending conditions. For example, a 40% deposit – obtained via a pension fund – and a good credit history could result in you being offered a five-year deal at 4.2%. Of course, you’ll always need to factor the mortgage repayments into your budget and long-term financial plans, as they could significantly reduce your yield and retirement income.
Interest rates: Using a mortgage to purchase property increases the unpredictability of your retirement plans. A Bank of England rate rise will result in you paying more money back to your lender and could significantly reduce your income.
Age limits: People approaching retirement age should have fewer issues obtaining a buy-to-let loan than regular mortgages, as the ability to pay is not determined by salary, but by the rent that a property can achieve. However, your age may affect your ability to obtain finance.
Gearing is the process of using finance to boost your returns.
Without gearing: If you use a £100,000 pension pot or drawdown to purchase one investment property for cash and let the property for £600 per month, you receive a gross yield of £7,200 per annum, which is 7.2%. If over five years of fluctuations in the property market, the house increases in value by 40%, you now own a property worth £140,000
With gearing: Here, you would use your £100,000 fund as deposits to buy five properties. Now, regular rental income – presuming they were all tenanted – would be £3,000 per month or £36,000
per annum. As you have borrowed £400,000 you have to pay interest. A rate of 5% would be £20,000 per annum. Therefore, net of interest, total yields are £16,000 per annum. Bear in mind that these yields are only net of interest, you still need to factor in the costs of maintaining five properties instead of one.
Furthermore, after five years of property price fluctuation, a 40% price rise would equate to a capital gain over £200,000 on the geared portfolio and you would now own property worth £700,000.
Purchasing purpose-built student accommodation (PBSA) as opposed to traditional HMOs can remove many of the complications involved with entering the buy-to-let market as a novice.
Your property will have a defined target market – and a very stable one, with over 2.28 million students studying in the UK between 2015 and 2016.
Logical investment criteria
Almost all major university UK cities are critically undersupplied and students are willing to pay up to a 70% premium for PBSA over HMOs. It’s no surprise that over £6 billion has been invested into the UK’s PBSA market and major property consultancies such as Knight Frank, Savills and CBRE regularly conduct independent research into what has been dubbed the UK’s best performing asset class.
Even though you own the asset and are free to sell it whenever you need, many PBSA apartments are available as fully managed investments. This means that very little commitment is required on your part before you receive your regular income.
Unlike the average house price of £300,169, PBSA assets are available between £100,000 and £200,00 and can be purchased outright removing any mortgage complications.
Part of a portfolio
The lower price of student property means that it can be used in conjunction with other assets as part of a portfolio. The remaining part of your retirement pot can be kept in savings accounts or in a managed fund.
Your pension. Your choice
Taking any of your pension benefits early is likely to reduce your income at retirement. Therefore, pension release is only suitable for a very limited number of people and circumstances and should not be seen as an easy option for raising cash. This is because a pension is designed to provide you with benefits when you retire.
Whatever you decide to do with your life savings and pensions pot, always seek impartial and professional advice and be confident you have enough money to see you through retirement.