I consider myself very lucky because I love my job and I can say that I look forward to going to work every morning. However, if there’s a downside of being a financial advisor it’s that people expect me to engage in conversation about financial advice in social situations. I suppose it’s a bit like interrupting a gardener on a night out to ask advice on the best plants for your garden. Except often, people in the pub don’t want financial advice for free - they want to challenge me about the wisdom of my advice.
The other day I was enjoying myself with friends in the sunshine when I was approached by one of these challengers to explain why investing in a pension is better than investing in property. I have to admit that I wasn’t exactly enthralled by this prospect, not only was the challenger a little on the drunk side, but he was also firmly in favour of property investment. While I think that property has its place if you’re lucky enough to be able to afford to use it as an investment, I think there’s more value in pension savings.
I should point out here that the sort of property investment my challenger was referring to wasn’t buying a home to live in – which is something I’d encourage anyone to do if they have the means - but buying rental properties. In his mind a rental property is a solid investment that will grow faster and provide more income in retirement than a personal pension.
There’s no doubt that potential capital gains on property might look attractive when the property market is booming – but pension saving is far less troublesome and more tax-efficient. If you’ve read any of my earlier blogs, you’ll know that I’m a fan of the tax relief that’s available on pension contributions. HMRC automatically adds 20% of a personal pension contribution to the pension fund; this tax relief is increased to 40% for higher rate tax payers.
The tax relief available on pensions contrasts with the tax rules on rental properties. The government charges an additional 3% stamp duty on second homes and, from April 2017, the tax relief available on mortgage interest is being reduced. There are also different capital gains tax rules on properties; from April 2016 capital gains tax rates were reduced 18% (or 28% for higher rate taxpayers) to 10% (or 20%). However, gains from rental properties were excluded from this rate cut so there’s effectively an 8% surcharge on rental property gains.
Some people quote the potential to sell property to provide lump sum capital in retirement as a clear advantage of rental properties but it can take many months to sell a property, often after one or more reductions in the offer price. While selling property is relatively easy when the market is roaring, there’s no guarantee that market conditions will be suitable when you need to sell. The costs of maintaining a rental property are also much higher than the costs of pension investment. It should be remembered that rental income isn’t guaranteed – there may be periods of time when property is unoccupied.
In defense of my challenger, he has no experience of personal pension savings and because he’s self-employed, he doesn’t have a workplace pension. In fact, he quoted the auto-enrolment workplace pension scheme as a reason to avoid pension savings because the minimum contributions are so low. It should be noted that the employer contribution is a tax-free benefit, much like the HMRC tax relief, so we consider it a valuable part of pension savings. The obvious solution to this low contribution is to make savings to your own personal pension which, in addition to the tax benefits already mentioned, has the following benefits:
Control by the investor: a little-quoted advantage of personal pensions is that investor retains control of the fund and avoids disadvantageous changes such as changes to terms of an employer’s final salary scheme. There are no penalties for accessing a personal pension fund early (as long as you’re aged over 55) and there are no limits on how benefits can be taken from the fund.
Flexibility of benefits: In the past retirees were limited on how they could use their pension funds, but a lot has changed in recent years especially with the introduction of the Pensions freedoms in April 2015. Now there are multiple ways of accessing a pension, so retirees can use their fund in a way that suits their circumstances.
Building a retirement fund: It’s increasingly common for individuals to wish to retire 8-10 years before they’re eligible for the State pension. This is only possible when a retiree has built up substantial personal pension funds to make up the shortfall in income between retirement and state pension age. This situation is likely to apply to more retirees as the State Pension age increases and should be a serious consideration for investors aged in their 20s and 30s.
While pensions and rental properties can both be beneficial in retirement if it comes down to a choice between the two I’d advise a client to use excess earnings to make personal pension contributions.
Finally, if you’re lucky enough to move in the same circles as a financial advisor and want to challenge them on financial matters, it’s almost certain that they won’t engage with you in the pub. So why not make an appointment and approach them with an open mind? You might find it’s beneficial for you and your finances in the long term.