The importance of getting on the housing ladder is so engrained in British society that many of us are putting it at the expense of other long-term savings needs.

Surveys suggest a quarter of people over the age of 50 will rely on downsizing when they stop working and nearly half of 35 to 54 year-olds plan to use property to fund their retirement.

The Financial Conduct Authority warned last year that taking the view ‘my house is my pension’ is extremely risky. The regulator’s chief executive urged people not to put all their eggs in one basket, pointing out that returns can decline over time.

Why is relying on property risky?

There’s no doubt property can be a sound investment. Over the past decade, average house prices in London have soared by an impressive 69%.

Unfortunately this is not the case across the UK. There are 17 major towns and cities in England and Wales where houses are worth less (allowing for inflation) than their 2007 levels.

The worst affected are Blackpool and Sunderland, where average house prices remain more than 10% below their pre-financial crash highs, according to HouseSimple.com.

Tom Selby, senior analyst at AJ Bell, warns that property, like every other asset, can go down in value as well as up.

‘Someone who chooses to rely on this single asset to pay for their retirement needs to understand that, by having all their eggs in one basket, they are totally exposed to the housing market,’ he explains.

‘If, when they come to sell, there is a sudden shortage of buyers, a seller relying on releasing equity to fund their day-to-day living will be left in a very difficult position – particularly if they have no other income sources.’

The difficulty of downsizing

When you’re young it can be easy to formulate a retirement strategy which involves selling your home.

But Steve Eggleton, wealth management consultant at Mattioli Woods, says this can be a lot harder to do when the time comes. Many people have a strong emotional attachment to their home, having built up a lifetime of memories in the property.

Instead of selling, one option is to take money out of your home via an equity release mortgage. But Eggleton says these typically restrict the loan amount to 35% of the property value.

‘Whilst there is no need to repay capital or interest until death, this route will have wider financial planning implications, particularly around inheritance,’ he adds.

Imagine you released £105,000 secured against a home worth £300,000 and the loan ran for 20 years. Assuming a fixed-interest rate of 4.5% a year, the debt will build to £253,000, putting a hefty dent in your children’s inheritance. There will hopefully be house price growth over the same period, but this isn’t guaranteed.

Pensions are more flexible

Generating income from property is much less flexible than generating income from a pension.

Fraser Kerr, a financial planner at financial advice firm 1825, says a modern pension lets you start, stop, increase and decrease your withdrawals after the age of 55.

‘You don’t have the same options with a fixed monthly rent. And if you’re looking at property as an investment that’s going to increase in value, remember that you have to sell to realise that value. This can be time-consuming and may mean you can’t access your money when you need it,’ he adds.

Property is also less tax-efficient than a pension. Your home plus any buy-to-let properties will form part of your estate for inheritance tax (IHT) purposes, which could mean 40% tax is due when you die.

In contrast, a pension is usually held in trust and free from IHT. If you die before age 75, your children can take your pension as a lump sum or as income without paying any tax whatsoever. If you die on or after age 75, the lump sum or income will be taxed at the beneficiary’s rate of income tax.

The power of pensions

Pensions enable you to invest in a huge range of assets across lots of sectors and geographical regions. This diversification can protect you if one particular asset or region experiences a downturn.

Pension contributions benefit from tax relief at your marginal rate – that’s 20% for basic rate taxpayers and 40% for higher-rate taxpayers. When you come to take the money out 25% is tax-free, with the rest taxed in the same way as income.

‘There is not a more cost-effective method to build a retirement pot than by using tax-relieved funds to invest in a wrapper which benefits from tax-exempt growth. Whether it is a standalone personal pension, or a group arrangement provided by an employer, it is possible to invest in a wide range of well-diversified funds capable of meeting all risk profiles,’ says Eggleton.

Combining the two

Most experts think a sensible approach would be to use a combination of property and pensions in retirement.

‘Given that huge amounts of value could well be locked in someone’s home it would be silly not to consider this when planning for retirement,’ says Selby.

‘However, to rely on that solely is a huge risk and could leave you in a sticky situation if the property market takes a turn
for the worse just when you need to sell.’

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