Should I invest in property to fund my pension?

Is property better than a pension? We look at the pros and cons.

Nzinga Akinshegun, 38, is looking for guidance on where to invest a cash lump sum of between £180,000 and £200,000 next year.

The NHS cognitive behavioural therapist, based in Somerset, is keen to:

• Invest in property to fund her future pension
• Make the most of pension wrappers and ISAs

Planning for the future

EARNINGS: Nzinga works part time, as she is currently studying to become a counselling psychologist. She earns £30,000 a year, but expects this to increase to around £39,000 in two years’ time when she completes her degree (if she stays within the NHS).  

Nzinga lives with her partner Edward, 54, a senior sales director who earns around £60,000 per year.

SAVINGS: Together, the pair are saving around £1,300 a month and currently have total cash savings of £50,000.

PENSIONS: Nzinga has only been working for the NHS for five years so has not had time to build up a lucrative pension. She has a few other small pots from previous employers, and thinks she has total pension savings of around £5,000.

Edward does have pension savings which he plans to cash in next year.

• Find out more: What to do with your lockdown savings and How to invest £50,000

• Nzinga also owns a flat in Bracknell, worth around £184,000, with an interest-only mortgage of £136,000. She’s looking to sell within the next 12 months, which should release cash of £49,000 – if the flat goes for the full valuation.
• Edward has pension savings that he is looking to cash in next year, which should give him a lump sum of between £80,000 and £100,000 after tax. 
• The liquidation of both these assets, plus their cash savings, will form the basis of their lump sum of up to £200,000. 

The couple’s main financial goals are to invest in property, which they plan to use to fund their retirement.

• Find out more: Different types of mortgage: which one is right for you?, everything you need to know about cashing in your pension savings and our guide to property investment

Funding property investments

The couple want to invest in houses of multiple occupation (HMOs) in the Somerset areas of Taunton, Bridgwater or Wellington.

HMOs are where:

• a minimum of 3 tenants live in the property, forming more than 1 household
• tenants share toilet, bathroom or kitchen facilities

The pair originally plan to start with two but will increase the number if it works out. Here’s an outline of that plan:

• Spend between £150,000 and £200,000 per house
• Fund house buying through buy-to-let mortgage
• Put down a 25% deposit (up to £50,000) per property
• Some of their investment properties will be kept to provide rental income in retirement
• They also want to “flip” properties to fund future purchases which involves buying a house, renovating it and selling it on for a profit
• If this goes well, Edward would replace his salaried income to flip one to two properties a year in order to keep an income

Their current home

The couple also plan to sell their current home in order to buy somewhere bigger in next couple of years. They have a mortgage of £191,000 on their £310,000 three-bedroom property in Somerset.

NOTE: If they sell before their five-year fixed term mortgage deal expires in 2023 they could incur a £2,000 charge.

The property was bought through the government’s help to buy loan scheme, which means 20% of the sale price will be held back to repay the loan. 

• Find out more: Guide to buying a second home and How to retire early

“We believe we have a fairly sound plan but wondered if you could highlight any potential pitfalls? We ideally want a blend of pensions, property and ISAs so would be very interested in any advice please.”

Nzinga, 38

What the experts say

Kay Ingram, chartered financial planner at LEBC Group:

Nzinga and Edward’s main objective is to save for their retirement. I appreciate they want to get into property investing, but in my opinion the best way to build a retirement income is through a pension scheme.

There are generous tax breaks on offer through a pension.

Unlike property, pensions are typically free from inheritance tax. Nzinga and Edward are not married, so if one of them were to die any assets passed to the other could potentially be subject to inheritance tax.

Unfortunately, pension plans cannot invest in residential property. They can be invested in a wide range of other assets, including:

• Shares
• Fixed interest loans
• Government bonds
• Cash
• Commercial property

Nzinga and Edward are likely to be much better off by investing in a selection of these within a pension plan, rather than investing directly into a residential property, which will be taxed very heavily in comparison.

Cashing in your pension

The last thing Edward should do is to cash in the whole of his personal pension when he reaches age 55. If he does this, it would:

• Increase his income for the tax year and result in him losing his personal allowance on the first £12,570
• Leave him paying tax at 40% on most of it, and possibly even 45% on some of it
• Mean that his future pension savings allowance would be reduced from £40,000 per year to just £4,000 a year

All in all, as both have employer pension schemes at work, paying extra money into their workplace schemes would seem to be an easier and less risky way of building pension funds. If they prefer to save into their own private pension, opening a plan is straightforward.  

Advice on which funds and investments to choose is readily available, at far less cost than the stamp duty they would pay to buy a property.

• Find out more: Guide to inheritance tax and How to choose investment funds

Rebecca Aldridge, chartered financial planner at Balance Wealth Planning:

Nzinga is busy studying and working and Edward’s salary suggests he has a senior job. Renovating and managing HMOs can be demanding. Is fitting kitchens at weekends and dealing with tenants and their ongoing problems something they’ll enjoy?  

Financially their idea may look lucrative in terms of the rent received, but it’s the profits that are important and they are easily eroded. HMOs are often tenanted with students, so you can have long void periods over the summer holidays.

Other costs to consider include:

• Letting agent costs
• Insurance
• Rent arrears if your tenants don’t pay on time
• The loan terms will be higher than for a normal mortgage and you can no longer offset all your mortgage interest against income.
• You only get a 20% tax credit
• There will be a 3% higher rate of stamp duty on acquisition
• Landlords pay an extra 10% in capital gains tax on disposal

It worries me that Edward is considering taking what looks like all his money from his pension to buy into this project.

There is no going back after moving money out of your pension pot, away from a tax-free environment. This rings alarm bells for me. 

Edward could pay money into his pension and get 40% tax relief.

For Nzinga, an option is to explore buying back years within her NHS pension. There are limited cases where this is possible, but it can be an excellent strategy.

Or she could set up a private pension and pay into that.

• Find out more: Buy-to-let: 10 things you need to know and Are ISAs tax free?

Vanessa Warwick, landlord and co-founder of PropertyTribes:

My first piece of advice is that Nzinga should not sell her flat in Bracknell.

There are significant costs associated with selling a property, and Nzinga already has a buy-to-let (BTL) property up and running here.

Houses of Multiple Occupation are generally regarded as the domain of experienced, hands-on landlords.

Bear in mind that HMOs are:

• Far higher risk than standard BTL
• Subject to far greater regulation and legislation
• There are also strict management regulations of these properties
• The fines for non-compliance are very significant and can be unlimited 

HMOs also require specialist mortgages, not BTL mortgages, and the criteria are different. So Nzinga needs to be clear on that, as she may not qualify for HMO finance.

Property investing: How to get started

If I were in Nzinga and Edward’s shoes, here’s what I would do:

• First pay off the loan on their own home via their savings pot.
• Once this is achieved, they can then take out a BTL mortgage on this property (no need to sell it and incur all the costs).
• The funds from this mortgage can be used as a deposit on their next residential home and further deposits for standard BTL properties.
• Even better, if Nzinga and Edward can buy a new residence that they can add value to and improve. This would help them build further equity and give Edward some experience in managing a refurbishment project.

This is exactly how I got started investing in property in 2004. I took out a BTL mortgage on my two-bed flat in North London, redeemed the residential mortgage on it and let the flat out. I was left with £140,000 which I used as a deposit on a new residence, and also as the seed cash for my BTL portfolio.

The above might not be exciting as the thought of high yielding HMOs, but it is far lower risk and far more suited to the couple’s circumstances.  

They could also consider a coastal holiday let due to massive demand and the favourable tax environment around holiday lets.

• Find out more: Is now a good time to remortgage?, Guide to holiday let mortgages, Best ways to add value to your home

Joanne Smith, senior lettings manager at Hamptons, Bath

The South West is currently recording some of the strongest rental growth in the country, due to a shortage of housing in the area. It’s definitely a good place for Nzinga to consider investing in right now. 

According to our research, rents in the South West rose to £931 per month in May, up 11.5% on the same time last year.

This marks the highest growth on record and compares to an average of 7.1% across Britain as a whole. 

Somerset West and Taunton offers an average gross yield of 6.1%. Smaller properties tend to command higher gross yields than larger properties but HMOs can be an exception to the rule. 

A smaller HMO will still have to pass health and safety checks. But adaptations, such as the installation of fire doors, will cost less too on a smaller property.

A licenced HMO can work for many properties and will generate a good income stream.

• Find out more: Should I buy a rental property or buy a pension?

In summary:

Investing in buy-to-let:

• Use the cash savings to pay off the mortgage on your residential home. Remortgage as a BTL and rent the house to a family who are likely stay long term.
• Use the money released from remortgaging to buy good quality two to three-bed family homes in your area, which you know and understand.
• Once you have a solid cash-flowing portfolio of stable and low risk BTL properties, you can start to take on higher risk properties (including HMOs).
• Consider a coastal holiday let due to massive demand and the favourable tax environment around holiday lets.
• If you would like to invest in property, there is high demand for HMOs but bear in mind greater regulation and legislation. A smaller property will incur fewer costs.
  
• Find out more: How to get started on buy-to-let as a beginner

The alternative:

• Consider a pension scheme, which offers generous tax breaks and is free from inheritance tax.
• Invest in a mixture of government bonds, cash and commercial property through the pension.
• Boost your workplace pension schemes and benefit from employer contributions.
• Pay into a private pension, taking advantage of tax relief.

Next steps

Nzinga says: “On the back of the advice we are now thinking of leaving the pension where it is and possibly saving and/or selling my flat next year to be able to buy a rental closer to us.”

Do you have a question for our team? Email Questions@timesmoneymentor.co.uk