Which is better: Property or Pension?

Often, when talking about tax planning and saving for the future, clients have spoken to me about investing in a buy-to-let property. For many, this type of investment seems to be something ‘everyone is doing’, and they are worried about missing a potentially lucrative boat.

However, there are a lot of myths around the returns that buy-to-let properties produce, and people often ignore the costs or restrictive nature of this type of investment. People hear stories of great returns – particularly in the home counties where property feels like a great investment – and are swayed by dreams of getting rich without really trying.

Approach with caution

We need to be careful – there is certainly a fashion – almost a cult – around buy-to-let properties. It’s important to note that there are also a number of scams that promise very significant returns on buy-to-let property, as it is an unregulated area.

So, before you get sucked into a scheme, you need to consider whether it looks too good to be true. You also need to investigate the qualifications and motivations of some of the people who are waxing lyrical about the advantages of buy-to-let property on YouTube.

To be completely upfront, I think for most people, there is a clear winner from a tax benefit, risk and flexibility point of view. But as with all tax planning, it has to start with your personal financial plan and be tailored to your circumstances – you should never make a serious investment based on advice from TikTok.

Always take professional and independent financial advice tailored to your circumstances before you make any big investment in pension or property.

Think Pensions First

For a business owner, corporate pension contributions are paid directly from the company, and therefore, the company reduces its profits by the amount of those contributions, which then saves corporation tax at the prevailing rate. At the moment, this is 19% (or 25%) on pension contributions.

In terms of the tax effect, when the contribution is made on the individual director, there is no tax liability at this point – no income tax effect, no P11D benefit (benefit in kind), and it is entirely tax-free.

Instead, pensions are taxed when they are received, so when the corporate pension starts to pay out, individuals receiving that benefit will pay income tax at the prevailing rate. The pension is invested in a tax-advantaged account, and 25% can typically be drawn as a tax-free ‘Pension Commencement Lump Sum’ with the remainder counted as earned income and offset against your annual allowance, basic rate tax bands and higher rate tax bands.

The disadvantage of pensions is they involve cash, and you won’t usually use leverage – meaning that you won’t borrow to make pension investments.

The disadvantages of pensions include:

• Access – You can’t access them until you’re 55 – or from 2028, 10 years before the state pension age.
• Advice – You may require professional advice from an independent financial adviser about associated costs, typically a small percentage or fixed fee.
• Growth – You can’t guarantee the growth of the pension, and you are open to the growth of the funds you are invested in.
• Unethical – If you are not careful, your pension might be funding unethical activities that impact climate change or political instability.
• Restrictions – Tax advantages are restricted by the amount you can contribute tax efficiently each year – your annual allowance – and by the total size of all your pensions – your lifetime allowance.
• Sharks and cowboys – You must watch out for ‘unregulated’ pension investments, which are rife with scammers. Seek good quality, regulated, independent financial advice.
• Practical – You can’t live in a pension.

The advantages of a pension include:

• Adaptable – It is very easy to change the way funds are invested and follow growth trends.
• Inheritance Taxes – Pensions sit out of your estate for inheritance tax, but recent budget announcements suggest this may change post-2027 (speak to your independent financial adviser)
• Insolvency – Often cannot be touched in most insolvency scenarios.
• Next generation – If you die before age 75, the pension can be passed on to anyone you nominate, and they can draw that pension free of income tax. If you die after 75, your nominated beneficiary can draw the pension pot at their marginal rate of tax. This area is subject to a treasury consultation at the time of writing and may change. Please consult your independent financial adviser.
• Guaranteed income – You can use your pension to buy a guaranteed income in retirement for the rest of your life – known as an annuity – so your money will never run out before you do.
• Tax – The assets that sit within a pension are both income tax and capital gains tax-free and inheritance tax-free (likely to change). Income tax is only triggered when you withdraw money from your pension.
• Retirement taxation – Most people will earn less in retirement, and therefore, tax-deferred by pension contributions is likely to be tax-saved.
• Flexible – You can start and stop your contributions as your means change, so you are not tied to a monthly mortgage repayment every month. Cashflow is the biggest risk to growing businesses; Property purchased with a mortgage creates a liability that must be met every month irrespective of your cashflow position.
• Impact – Your pension funds can invest in the economy of the future, providing solutions to climate change.
• Mobile – You can easily switch your investment around within your pension should the returns not be what you need. It’s much easier to do this than it is to sell a property or relocate it.

Residential property

Part of the attraction of buy-to-let property is that it’s a visible asset.

The Office for National Statistics published data based on Land Registry information for house prices in both the UK and London – you can see a graph of this data below. Over the past 30 years you can see that there have been periods where property has outperformed the sector average of ‘global funds’ and periods where it has underperformed.

What will happen next is anyone’s guess. I would suggest it is sensible to have exposure to both residential property and global funds. Most people already have a large exposure to residential property through their main residence but little in global funds through their pensions. Remember that both property and shares can fall in value as well as rise.

Advantages of residential property include:

• Borrowing – You can secure a loan or mortgage to leverage the investment. This increases long-term returns but also increases your risk.
• Enhance –  It’s a tangible asset that you can improve with your DIY skills or by using (more expensive) experts.
• Growth –  It may provide ‘real growth’ over the long term, especially as there is a shortage of affordable housing in the UK.
• Home – the property could be used as a home for the owner in the future ( watch P11D issues).
• Demand – No shortage of demand for affordable homes currently.

Disadvantages of residential property include:

• Requires a deposit. That deposit, unless already held personally, will need to be extracted from the company, and therefore you need to consider the income tax effect of getting that deposit money from your business or your company account – which may mean paying additional dividends at 33.75/39.35%.
• Stamp Duty – your property will be subject to stamp duty, and remember that you pay increased stamp duty on a second property. So, the money needs to be found for the stamp duty – you will only get tax relief on the stamp duty when the property is sold.
• Capital gains – your property will be subject to capital gains tax on the sale at either 18% or 28%, and you must pay this within 60 days of the sale.
• Slices –  it is not easy to sell ‘slices’ of property; you tend to sell the whole thing at once, so CGT cannot be spread over several tax years.
• Maintaining a property is expensive – you need to budget for repairs, arrangement fees from the mortgage provider, insurance, rates and agency fees – although these will reduce your profit on the property. These costs can be high, and you may also have the hassle of dealing either directly with tenants or with a letting agency.
• Void periods – Your property could be empty between tenants, or you may have tenants who can’t pay the rent – and yet you will still have to make mortgage payments. You need to be sure you can afford to pay the mortgage if no rental income comes in.
• Physical risks –  A residential property can be subject to flooding and storm damage, and the areas where people want to live now may change. This risk will increase as the climate warms.
• Rental –  The assumption is that the rent on residential property will exceed the mortgage repayment and interest rate. Should interest rates rise, it is possible that the interest rate may exceed the rental yield. You need to consider what you do in this circumstance.
• Interest – The mortgage interest paid is no longer fully tax relievable; therefore, the profits you make on the property are subject to income tax. You need to consider whether this income effectively pays for the property, how much tax you will pay, and what tax band it will sit in – and that will depend on your circumstances.
• Repayments – You also need to consider that the capital repayment of your mortgage will need to come from earned income – income you have already paid income tax on. Otherwise, you will need to make increased withdrawals from your company and, therefore, be subject to more income tax at 32.5% or 38.1%.
• Political risk – in recent years, there has been a trend of governments to discourage buy-to-let properties through taxation as they try to boost home ownership, particularly for affordable housing.

At the mercy of the property market?

You should also consider whether you want all your assets in property – it is likely that you already have a significant property you live in. You need to be aware that you could be heavily at risk from local and national property market changes.

What happens next?

Will you continue to rent out the property when you retire? Or is that when you want to realise your investment? Because you have to sell the entire property – you can’t release property equity a bit at a time – your tax planning options are much narrower.

You might be thinking about passing the property to the next generation in your family. Residential property will be part of your inheritance tax estate, so you need to consider the consequences for your beneficiaries.

One thing you need to consider is that there is a shortage of properties for first-time buyers, which has resulted in an overinflated market. You need to give some thought to whether you’re comfortable with the idea of owning more than one property when there are individuals who can’t afford to own even one property – owning a second property is often a moral decision as well as a financial one.

Beware insolvency

A ‘factor of magnetic importance’ often overlooked by entrepreneurs is the difference in the treatment of residential property investments versus pensions by the insolvency courts. As a dynamic entrepreneur, you are taking a risk with your financial future by running a business. Your greatest opportunity to improve your returns is by improving your return on investment in your own business.  Sometimes, often through no fault of your own, your business can get into financial difficulties.

Pensions are usually protected from creditors in bankruptcy. If you want to make serious returns – let’s work on your business and make sure we move your profits into a safe investment that will support you in later life. Pensions provide a tax-efficient home to help you keep the money you make through your business. If you invest in residential property, that property will be fair game for an insolvency court and you may have to sell in order to settle your debts, meaning that you lose the money you have invested for your future.

What’s the answer?

Well, that comes down to your financial goals and your long-term plans. Everyone is different – the number of years you have until retirement, the age you want to retire at, the investments and pensions you already have in place, the things you want to do later in life, and the cash flow you need to have available to do them.

That’s why you should have a personal financial plan that you create with a trusted independent financial adviser who can walk you objectively through the pros and cons of both strategies, giving you the information you need to make the best decision for you and can help you keep up with the changing tax landscape.

Please get in touch if you would like to discuss your plans.

Please note: This is not meant to constitute professional advice. It is generic guidance only, and things may have changed since it was written –please always seek specific & tailored advice for your circumstances.