Buy to Let vs Pension

We often hear that people who have some excess money to invest are drawn into a Buy to Let vs Pension argument and there are a wide range of opinions on this subject.

Some giving their opinion on the buy to let vs pension argument could be accused on being biased, we hope to provide a more balanced opinion.

Given all the hype in the papers and the many programmes on the telly telling us that you can make your fortune simply by ‘flipping’ property. Couple this with the fact that you are never far away from a headline that states ‘Billions wiped off pension funds’ it is little wonder that one of the most commonly accepted thoughts out there is that you cannot lose money investing in property.

Even the Chief Economist at the Bank of England, Andy Haldane, stated in August 2016 that property is a better bet than a pension.

So you could be forgiven for thinking that a good way to invest you hard earned cash is to try to build a portfolio of buy to let properties. You can then tell everyone that you are a property tycoon and never have to worry about money again!

I am a financial planner so you may be thinking that I am going to waste your time by slating property as an investment and tell you to invest in a pension instead as I have a vested interest.

Well, you’d be wrong, sort of!

Whilst I believe that pensions are now pretty cool (OK, it’s relative!) I also am not against buy to let properties. What I do strongly believe in though is that people should have sufficient information about both options before making a decision on which (if either) is better.

So the purpose of this post is to present a pros and cons of both, in a balanced and impartial way so that if you are considering what to do with your money you will have an idea of what you may be letting yourself in for.

Buy to Let

Let’s start by looking at buy to let property. Perhaps the most obvious advantage is that you can see and touch a property, it is bricks and mortar and you can visit it any time you like. This can be reassuring to some as it makes your investment tangible.

With a tenant in place the property should provide you with a steady stream of income.  To a certain extent you can vary this by adjusting the amount of rent that you charge. This income can be used to cover any borrowing you may have taken out to buy the property and also provide you with an income, this may be enough to cover your cost of living, or it may simply supplement your other income.

If house prices increase, you may be able to sell in the future and benefit from this increase in value. You could even plan to sell the property before you retire so that you can then invest the proceeds

Owning a portfolio of buy to let properties can lead to a significant income stream and if you have borrowing that is covered by your income

Now onto the disadvantages.  By sinking all of your money into a property you are potentially concentrating your financial future on a single asset. The housing market has good times and bad times and if you need to sell during a bad time it can take a long time to get your hands on the money.

This is no good if you need the money in a hurry and can mean you being forced into a quick sale at a lower price than anticipated simply to get the money.

There is actually some work involved in owning a rental property. You may end up getting calls at 3am telling you the boiler has broken down for example, you can employ an agency to take care of things like dealing with tenant queries but this increases your costs and so the amount of income you get will be reduced.

If the boiler does break you will need to cover the cost of the new one.

The rental income is not guaranteed; you may have periods of time when the property is empty and so any mortgage payments will still need to be made. Your income is therefore restricted to whatever the market will pay. You can’t take out part of the value if you need a lump sum and you can’t take a few bricks down to Tesco to pay for your weekly shopping!

The income you receive is likely to be subject to tax, although you can offset some of your costs against this. If you are fortunate enough to sell at a profit you may also pay tax on that profit. The property will form part of your estate for inheritance tax purposes so there may be more for the tax man there as well!

The rules are complex here so make sure you look into them to avoid any surprises when you complete your tax return.

If you are looking to take out a mortgage to buy the a rental property it is worth considering, not just if you can afford the payments now, but if there were to be an increase in interest rates and a subsequent increase in your mortgage costs, that you are still able to meet this obligation.

When buying a rental property ensure that you are aware of the additional costs that come along such as legal costs, mortgage arrangement fees, stamp duty and factor that into your equations.

This is extremely rare but there is also a risk that the tenants decide to just stop paying the rent, trash the house and refuse to move out. You then have the emotional and financial pain of going through the courts to get them evicted.

Due to its physical presence in your life there is a danger that you can become emotionally attached to a property and become tempted to do things to it that you would personally like but that your potential tenants may hate, try and avoid this.

You may also think that your property is worth more than all of the other properties on the market because you chose a certain paint colour or style of carpet.

Every other property owner will also feel the same, and you can’t all be right!

The fact of the matter is that the market will decide how much you can charge for rent or sale and so becoming emotionally attached to a particular figure in your own mind can lead to you making bad decisions.

If you think the property is worth £1,000 per month and the estate agent suggests a figure closer to £750 you might kick him or her out! You may also waste time trying to rent it at the higher level and miss out on a fair few months of rent before you realise that the estate agent may have known what they were on about!

The advantages are clear but you should also be aware and comfortable with the risks and possible downsides of property investment before you start picking tester pots.

Pensions

Now onto the advantages pensions and despite what you may read in the press, there are some.

When you make a payment into a pension you receive tax relief on that payment, this is effectively the government giving you some money. If it is a pension that your employer pays into as well, the actual amount going into your pension is far higher than the cost to you.

Once it is in the pension you can spread your investment over a wide range of different ‘asset classes’ i.e. stocks and shares, Government and Corporate bonds etc. This means you are able to spread your risk.

If the funds grows, it does so tax free and under current legislation at the point you access what is called your ‘pension commencement lump sum’ (often referred to as your tax free cash) 25% of your accumulated fund can be taken by you free of tax.

You then have complete flexibility over how and when you take your income. You can buy an annuity (a secure income for the rest of your life) if you want security of income, although annuity rates can often be seen as poor value because people are living longer.

If you die before you reach age 75, the pension fund can be passed on to whoever you want (assuming you’ve filled out the form) free of any tax. If you die after your 75^th birthday you can still pass your pension on, but any income taken will be taxed like employment income on the recipient.

There are also some disadvantages to pensions and the main one is that you are not able to access your money until you reach age 55. Due to the tax advantages outlined above you are also restricted on the amount you can pay into a pension each year. This is linked to your earnings but is still very generous at £40,000 per annum.

In addition, you are restricted on the amount you can build up in pensions without suffering a tax charge.  This is known as the lifetime allowance and is currently set at £1m!

We mentioned above that you are able to spread your risk but any investment involves the risk that you won’t get back as much as you put in. Some investments carry very high levels of risk and can involve a roller coaster like experience with values going up and down.

As with property you could become emotionally attached to your pension fund, this can lead to bad decisions such as selling during a market downturn because you get the jitters and you then try to go back into the market when things get ‘better’.

The difficulty here is that you have to guess right, twice! This is something that, evidence suggests, cannot be done. Even by those fund managers who charge high fees to do exactly that.

You can reduce risk by spreading your investment around, but it is important to understand these risks and feel comfortable with them before investing.

Overall there are advantages and disadvantages to both and my only advice (with a small ‘a’!) would be to make sure you fully understand the risks associated with each option and that you have considered the overall purpose of what you are trying to achieve before making a decision.

Financial Planning

Before any decision is made in the buy to let vs pension argument we believe it is important for you to seek professional financial planning advice.

Irrespective of which option you favour  (or even a combination) having an idea of the impact of making a financial decision can only be a good thing.

This is where a financial planner can help, doesn’t have to be me but I would recommend employing a financial planner to look at this with you.

A good financial planner will charge you a fee and will therefore not be conflicted to sell you something to get paid.

They will help you to understand and to clarify what it is that is important to you and why you think that either a property or a pension is a way of achieving that.

They can test how sensitive you are to changes in interest rates, help you to understand what the risks are and should spend time with you understanding what attitude to risk is, how much risk you may need to take and whether you can afford the losses that may arise from taking this risk.

If you are looking for a financial planner, look for one that is either Chartered or Certified, not the be all and end all but at east shows that they take their position seriously and have been willing to commit many hours of study to gain those qualifications.

Also look for a firm that you pay a fee to. You may have to write out a cheque for the fee but you will do so knowing that they are being paid to work for you, not to flog you something.

Most importantly and perhaps the most difficult thing to gauge without meeting someone is to choose someone you can be open and honest with. For this to happen you will need to trust that person and again this may be difficult without meeting them.

Trust is essential because there may come a time when your financial planner tells you that you are making a bad decision. If you do not trust them you may feel that they don’t have your best interests at heart and you could ignore them.

It then doesn’t really matter who is right or wrong, the value in that relationship has disappeared. Having an objective third party between you and a bad decision can prove to be valuable and so you should look to work with someone you can have this kind of relationship with.