Don’t rely on downsizing to make up for your insufficient pension

After years of runaway house prices, few will be surprised that a sizeable proportion of the UK’s net wealth is tied up in property. The latest ONS statistics show that dwellings make up a massive 62 per cent, or £5.5 trillion, of the country’s £8.8 trillion total.

So it is also unsurprising that many see the equity locked up in their homes as a convenient way to boost their living standards in retirement, or even as an alternative to a pension.

Research last year from Legal & General found there are 3.3m “last time buyers” in the UK, people over 55 sitting on £820bn of property wealth who are looking to “rightsize” at some point in the future. Equity release – the name for a suite of products that enable homeowners to take money out of their property without selling up – is also rising in popularity. One leading provider KeyRetirement says customers released £633.8m of property wealth in the third quarter of this year, compared to £470.9m in the same period of 2015.

Hurdles

It’s an attractive proposition. The kids have flown the nest, your house is too big, and (if it’s your main property) you won’t pay capital gains tax at sale. Yet it’s almost certainly too good to be true.

The first problem is in the practicalities. Almost every recent report examining the wishes of older people has found significant proportions considering downsizing. Yet the actual numbers selling up for something smaller are quite low. Retirement house-builder McCarthy & Stone, for example, found that just 15 per cent of over 55s had done so.

There are a variety of reasons. There’s the emotional side, says Richard Parkin of Fidelity. It may involve moving out of your community, away from family and friends, an unappealing prospect as you get older. With children living with parents for longer, you may not even have the empty space to begin with.

Property is also illiquid. There’s no certainty you’ll be able to sell when you need to, and Lisa Caplan, head of financial advice at Nutmeg, adds that “unlocking that money is often more costly than you expect. You need to bear in mind the costs of stamp duty [on the new property], lawyers, estate agents, moving and decorating – and of course the cost to you in time and stress. Most people underestimate all of these.”

In common with other parts of the housing market, there is also a shortage of smaller homes suitable for retirees. According to Legal & General, just 2 per cent of the UK’s housing stock meets the needs of older people.

Equity release

For these reasons, rather than selling up entirely, many are looking afresh at the equity release market. “People have more confidence in the value of their properties than a few years ago,” says Nigel Waterson, chairman of the Equity Release Council. There has been substantial product innovation over the past few years too, he explains, with rising competition pushing costs down.

Within the category, the most popular option is the drawdown lifetime mortgage, which enables a borrower to negotiate a loan facility on their property and to withdraw money as they need it while paying (compound) interest on what they take out. “The agreement comes to an end when the person dies or goes into long-term care,” says Waterson. “At that point, the debt crystallises and the provider can sell the property. If there’s anything left over, it goes to the heirs.”

While this isn’t an option for everyone, as many will be concerned about requiring their heirs to sell the family home when they die, Waterson emphasises that Equity Release Council members offer a no negative equity guarantee, so borrowers never have to pay back more than the value of the house. Equity release should only be accessed via an independent financial adviser.

No country for young people

There is another side to all this. Bank of England chief economist Andy Haldane made headlines earlier this year when he was asked by a journalist which he thought was the better investment: a pension or property. “It ought to be a pension,” he replied, “but it’s almost certainly property.” But younger people would be unwise to follow his argument to its logical extreme and avoid pensions entirely in order to maximise the size of property they can buy.

Most obviously, pensions come with substantial tax benefits above and beyond what you can gain from investing in property. Upfront tax relief on contributions is particularly attractive for higher earners, and there is no capital gains tax or income tax levied on returns within your pension pot. Matched employer contributions into pensions make a big difference too, and employers are unlikely to increase your salary as compensation for opting out of a workplace pension scheme.

Second, while there’s obviously no certainty about the future performance of any investment, there are particular reasons to think house prices will not rise as strongly as they have done indefinitely. Parkin points out that the housing market has been boosted by cheap credit and low interest rates, and these won’t last forever. It may come to nothing, but the government has also indicated that it is newly serious about increasing supply rather than boosting demand, and building more homes could trim annual price growth. “House prices don’t always rise: negative equity was a very real thing in the 1990s, and house prices are not increasing throughout the UK,” says Caplan.

There are also problems involved in tying up all your capital in one place. You’re putting “all your eggs in one basket,” says Caplan. “A property investment isn’t diversified, it’s totally concentrated in the UK property market.” Any problems at sale could be disastrous if you have no other savings to rely on.

Confused priorities?

Beyond Haldane’s eye-catching comments, the property versus pension debate has taken on fresh relevance due to the coming introduction of the Lifetime Isa. This new savings vehicle will allow under 40s to contribute up to £4,000 annually, and then receive a 25 per cent bonus from the government on their contributions at the end of each tax year. While this money can be taken out tax-free in retirement, it can also be unlocked beforehand if it goes towards a deposit on a house worth up to £450,000. Government top-ups will cease at 50. While a pension can only be touched after the age of 55, you will be able to take money out of your Lifetime Isa for other purposes if you pay a sizeable tax charge.

A number of high-profile industry figures have sounded the alarm. If people defer pension saving until later in life (because they’re prioritising their Lifetime Isa contributions), said Royal London’s Steve Webb earlier this year, they could end up having to work until their 80s to get the sort of retirement their parents enjoyed. Graham Vidler of the Pensions and Lifetime Savings Association adds that “it is not clear how savers will be helped to choose an investment approach appropriate to their savings goals.”

While this debate can seem quite complicated, it does come down to something very simple: making extreme investment choices – whether putting everything into property, or everything into a pension – can leave you trapped. “Somebody who saves entirely through a pension will have to rent in retirement, and that can be expensive. Save exclusively through property and you will have no flexibility about selling your house as all your capital will be tied up,” says Caplan.

A survey released last week by the Pensions and Lifetime Savings Association found that one in five of those who had already used property to finance their retirement “felt they had no choice” but to do so. This is not a situation anyone should want to be in.