Pension or property: Which is the better investment?

Both pensions and property investments can deliver long-term growth – and, when it comes to funding your retirement, both could have an important role to play.

Here we weigh up the advantages and limitations of both property (whether buy-to-let or your own home) and pensions as a source of retirement funds.

What are the pros of property investment?

When it comes to picking an investment most likely to grow over the years, property has long been seen as a good choice.

When it comes to picking an investment most likely to grow over the years, property has long been seen as a good choice.

The UK property market has been famously bullish despite the occasional slump, typically lasting a few years. And as property values have soared in recent decades, some investors have capitalised on the trend of building property portfolios worth hundreds of thousands of pounds.

While demand for buy-to-let properties has decreased over recent years, demand for rentals is outstripping supply, so property investment is still attractive.

Rental yields and capital growth

Along with rental income, the potential increase in value of the property over time can deliver a sizeable profit when you come to sell.

The combination of rental yields and capital growth means you have both immediate income and the potential for long-term profit. You also have the option to sell the property at any point and invest the money in other ways.

Those are the main advantages of this kind of investment, although property isn’t without its drawbacks, too.

What are the cons of property investment?

Like any financial asset, investing in property carries risk. Burgeoning house prices have often produced a great return, but this isn’t guaranteed.

When working out the rental yields you could expect from a property, you’ll need to consider costs such as maintenance, repairs, insurance and other fees. You’ll need to pay tax on your rental income as well.

Capital growth – how much the property is likely to be worth when you come to sell compared to what you paid for it – is also an important factor.

Liquidity may be your biggest problem – that is, how easy (or hard) it is to get your money out when you need it.

Selling a property can take many months, so if you are relying on the proceeds for your retirement, then you’ll need to plan well in advance. You’ll also need backup plans in case a sale falls through or the markets crash.

Practical burdens and lack of flexibility

If you’re planning to fund your retirement from rent alone, bear in mind that this may not be enough to bring you the income you need, especially if you still have mortgages to pay on any property.

Also, bear in mind that being a landlord isn’t an easy job, and you may not want this responsibility as you grow older.

You can, of course, get an agency to handle most of it, but this may be costly.

Increasingly, you may also feel you have less control over your investment. The new Renters Rights Act, for example, will make it harder to raise rents and evict tenants.

Property also isn’t very flexible. You can’t just put an extra £10,000 or so into a property – it forces you to invest in chunks of many tens or even hundreds of thousands of pounds.

This can limit your ability to expand your portfolio unless you are already very wealthy.

Tips for choosing the right property

Investing in the right property, in the right location, and with the right mortgage, is essential for a high rental return.

If any of these factors aren’t spot on, your investment may not give you the results you’re after.

Choosing the right location is often the most important thing when it comes to investment growth.

This article explores the best areas for buy-to-let in the UK. 

Is buy-to-let still worth it?

Some people choose buy-to-let as a retirement income, often taking tens of thousands of pounds out of their pension pot to fund it.

If you’re considering this, it’s essential to speak to a financial adviser first, as raiding your pension pot can have big implications, and there could be extra income tax to pay.

Despite some challenging conditions in the property market, there are still advantages to buy-to-let, including:

• You’ll earn rental income.

• At the same time, you could generate capital growth as your money grows and your property value increases.

• You can take out insurance to cover against loss of rental income, damage and legal costs.

But you’ll need to consider the disadvantages too:

• Your tax bill will be higher than it once was, and it will impact your profits.

• If you don’t have the right insurance in place, you might not generate an income if the property is unoccupied.

• If property prices fall, your capital will. And if you have an interest-only mortgage, you’ll need to make up for any shortfall if the property sells for less than you bought it for.

• You’ll need to factor in the costs of stamp duty, insurance and wear and tear.

• You’ll have the responsibility of being a landlord.

Recent tax changes for landlords

It’s also important to note that there have been many tax changes over the last few years that affect landlords, including no longer being able to offset mortgage interest payments against rental income.

While landlords get a 20% tax credit, this isn’t as beneficial for higher-rate and additional-rate taxpayers.

In April 2024, the capital gains tax (CGT) allowance was reduced to £3,000. So, if you’re selling a second property, you will pay more tax than in previous years. The CGT rate for landlords is 18% for basic-rate taxpayers and 24% for higher and additional-rate taxpayers.

Private residence relief changed in April 2020. Previously, if you lived in your property before letting it to tenants, you’d get private residence relief when you came to sell.

This meant you wouldn’t pay any capital gains tax for the time you lived in the property, plus an extra 18 months after you moved out. But under the changed rules this has been reduced to nine months.

The £40,000 of lettings relief (which you can claim if you rent out a property that’s been your main home) will only apply to landlords who share an occupancy with their tenants.

Finally, when you buy a second property, you’ll now also need to pay a higher rate of stamp duty (a 5% surcharge).

What are the pros of investing in your pension?

A pension is basically a long-term investment plan with the added benefit of tax relief on your contributions, equivalent to the rate of income tax that you pay.

Getting tax relief on pensions means some of your money that would have gone to the government as the tax goes into your pension instead.

Most pensions today are defined contribution schemes (though some employers offer salary-related defined benefit schemes, mainly in the public sector).

Both enjoy the same tax advantages, making them more efficient investment vehicles than any other mainstream product.

Tax benefits and compound growth

As you save into a pension pot, it builds compound interest over many years.

The earlier you start investing in a pension, the more you’ll benefit, as the interest itself earns more interest and the whole pot grows faster.

If you have a self-invested personal pension (SIPP), you can take more control over the types of investments you include in it. You can even invest in commercial property via your SIPP.

Learn more: SIPP vs ISA: which should you choose?

When you are old enough to start taking money out of your pension, you can take 25% tax-free. The remainder will be taxed as income.

What are the cons of investing in your pension?

The only real disadvantage of putting money into a pension is that you can’t access it until you’re at least 55 (this is set to rise to 57 in April 2028).

But given that the whole purpose of a pension is to invest for retirement, this shouldn’t be considered a drawback.

You’ll also need to pay income tax when you come to withdraw a pension income, although you can take the first 25% tax-free as a lump sum. But bear in mind that if you are comparing pensions with property, rental income would be taxable too.

If you expect to need access to additional funds before you reach 55 or 57, you should set up other investments in addition to your pension, for example, a stocks and shares ISAs – a financial adviser can help.

Market risks and drawdown management

Given that your pension will be invested in stocks and shares, there’s risk involved.

However, this risk is significantly less than with other similar investments, since tax relief adds such a sizeable bonus.

You can also move your pension into less risky investments as you approach retirement age to reduce the risk of last-minute losses.

The main area of risk with pensions occurs if you decide to use drawdown to take money out.

With income drawdown, your money remains invested in the stock market, and you make withdrawals as and when you need. But your income is not guaranteed as it would be if you bought an annuity. If you take too much out, you could run out of money.

However, with the right advice, you can mitigate the risk here too.

Which option has most tax benefits?

Pension contributions benefit from tax relief, giving your retirement pot an instant boost.

Once contributed, the investments in your pension are sheltered from income and capital gains tax too, which can make a significant difference to the value of your pension pot over the years.

Increasing tax burdens on property

The tax rules on property have been getting less generous.

When buying a property, you’ll need to pay stamp duty land tax, as well as other fees for conveyancing and surveys.

There is an additional 5% stamp duty charge for residential property if it is in addition to your primary residence – this is on top of the normal stamp duty rates that apply for primary residences.

In addition, income from buy-to-let needs to be declared as part of your self-assessment tax return.

The tax on your income is then charged in accordance with your income tax banding – 20% for basic rate taxpayers, 40% for higher rate, and 45% for additional rate.

From April 2027, the rates of tax on property income will rise by 2% to 22%, 42% or 47%, depending on your tax band.

When the time comes to sell your investment property, there may be capital gains tax to pay if the value of the property has risen.

In short, when it comes to tax, pensions win hands-down.

Which is the less risky investment, your pension or property?

If property price growth slows, buy-to-let can be risky. If you have a mortgage, you could be left in negative equity if house prices fall, meaning you’ve paid more for the property than it’s worth.

With pensions, some defined benefit (final salary) schemes in the private sector have come under scrutiny recently.

The collapse of firms, including construction giant Carillion and department chain BHS – and the resultant effect on their pension funds – has led many people to question whether their pension schemes are as safe as they once thought.

Fortunately, these pensions are protected. If your employer goes bust before you retire and you have a final salary pension, you will still get a guaranteed income.

If you have a defined contribution pension, it won’t be affected even if your employer goes bust, as it’s not connected to them in any way.

In the unlikely event your pension provider goes bust, you can get compensation from the Financial Services Compensation Scheme (FSCS) as long as your pension provider is authorised by the Financial Conduct Authority (FCA). 

Your defined contribution pension can lose value if the stock market falls, but over a long period, its growth is likely to be positive – as likely as property growth, anyway.

Which has the better potential returns?

Investment income is money that someone earns from an increase in the value of investments. It includes dividends, capital gains from property sales and interest earned on savings accounts.

So how do property investment and pensions compare?

In recent decades, property values have shown phenomenal growth. However, changes in how property is taxed have meant that the big gains from rising house prices may be harder to replicate in the future.

It’s unlikely you’ll end up with less than you’ve put into a pension, although this is a risk with any type of investment. 

Can I use my house as a pension?

The real question is, ‘Can I use my house to fund my retirement?’ since a house is not a pension (because pensions get tax relief and houses don’t).

Property is one of the least ‘liquid’ of all assets, which means it’s not always easy to turn it into spendable cash, especially if you’re living in it at the time. The money in your property is locked away in bricks and mortar.

But there are ways to access it.

One way is to sell up: if you downsize and buy a cheaper property, you can pocket the difference to help fund your retirement. 

But the catch is that after fees and charges, you might not raise as much as you’d hoped, as few people will want to make significant changes to their quality of life.

Alternatively, you have the option of equity release to fund your retirement.

Equity release is the process of turning some of the value of your home into spendable cash, while continuing to live there.

Many people approaching retirement age may be fortunate enough to have 100% equity, having paid off their mortgage.

Although equity release can be a useful way to release the stored-up value in your home, it’s important to consider the implications.

Considerations for equity release

Most equity release plans are now lifetime mortgages.

This involves taking out a loan against your home, but rather than making monthly repayments, the interest rolls up, and the loan is only repaid when you die or move into a care home. This means that the longer you live, the more expensive your loan becomes.

So, by choosing equity release, you would be reducing the amount your children and other beneficiaries would inherit (although no negative equity guarantees mean you should never owe more than the sale value of the property).

Pensions retain many advantages over property, including tax relief, employer contributions via workplace pensions, lower volatility (as they invest in a broad range of assets), and greater accessibility and flexibility.

In reality, downsizing or equity release might be a helpful way of supplementing your retirement income if you only have a small pension, but it would be unwise to rely on either option entirely.

Should I seek professional financial advice?

Planning how you’ll fund your retirement requires a great deal of thought, so you’ll need to have peace of mind that you’ve made the best possible decision.

It’s always best to take financial advice first. A financial adviser can help you decide which route suits your needs and goals, so you can look forward to the retirement you’ve always dreamed of.

If you found this article helpful, you might also find our guide on pensions vs ISAs informative, too.