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 weight 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.

The UK property market has been famously bullish despite the occasion slump typically lasting a few years. And as property values have soared over the last few years, 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.

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, tax and other fees.

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.

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.

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, which can be tricky as rates have recently soared, is essential for a high rental return.

If any of these factors aren’t spot on, your investment may not give you the financial 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?

Lots of 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 (though possibly less than in previous years)
• 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 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 also 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

It’s also important to note 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.

What are the pros of investing in your pension?

A pension is basically a long-term investment plan with tax relief.

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

As you save into a pension pot, it builds up compound interest over a period of 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?

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.

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 – a financial adviser can help.

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.

Also, you can 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 choose a drawdown scheme.

This keeps your pension investment in the stock market during your retirement. However, with the right advice you can mitigate the risk here too.

Which option has most tax benefits?

Pension contributions benefit from tax relief.

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

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.

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 less risky?

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 Carilion 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, pensions are protected. However, if your employer goes bust before you retire and you have a final salary pension, you may lose a small proportion of your pot.

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.

However, a house does give you 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.

By choosing equity release, you would be reducing the amount your children and other beneficiaries would inherit.

Some of the value of the home will also end up going to the provider of the equity release plan. Sometimes this arrangement can work out very unfairly for the homeowner.

If you intend to sell your property to move into a smaller place, the smaller home will also have risen in value – so you may not have as much money left over as you hoped.

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.

Should I seek professional financial advice?

Planning how you’ll fund your retirement requires a great deal of thought so you’ll 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.