Your home as retirement fund – the pros and cons
New research suggests that homeowners are saving less into pensions than people who rent their properties. Some are clearly banking on their house as a source of money in later life – but when it comes to retirement, is property or a pension your best friend?
Here’s a new one: if you own your own home, you could end up poorer in retirement than those who don’t. At least, that’s the extraordinary suggestion from the National Institute for Economic and Social Research (NIESR). Based on their latest data, people with a mortgage to pay off are saving less into their pensions, resulting in an average 15 per cent less pension income in retirement.
Yes, but hang on a minute…
The obvious riposte to this is that property is itself an investment. The homeowner may indeed be paying less money into their pension, but that’s because they’re putting that money into their home. Aside from the interest on the mortgage, the money is still theirs – just locked away in bricks and mortar. And given that property prices tend to increase over time, the homeowner could argue that their investment is just as good, if not better.
So who’s right?
Historically, property has indeed proved a relatively sound investment. House prices tend to grow for long periods between each crash, feeding the perception that property always increases in value. Nevertheless, it would be a mistake to think, ‘My house is my pension’ and rely mostly on its value to support you in retirement. Here’s why.
Eggs + (1 x basket) = error
First of all, there’s the diversification rule (shown above as an equation). No experienced investor would ever contemplate sinking all (or nearly all) of their wealth into a single asset class – in this case, property. In the event of a crash, which might coincide with your retirement, you have no plan B.
Secondly, you need to consider accessibility. Property is one of the least ‘liquid’ of all assets – it’s not always easy to turn it into spendable cash, especially if you’re living in it at the time. There are ways to do this (see below) but they come at a cost.
Thirdly, even if property prices do soar, remember that you will still need somewhere to live in retirement. If you intend to move into a smaller place, remember that the smaller home will also have risen in value – so you may not have as much money left over as you hoped.
Where pensions beat property
Property remains a decent long-term investment, and there are certainly more good reasons to buy your own home than to rent for your whole life. However, you shouldn’t pour all your money into your home at the expense of your pension. Pensions retain many advantages over property, including tax relief (effectively money back from the government), employer contributions (in the case of most workplace pensions), lower volatility (as they invest in a broad range of assets), and greater accessibility and flexibility.
Nevertheless, many people do use the value of their home to supplement their retirement income. You can do this by downsizing to a cheaper property, or by renting out one or more rooms. Alternatively, you may want to consider equity release.
Equity release is the process of turning some (occasionally all) of the value of your home into spendable cash, while continuing to live there. Equity here is defined as the portion of your home that you own once any mortgage has been paid off. Many people approaching retirement age may be fortunate enough to have 100 per cent equity, having paid off their mortgage.
There are two main kinds of equity release: a lifetime mortgage, and a home reversion plan.
A lifetime mortgage is a loan secured against the value of your home. You receive a tax-free cash lump sum to spend as you wish, and the loan is repaid from the value of your home when it is sold (usually when you and your partner either die or move into long-term care). The loan will accumulate compound interest, so the amount repaid will be greater than the sum you received. The amount you can borrow is usually between 18 per cent and 50 per cent of the property’s total value – typically the older you are, the more you can release.
Home reversion plans
This is where you sell part or all of your home to a specialist company in exchange for a tax-free cash lump sum, with a guaranteed lifetime lease that entitles you to continue living in the property rent-free for as long as you wish. If you retain ownership of any portion of the property, you also benefit proportionally from any increase in its value.
With both lifetime mortgages and home reversion plans, you are protected from negative equity (that is, the risk that you or your beneficiaries will end up owing more to the provider than the property is worth). Provided that the scheme is approved by the Equity Release Council, any shortfall at the end will be written off.
Is equity release right for me?
Although equity release can be a very useful way to release the stored-up value in your home, it’s important to consider all the implications.
You should discuss the option with your children and any other potential beneficiaries, as by choosing equity release you would be reducing the amount they would inherit. Remember too that some of the value of the home will end up going to the provider, whether through interest payments on the lifetime mortgage or the terms of the home reversion plan.
If you have bought your house on an interest-only mortgage and do not have the money to pay this off, equity release may be a way to repay the loan.
Unlocking the value of your home is always a major decision, so you should take full financial advice before proceeding. A financial adviser can help you decide whether it suits your needs and goals, whether or not other options exist, and which is the best form of equity release for you.
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