Although home ownership is an aspiration for the majority of us, increased property prices and rising interest rates mean it remains out of reach for many. So it’s tempting to think of using your pension as a way to own property, whether you want to live in it yourself or use it as a nest egg for the future. The bad news is, there are strict rules about what you can and can’t do when it comes to property and your pension, and you must tread carefully to avoid expensive mistakes. This guide outlines what you need to know.
Can I use my pension to buy a house?
While it's not illegal, there are stringent rules around including residential property as an investment within a Self-Invested Personal Pension (SIPP). If an investment is deemed to be residential, you lose all the usual tax advantages that come with a SIPP tax wrapper. You would face a hefty tax bill of up to 55% of the value of the property, with any investment gains on top generating another tax bill.
But that doesn’t mean you can’t have any property exposure in your pension. You can get this by investing in property funds, which will usually give you exposure to commercial property (think things like office buildings, shopping centres or industrial premises) or Real Estate Investment Trusts (REITs) if you want to own residential property. See below for more on this.
If you really want to buy your own residential property, you have the option of cashing in some of your pension pot and using it to buy a property when you are over 55 years old and can access your pension pot without incurring penalties. However, there are a number of things to consider before you go down that route. We explore them below.
Diversification
Your diversification may suffer if you decide to invest in property with your pension pot. If you had a well-diversified spread of investments in your pension, you would have spread your risk across a few different asset classes while your money was in the market and (hopefully) growing. When you cash out, you are now out of wider financial markets and exposed to just one thing – the property market – so you have lost your diversification benefits.
Although there was no guarantee all your stocks and funds would rise in value, it was likely that at least some of them would. Now your eggs are in one basket, so you’ll just have to hope that house prices will keep going up. Meanwhile, your cash is tied up in an illiquid asset which will take time to sell, and you may not get the price you want for it depending on what the market is doing at that time.
Tax
There are also a lot of different expenses associated with using pension money to buy a house. You can withdraw 25% of your pot tax-free after the age of 55 (due to go up to 57 from 2028) but anything above that will come with an income tax bill of as much as 45% depending on your tax bracket. If your provider doesn’t have an up-to-date tax code for you, you may also find you are charged emergency tax which you will have to reclaim later, so the total bill could be a bit of a shock.
Don’t forget about the inheritance tax implications too. If there is money left in your defined contribution pension when you die, it would not be subject to inheritance tax. But, if you bought a house with your pension savings, that house would form part of your estate and would be subject to IHT after your death.
Fees
Then there are the costs involved in the property purchase itself. Depending on the value of your property, you may have to pay stamp duty if the property is worth more than £250,000, unless you are a first-time buyer.
There will also be fees for a solicitor, a surveyor, and a mortgage adviser if you are using a mortgage to fund some of the purchase price.
Location
What about overseas property? If you’re thinking of using your pension fund to buy a property abroad, you need to think about all the points above, plus a few more. You should consider any local taxes you might pay, make sure you understand local regulations on property purchases and any currency risk you might face. Think carefully before buying off-plan properties, as there’s always a chance the build may never be finished, and keep your wits about you to avoid scams. If you are buying a holiday property, will you be using it yourself or letting it out? There will be costs associated with finding guests, and you’ll probably need a local agent to help you.
Can I use my pension to buy a commercial property or buy-to-let?
You can use your pension to buy commercial property and there are tax benefits to doing so. You could potentially get the benefit of capital appreciation and rental income, but you will avoid paying capital gains tax when you come to sell, and you won’t have to pay tax on any income the property generates if you hold it within your SIPP because it is a tax wrapper.
It’s quite common for business owners to buy the premises they work from so that the business ends up paying the rent and their pension fund benefits from the income.
Permitted property you could own in your SIPP includes shops, restaurants, office blocks or factories, garages, farmland, and even an airport, pub or zoo.
You can’t hold a buy-to-let property through your pension because it is classed as residential property, but you could pull your money out of your pension and use it to purchase one. In this scenario, you would be hit with an income tax bill on the money you withdrew (see above). Then you would also face tax on rental income, capital gains tax if you ever come to sell, and inheritance tax on the property after you die.
With buy-to-let, as well as the usual costs associated with buying a property like stamp duty, legal fees and the cost of surveys, there are other expenses to think about too. If you’re going to be a landlord, you will probably need insurance; you may have to engage a letting agent or property manager, there may be costs to carry out credit and reference checks on prospective tenants, and the risk they won’t pay their rent, plus ongoing maintenance and repair costs.
If you are using a mortgage to fund part of the purchase, bear in mind the changes to tax relief on mortgage interest which the government brought in to stop buy-to-let investors from offsetting their mortgage interest against their profits. The rule changes have made buy-to-let look much less like an obvious money-spinner for would-be landlords.
If you want exposure to property, a much cheaper and easier option is just to hold funds which invest either directly in physical property (known as ‘bricks and mortar funds’) or indirectly by holding shares of listed property companies like developers or housebuilders. Another option is to hold real estate investment trusts (REITs), which can give you exposure to both residential and commercial property. REITs are liquid and easy to trade on the open market just like shares, and they distribute most of the rental income they earn to their shareholders. Take a good look at the fund literature so you know which type is which and can be sure of what you are buying.
Is property a good alternative to a pension?
When it comes to retirement planning, there are pros and cons to choosing a property over a pension.
There’s no simple answer as the best option for you will depend on your individual circumstances, so get professional advice. But, in a nutshell, here are some of the key points.
Pros and cons of property for retirement planning
Pros:
- Property prices have seen a stratospheric rise in recent years, if this continues then the returns from property could dwarf those from other asset classes.
- You could get a regular yield from the property without having to wait until you reach age 55.
- You could release equity from the property if you need a cash injection.
- You can live in your investment or let it out.
- You own a physical asset which won’t disappear if the market falls.
Cons:
- There’s no guarantee property prices will continue to rise. Bubble fears may be justified as homes in some areas are now unaffordable even to those on above-average incomes.
- You need to make a big financial outlay at the start to buy a property, and this isn’t an option for everyone.
- Your capital is tied up and it might be hard to sell quickly, plus you may not get the price you want.
- Owning property can come with a lot of unwelcome tax liabilities.
- You may have to take on some debt to fund your property purchase.
- Equity release is typically expensive.
- You could end up in negative equity if property prices fall and you have a mortgage.
- It’s a lot less attractive to be a buy-to-let landlord now with fewer tax breaks.
- Repairs and maintenance can be costly.
- Tenants can be hard work and a financial risk.
Pros and cons of pensions for retirement planning
Pros:
- You can save a modest sum each month and it should still grow in the market due to compound interest.
- You can have a diversified portfolio which spreads your risk and is tailored to your risk appetite and life stage.
- Pensions are very tax efficient.
- You have a lot of investment choice.
- Your employer may contribute to your pension.
- You could buy an annuity to get guaranteed payments for life, although pension freedoms now mean you don’t have to.
Cons:
- Your money is locked away until you reach the age of 55, and then you can only withdraw 25% without incurring an income tax charge.
- Your pension scheme could run out of money and collapse.
- Financial markets could crash and wipe out a chunk of the value of your pension.
- Your pension may not grow enough to give you a comfortable retirement.
- Government tinkering means pension rules may change at any point.
- You will have to pay fees to your pension provider which will eat into your returns.
Summary
Ultimately, the best bet if you can afford it is to have a mix of both property and pension. Another option which could be a good compromise is a Lifetime ISA. It gives a generous government bonus of 25% on top of your annual contributions (you can save up to £4,000 a year). You can use it to save towards a property purchase or for retirement, but you can’t touch the money unless it is for either of those purposes (and you are aged 60 or over for the retirement option) without incurring a penalty and losing your bonus.
When choosing a pension provider, you will want to keep costs low so you can keep as much of your return as possible. To find the right product for you, check out our SIPP comparison page.
As we have demonstrated in this article, SIPP residential property rules and the tax implications are a bit of a minefield. If you are considering using a pension fund to buy a house, you really must take professional advice, ideally from a financial adviser in relation to your pension, and a mortgage adviser in relation to your property purchase. Don’t squander your hard-earned retirement fund by making a hasty decision which could cost you dearly in the long run.
How can you find a good independent financial adviser you can trust? A personal recommendation is ideal but if this isn’t possible, there are some useful and free online services you can use. For example, Unbiased* allows you to find an IFA near you by searching its database, plus it rates the financial advisers based on genuine client reviews. MoneytotheMasses.com readers can also get a free pension consultation* through Unbiased. You can also read our guide to finding the right financial adviser.
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