Pension freedoms: Lump Sum vs Property Investment

Written by: Simon Morris, founder of Morris Properties
With investors eager to access and release pension capital, it’s worth analysing the risks of this strategy – and the calculations investors need to make before investing a lump sum pension in property.

On 6th April reforms came into effect that allow people who are 55 or older with a defined-contribution pension to remove their money as a lump sum instead of buying an annuity. Retirees are allowed to remove 25 per cent of their pension fund tax-free, whilst the remainder will be taxed at the same rate as income.

Research indicates that a third of people between 45 and 64 may cash in their pension pots to invest in the buy-to-let market. Statistics show that every £1,000 invested in the buy-to-let sector in 1996 is now worth £13,048. With interest rates remaining low, property seems like a relatively risk-free investment opportunity.

Investment is a risk vs reward game. You may be able to withdraw 25 per cent of your pension tax free, but the rest will be taxed at a considerable rate. Will you regain your investment or will you lose your pension fund? And how long will it take to make a profit?
There’s a lot of risk involved in taking out a pension as a lump sum to invest in buy-to-let. The three key risks of investing into buy-to-let are:

  1. Tenants can be unreliable and property could remain empty for periods of time – this results in an investor covering the mortgage and bills when the property is unoccupied.
  2. Property prices do increase, but they can also plummet. Your original investment is not secure or guaranteed. London has seen significant house price rises in the last few years, but these increases are not UK-wide, so do your research in terms of location and history of property prices.
  3. Interest rates are currently low, so if you are using a pension lump sum as a deposit and buying the property with a mortgage, it’s likely that interest rates will increase and so too will your repayments.

Morris also suggested that potential investors need to take several measures before they cash in their pension as a lump sum to invest in property. Ideally, you should reserve taking out a lump sum as a last resort and be wary of cold calling companies who are selling products to you. Decide on your own, then research companies and use an Independent Financial Advisor (IFA) to choose the best product for you.

An experienced IFA will weigh up your appetite for risk against your expectations regarding yield, to point you in the direction of the right financial product for your circumstances.

I also advise retirees to look at alternative property investment vehicles.

You don’t need to invest in bricks and mortar stock to capitalise on UK property. You could consider property bonds and funds. They can provide you with tax advantages when they’re used within an ISA wrapper and some products guarantee your initial investment. I would always suggest that a potential investor seeks as much independent advice as they can and opt for a regulated investment product if they want to generate healthy returns.

I’d also suggest that investors take some time to look at the free guide to property investing in 2015 before they commit to any investment option. This guide was written to give private and commercial investors the information they need to ensure they are asking sensible questions prior to taking out any financial product.

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