How to fund your retirement with property
Downsizing your home and equity release are ways to realise cash from your home
Both these options incur several costs
Buy-to-let property can provide retirement income, but this is a risky and labour intensive option
Most people’s main source of retirement income is pensions but other assets, including property, can also contribute to this in a number of ways. Whether or not property is a good way for you to generate part of your retirement income depends on a number of factors.
Downsizing your home
Selling your home and buying a new one for a lower value can help to fund your retirement. This can be possible if you have benefited from a long period of rising house prices meaning that the difference between the price of your existing and new homes is large. Living in a smaller home could also mean that your monthly bills are lower.
However, you should not over estimate how much you will get for your home as generally rising house prices don’t guarantee that you will get the amount you hope for. And although “the [property] market has remained buoyant for years that is not to say it will [continue],” says Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown (HL.).
Selling a property can take months and there is the risk that the sale falls through so you need to do it well in advance of when you need the money. If the property you want to move to is more expensive than you expect, it might not leave enough to cover your required retirement income and costs.
You need to consider if you could live in a smaller property if you are used to a home of a certain size. And if you have friends and family where you currently live would you really want to be at a distance from them? James Renn, mortgage support consultant at Timothy James & Partners, says he has had clients who downsized, but no longer had a support network in the area they moved to. They ended up moving back to where they originally lived incurring even more fees and expenses.
The costs of buying and selling include stamp duty, estate agents’ and solicitors’ fees, and removal companies’ charges, and will reduce the profit you make from downsizing.
Ann-Marie Atkins, managing partner, financial planning at Tilney Smith & Williamson, adds that you need to consider what you do with the capital you realise. If it is in cash inflation will erode its value so you need to put the time and effort into investing it appropriately, and be prepared for its value to fall if equity markets are volatile.
If you do not want to leave your home and are over age 55, you could consider equity release. This involves buying a financial product which offers you money as a lump sum or in a number of smaller amounts against some of the value of your home. The debt is settled when you die, go into care or sell the property.
There are two main types of product (see box). Equity release could be a good option if your home is valuable, especially if you have paid off the mortgage. Accessing the cash could be useful if your pensions income does not cover your costs, or could enable you to fund a large cost like travel or giving money to your family.
It can also be a way to reduce the value of your estate and potential inheritance tax (IHT) liability because debts are deducted from the value of an estate. And if you spend the money you realise or give it away and live for seven years after doing this it will not incur IHT.
However, if you take out an equity release product against the value of your home, when you die your children or other beneficiaries will not receive its full value. Louise Rycroft, financial planner at Timothy James & Partners, says to discuss equity release with your family before doing it so that they are aware of this. If you are very keen to leave a legacy equity release might not be a suitable option.
Equity release products are regulated by the Financial Conduct Authority and providers who are Equity Release Council members have to comply with further regulations to protect customers. These include a no negative equity guarantee which means that when your property is sold, and agents’ and solicitors’ fees have been paid, even if the amount left is not enough to repay the outstanding loan to the provider, you or your estate will not be liable to pay any more. The security of tenure means that you can live in your home for the rest of your life or until you go into care, as long as it remains your main residence and you abide by the terms and conditions of your contract.
However, rates of interest for equity release products are typically more expensive than for ordinary mortgages – between about 4 per cent and 7 per cent, according to comparison website Moneyfacts.co.uk. This means that it is particularly expensive if you let the interest this roll up. “By the time the property comes to be sold the outstanding balance could be much higher than the initial loan,” says Morrissey.
If you release equity from your home, you might not have as much value in your property to meet costs later in your life such as for care.
You have to pay arrangement fees for equity release products which can be between £1,500 and £3,000, according to government sponsored financial information website moneyhelper.org.uk. These include valuation, arrangement, solicitor’s and advice fees, as you cannot take out equity release without consulting an adviser.
Buy-to-let properties can provide a regular monthly income which is not correlated to equity market movements so provide diversification if another portion of your retirement income comes from equity investments. The capital value of the property might also increase.
Having a property in a good rental location is important because no tenant means no income, but costs such as mortgage repayments, maintenance and utility bills still need to be paid. Tenants can default on rent and legal action to remove a tenant who refuses to leave can be costly.
The rent from buy-to-let property contributes towards your income and could push you into a higher tax band, though you can deduct certain expenses from your rental income such as maintenance, insurance and letting agents’ fees when working out your taxable profit. You also get 20 per cent tax relief on mortgage interest payments.
If you sell a buy-to-let property, because it is not your primary home you are liable to capital gains tax (CGT) on the proceeds.
Because of this, Rycroft says that buy-to-let property could be better if you are a non or basic rate tax payer – alongside other income streams. And Atkins says that if you have a spouse or civil partner who is a non tax payer or in a lower tax band than yourself it could be more efficient for them to hold the buy a buy-to-let property. Or you could hold it jointly with them and make use of both of your tax allowances rather than just one.
Unlike securities such as funds and shares, you cannot sell small portions of buy-to-let properties if you want to realise some capital which also means that it is harder to diversify than portfolios of funds and shares. You may have all your money in one property and even if you have a few it is less varied than a portfolio of funds and shares can be, concentrating your risk.
When you purchase buy buy-to-let property you pay 3 per cent higher stamp duty than for primary homes, and costs such as insurance and ongoing maintenance reduce eat into your rental profit.
It takes time and effort to manage buy-to-let property which might not be possible or what you want as you get older, so you may have to sell the property or pay an agent to manage it.
You can hold certain types of commercial property in self invested personal pensions (Sipps). Sipps do not pay tax on the rental income from property and they sell property it does not incur CGT. The value of your Sipp can be passed onto your heirs outside of your estate for IHT purposes so it could be an efficient way to leave this asset to your family.
A Sipp can be a tax-efficient way to hold business premises such as surgeries, solicitors’ offices or factories while you are working, and it could continue to let the property after you have retired, even if you have sold your business, providing an income stream. Sipps can borrow up to 50 per cent of their value to buy a property so can invest in one worth more than the assets you have in them. Or your Sipp could jointly buy a property with other Sipps, for example, those of partners or colleagues.
Commercial property is not necessarily correlated with residential property so could diversify your home and portfolios of funds and shares.
But you have the risks of void periods when you have no tenants, the property falling in value and difficulty in selling. There is concentration risk because you are investing a large amount in one asset, rather than diversifying across various, and cannot sell small portions of it. Atkins points out that this could be a problem if you want to take your 25 per cent tax free lump sum from your pension and your Sipp does not also hold more liquid assets such as cash.
And other than the 25 per cent tax free entitlement, withdrawals from pensions are taxed at your marginal income tax rate.
Sipps which enable you to hold commercial property typically have higher charges than ones which just offer funds and shares, and there are extra costs associated with the property so administration charges could add up to £3,000 or more a year (see ‘Should I invest via a full-service Sipp?‘, IC, 27.05.22)
So Rycroft argues that this is an option for business owners who already have a commercial property.