House or pension?

Bob Champion | Later Life Academy
5th June 2019
Bob Champion LLA Later Life Academy
"Owning the house you live in is effectively owning a utility, not an investment."

The view of the pensions industry is that people are not saving enough into their pensions. The 8% of band earnings that is the current minimum contribution into an auto-enrolment pension is not enough for an adequate income in retirement - this figure should be 12%, others argue for more.

But what is an adequate retirement income? Michelle is buying her own house. Ricardo is renting and has no prospect of owning his own house. According to Royal London, Ricardo will need £180k more in his pension pot than Michelle to pay his rent after he retires. That’s a not inconsiderable amount in anyone’s language.

Aegon recently published a report saying that a break in paying pension contributions could be costly. A break of 10 years for someone in their 20s could mean that an expected retirement fund of £398,900 at State pension age would be reduced by £91,600.

A common reason for taking a break in paying pension contributions is the need to save for a house deposit. On the basis of the above numbers, if Michelle had taken a 10-year pension contribution holiday she would still be nearly £90k better off than Ricardo over their respective retirements. This also ignores the value of the house Michelle will own and how she may use that house to enhance her retirement income.

However, pension contributions are probably the most efficient retirement savings that can be made. In addition to your own contributions you receive an employer contribution and tax relief. The basic 4% net auto-enrolment contribution is effectively doubled. This shows the fallacy of the pension or house debate and it’s therefore clear that some new thinking is required.

Any action should have a result in mind though. The result is a financially comfortable retirement, but how can that result be achieved? For instance, you do not know:

• When you will retire;
• How long you will live after you retire;
• What your retirement spending requirements will be; and
• For younger people, when your State pension will be paid.

You do however know that you will need somewhere to live in retirement and the State pension is unlikely to provide an adequate retirement lifestyle. Therefore, you will need some savings to live off. At times when house prices are booming it seems everyone talks about how much money they have made. But, let’s be clear here, they have not made that money unless they have sold for a profit and acquired a similar home at a lower price.

From a retirement planning point of view, they should be looking at what it costs to rent suitable accommodation in retirement for 20 or more years. That is the contribution the house they are living in is making to their retirement if the mortgage is paid off.

Owning the house you live in is effectively owning a utility, not an investment. If you own a five-bedroom detached home in retirement, you will not be saving the amount of rent that property could generate. You are only saving the rent of the accommodation you actually need.

A bonus of owning a home in retirement is that it can contribute to your retirement income. You can release equity by moving to a house that costs less or by using the various equity release plans that are available. More needs to be done to increase the understanding of the contribution home ownership can add to retirement.

In pure investment terms owning one house is a high-risk investment. When purchased it could be in the catchment area of a highly sought-after school. If, whilst you own it, the head teacher changes and the school deteriorates, you will lose the premium you paid to acquire the house. There can be other local market issues that could affect the value of your property differently to the market as a whole. Home ownership as an investment should be viewed similarly to owning shares in one company.

On the other hand, as can be seen from Royal London’s numbers, to own your home in retirement contributes to your standard of living in retirement in that you do not have to spend a large proportion of your retirement income on rent.

We need to talk more about what the retirement goal is and how it can be achieved. It will not be achieved by pushing people into a pension versus home ownership dilemma. A rapid increase in minimum auto-enrolment contributions will by definition lead to a reduction in take-home pay - this will make it more difficult to save for deposits and to pay mortgages.

The effect could be, particularly among the young, an increase in the number who opt out of their employer’s pension scheme – this is a result no one wants. Therefore, the earlier people are introduced to holistic retirement planning the better, and advisers are clearly in the strongest position possible to make this introduction.

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