Pension vs property: which option provides the best income for your retirement?

Investing in a pension or a property are seen as good long-term strategies for maximising your retirement income. But which is better?

With growing uncertainty about the future of the state pension and the cost of retirement increasing, it’s becoming increasingly apparent that wannabe retirees will need to do more to plan for their financial future. Even now, more pensioners are having to consider part-time work to top up their pots.

Taking advantage of company schemes and investing in your own pension pot are ways to ensure you can afford a comfortable retirement. However, recent research has found people are currently grappling with smaller pension pots than anticipated.

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Meanwhile, investing in property - usually through buy-to-let homes - has been seen as a sure-fire way of generating enough income for retirement. This strategy has also faced challenges in recent years as mortgage rates have soared, and house prices have stalled.

So, which strategy comes out on top? Wealth manager Netwealth has crunched the numbers. Here’s what it has found.

Pension vs. property gap has widened year-on-year, Netwealth finds

To find out which retirement strategy came out on top, Netwealth took a £50,000 pension pot and a property investment pot of £50,000. It then compared the average financial returns of both over a 20-year period.

To work these out, it applied the tax bills and additional costs an investor would expect to incur over the time frame (assuming current rates continued for the next two decades). It also assumed typical property values and annual growth rates from 2023 applied to the two different strategies.

What it found was that the pension pot grew to £147,000, while the property investment increased to £83,000 on average - a difference of £64,000. It means an investment in a pension offered a 77% better return than one in property - a jump from the 38% gap recorded by Netwealth in last year’s research.

The flexibility and tax relief provided by a pension was cited as a major reason why it performed better than property. The initial £50,000 investment would have immediately gained tax relief of almost £16,700. Assuming the pot grew 5% annually, it would stand at almost £150,000 by the end of the 20-year horizon.

For property, maintenance, tax and fees were all negatives. Assuming a buy-to-let property was bought for just under £170,000 with a 25% deposit (a typical figure, according to Netwealth’s analysis), the cost of stamp duty and purchase fees (including solicitor and surveying costs), followed by mortgage interest, capital gains tax and the general costs of letting a home (such as maintenance and letting agent fees) would all serve to slow the investment down.

Worse still for property investors, say there was a base of 0% capital growth over the two-decade time period, the value of the investment would tumble from £50,000 to £7,225. In fact, purchase and sales costs combined with letting fees would wipe out the gross rental yield a buy-to-let could achieve if there was no capital growth over the 20 years.

This situation has been made even more desperate by the current 16-year high Bank of England base rate, which could remain frozen for several months yet.

Pensions a 'more worthwhile' investment, Netwealth says

Commenting on the findings, the CEO of Netwealth Charlotte Ransom said: “In light of current economic challenges, the combination of high interest rates and the associated costs of buying and managing properties has seen property investment fall out of favour as a way to fund retirement. While the British love affair with property has long made it a popular asset in recent years, housing has become less affordable and less attractive as an investment due to dwindling returns and cuts to tax relief for landlords.

“As our data shows, pensions are proving to be an increasingly valuable, reliable and less burdensome alternative. The appeal of additional pension contributions is only further reinforced by the government’s abolishment of the lifetime allowance, currently set at £1,073,100, enabling savers to contribute more to their pensions without incurring tax should they breach the former limit.”

Ransom added: “In order to make the most of retirement savings, it’s important to make a proactive decision about what your pension and retirement savings are invested in, and to ensure you have exposure to appropriate returns to line up with your needs during retirement.”

She said property would be unlikely to make up any significant ground on pensions “in the short to medium term”. Ransom added that the tax perks you can get on a pension make it a “truly compelling” and “worthwhile” option for investors.