Don't Rely On Your Property For Your Pension!

Why using your home to fund your retirement could be a risky strategy.

When I write about retirement planning, I often receive comments from Fools that express their profound dislike of pensions.

This post from debtwagon regarding my recent article A New Way To Boost Your Pension Income sums up this sentiment pretty well:

"Conclusion - all pensions are a waste of time... Put your money somewhere else, where you have access and control over it. It's about time that the whole pensions rip-off had the rug pulled from under it."

True, saving in a pension means no access until you're 50 -- or 55 from April 2010. And unless you manage the fund yourself, you will have to give up control to someone else. But I can't agree that pensions are a waste of time.

Personally, I advocate pensions as an effective way of saving for the future. 

But I can understand why so many Fools have turned their backs on them. After all, the mis-selling scandal of the late 80s has deeply damaged the reputation of the pensions industry. What's more, heavy charges and the poor performance of some  schemes has made pensions seem unappealing across the board.    

Popular property

It's no wonder then that many of you would prefer to rely on an alternative income source in your retirement. And of the alternatives available, property is one of the most popular. Last year, as many as seven million homeowners intended to release equity from their homes to supplement their retirement income. (If you want to know more, read Will Your Home Be A Good Pension?)

At that time, my fellow Fool Cliff D'Arcy, warned against relying too heavily on property for your pension. He said strong house price growth couldn't be guaranteed forever -- and he was right. As we all know, house prices are now falling. Predictably, many people -- who were planning to use their homes as pensions -- are beginning to re-think their strategy. 

According to recent research by Barings Asset Management, 5% of the UK population -- that's 2.3 million Brits -- have reviewed their pension planning in the last year because of falling house prices. Barings said just 878,000 people now plan to use property alone to fund their retirement.

But it still concerns me that anyone is pinning their standard of living in retirement on the performance of a sole asset -- that is, their home.

While house prices have always recovered over the long term, if you're due to retire soon, prices are dropping at exactly the wrong time. If you're planning to unlock the value of your home through an equity release scheme, you could find the value of your home has fallen significantly just when you need the cash. If you have no other retirement savings, you could be left high and dry. 

But with pensions there's a chance to get round this problem. A properly diversified pension fund will be invested in a range of assets, so you don't need to rely on a single investment doing well.

That said, you don't necessarily have to use a pension to save for your retirement, but think very carefully before you reject it as an option.

Pensions have several other obvious benefits. Firstly, contributions qualify for tax relief. This means you will effectively get tax back on any money you pay into your pension, which is a valuable boost to your savings. Secondly, pensions grow virtually tax-free, although income taken from the fund through an annuity is taxable at normal income tax rates. And thirdly, pensions make a lot of sense if your employer is willing to contribute on your behalf.

Consider ISAs

If -- like debtwagon -- you're concerned about losing access to your savings, you could put some of it in a stocks and shares ISA, for instance. With an ISA you can draw on your money as you wish, and you don't have to give up your accumulated fund to an annuity provider when you want to take an income. This means you retain control over how and when you draw benefits.

And although there's no tax relief on ISAs contributions, your savings grow tax-free, and any money you take out is tax-free too. So the tax benefits of ISAs and pensions, while treated differently, are equivalent.

Most investment funds run by UK fund managers can usually be held in both pensions and ISAs, so  -- from an investment perspective -- they can be very similar too.

Whichever way you choose to save for your retirement, make sure your investments aren't too concentrated. Exposure to a range of assets -- including shares from different markets and sectors, as well as bonds and property --  is probably a good idea. In fact, exposure to property can be achieved by investing in the commercial property sector as well as your own home. 

Just remember the overall aim is to diversify your portfolio, so that assets which perform poorly are offset by those which are doing well. For more help with this read How To Invest Your Pension. The investment principles outlined in this article also apply to ISAs.

If you don't feel confident diversifying your portfolio this yourself, consider speaking to a good independent financial adviser.

Go it alone?

Both pensions and ISAs have been frequently criticised for poor performance. If you think you can do better than a fund manager, you could try your luck by investing directly in shares through a self-invested personal pension (SIPP) or a self-select ISA. Of course, these methods rely on much more hard work from you, and as very high-risk strategies, they aren't advisable for novice investors.

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