Property or pension; which is better to invest in as a contractor?

Many contractors hold the view that property is their pension, writes Hrishi Kulkarni, managing director of iSIPP.

The three Rs: rising, reliance and risk

With rising house prices over recent decades, it's easy to see the appeal of using rental income and property sales to fund retirement.

But relying solely on property while shunning SIPPs can be a risky strategy. Why? Well, not just because of our stubbornly shaky economy -- SIPPs offer unique advantages that make them an attractive option for retirement planning.

Property as a pension -- the advantages

For contractors, property investment may seem an attractive prospect when the going’s good. In competitive housing markets like the UK, property values have consistently increased over time. And despite the ongoing cost-of-living crisis, house prices appear to remain strong, which provides contractors with the potential to make substantial returns -- when they eventually sell.

What's more, buy-to-let properties can generate rental income, and quickly. If managed carefully, this extra cashflow could help fund lifestyle costs in later life. With demand for rental accommodation high, there's even potential for buoyant rental yields.

The risks of relying on residences in retirement

However, while returns can be strong, they are never guaranteed. Property markets experience periodic slumps and crashes. Over-exposure and tying up all retirement funds in illiquid assets like property could leave contractors cash-poor in old age, notably if the market takes a prolonged downturn.

Crucially, especially so for a time when you’re no longer working and could have health-related or medical costs, if money is needed quickly, property cannot be accessed as flexibly as SIPP savings. The process of selling properties, finding buyers and exchanging contracts makes it an inflexible asset. This lack of liquidity and access could cause major issues for those relying on property sales, or equity release, to supplement retirement income.

Where a Self-Invested Personal Pension comes into its own

By contrast, SIPPs offer contractors several advantages.

Chiefly, tax relief on contributions provides an attractive incentive. At the basic rate of tax, every £100 saved into a SIPP only costs £80 in terms of contributions from the contractor.

In addition to tax relief, pension investments can benefit from no tax on growth. Over the long term, this can allow pots to grow significantly above and beyond what is initially saved in.

SIPPS aren’t risk-free…

Be aware, SIPPs do involve some investment risk, as the pots are invested in stock markets. But they remain far less risky than most other asset classes. Sensible investment strategies within SIPPs can give exposure to growth while minimising risk.

Helpfully for contractors we know, SIPP funds can be withdrawn flexibly from the age of 55. This allows contractors to structure retirement income to match their needs. Options like tax-free lump sums, adjustable income drawdown, and annuity purchase provide extensive flexibility -- and that’s simply missing from reliance on property, or even on a property portfolio.

An ‘either-or’ approach?

Indeed, contractors relying solely on property for retirement savings potentially face significant challenges. That said, equity release, downsizing, or renting out rooms could theoretically supplement pension income but, be on guard, because this adds complexity and reliance on an illiquid asset class in retirement.

Don’t forget that ongoing costs like repairs, agent fees, and tenants' unpaid rent may also diminish income over time. And that’s assuming you have tenants continually -- void periods with no tenants will obviously eat into cashflow!

Final (security) considerations

So compared to the flexibility of SIPP withdrawal options, property seems a rigid and risky retirement-funding source. With considerably less upkeep required than bricks and mortar, SIPPs generally come with excellent tax, growth and access incentives which collectively underpin retirement security. We believe it’s the case that avoiding SIPP investment, or even just minimising it, in favour of property is a high-risk strategy for contractors -- and not just in the current climate. While a second property can be useful for contractors, a balanced approach using both SIPPs and some property exposure is likely to deliver the best long-term returns.

Find out more about iSIPP here.

Disclaimer from the author, iSIPP:

As with all investing, your capital is at risk. The value of your portfolio with us can go down as well as up and you may get back less than you invest. We do not provide investment advice.

iSIPP is a trading name of iPensions Group Limited registered in England and Wales with Company Number 03683070 with the registered office at 2nd Floor, Marshall House, 2 Park Avenue, Sale, M33 6HE. Authorised and regulated by the Financial Conduct Authority, Licence Number 464521.