From April of this year people with private pension schemes have been given unprecedented access to the assets in their pension pots as part of a major change to the UK pension system. We are often asked what impact this may have on house prices – and so on future legacy values.

Until now, at the age of 55 people with a ‘defined contribution’ scheme could take 25% of their pension pot as a tax-free lump sum. Most of these people would then use the remaining assets to buy an annuity, providing a guaranteed income for the rest of their lives. With annuity rates falling over the past few years, there was increasing dissatisfaction with the straitjacket this system imposed.

To stop people abandoning their pensions schemes, there have been a number of changes in pension regulations over the past few years, culminating in the changes that came into effect this April. While the ability to take 25% of a pension pot as a tax-free lump sum remains in place, people can also take some or all of the remaining 75% as a lump sum (although this element would be subject to tax at that person’s marginal rate).

When this change was announced last year it led to – possibly far-fetched – concerns that people would be tempted to cash in their pension and blow it on exotic holidays and Lamborghinis! More realistically it was said that people might cash in their pensions and use the proceeds to invest in buy-to-let property, thus providing an alternative source of income during their retirement.

Research carried out by You Gov for investment advisor Old Mutual Wealth suggested that 11% of people approaching retirement were now planning to buy a second home, compared to an estimated 6% of pensioners who currently own one. Some commentators suggested that this increased interest in buying a second (or third) home was partly driven by people thinking about using their pensions pots to fund these investments. Such an increase in demand for housing stock would undoubtedly put further upward pressure on house prices (although it would also help to alleviate the shortage of rental properties).

There are a number of reasons why people might prefer to invest in housing to generate income, rather than other investments:

  • Residential property is generally seen as a less volatile and relatively safe long-term investment, when compared to other assets such as equities 

  • It can provide a regular rental income 

  • There may be strong capital appreciation in the property over the medium-to-long term
  • It is a tangible asset that people generally feel more comfortable with and understand better than other more complicated investment vehicles.

However, even though the YouGov figures may be correct and people approaching retirement age would like to buy a rental property, we think that in reality such an increase is unlikely.

Apart from the amount of time and effort that typically would have to be put into buying and managing a buy-to let property (which many newly retired pensioners wouldn’t want to take on) there are three other factors that will deter people from using their pension pots to buy property:

  • According to the Pension Policy Institute the average fund size used to buy an annuity is only around £25,000, which means that if the 25% tax free lump sum has been taken the overall pension pot in a ‘defined contribution’ pension scheme would be around £33,000. Such a sum would clearly be inadequate to purchase a property anywhere in the UK, and would mean that the pensioner would need to raise extra finance, probably through a mortgage. However, it is likely to prove difficult for many 55+ year olds to get a mortgage as lenders have been toughening their stance on borrowers who cannot repay their mortgage before retirement
  • Less than 25% of people reaching pension age today have a defined contribution scheme and so are affected by the new rules
  • The 75% lump sum that can now be taken on retirement is liable to tax at the marginal rate and so for those with pots of sufficient size to fund a reasonable element of the cost of a buy-to–let property, this might mean a tax rate of 45%. Such a tax charge would certainly deter people from such an action.

On balance then we think that the recent pension changes will have a minimal impact on UK house prices.