The danger of using property as a pension

Standard Life says the average monthly income retired people can expect to get from downsizing your home is just £190 per month*. It varies dramatically though, with someone moving from a terrace to a flat in the North West saving nothing, but someone moving from a detached to a bungalow in London saving perhaps £680pm.

For many people the income available from downsizing isn't going to be sufficient for retirement. If you try to rely on just one thing for your retirement you're taking considerable risk. That's why I recommend you make use of no less than three simple ways to prepare for life after work.

• Watch our Your two pence - Property vs pensions video

1. Use your home

I've already started on using your homes, so let's consider other ways to benefit from them in retirement. Rather than selling outright, you can sell part of your home in an 'equity release' deal. For a £160,000 property, a 65-year-old could get maybe £210pm, but quotes vary hugely, as do the terms and conditions.

I suspect the cost of equity-release products is rather high for two reasons: 1) the huge sales push on this product indicates it's very lucrative and 2) the cost is not easily understood by the public, making over-charging simpler. I have other misgivings, some of which are explained in this article, so do your research.

Despite that, equity release can be useful if you need more income and have no other options, and aren't looking to pass on your home to anyone.

Aside from downsizing and equity release, simply owning our own homes outright is likely to be a great investment, as we'll have no accommodation costs. That's the best bit about owning your own home.

Let's look at more ways to provide yourself with an income.

2. Invest

If you invest £200 per month for 35 years and make just 4% above inflation per year, you might expect to get about £860pm in retirement. If your retirement is nearer than that, you may have to invest more to get close to those returns (but I wouldn't recommend investing for less than ten years).

We don't know how well investments will perform in future, although we do know that over long periods of time the stock market has so far done well against inflation, despite its many big drops.

Investing for retirement doesn't necessarily mean pensions. Stocks and shares ISAs are increasingly becoming a better option for more people. Many of us should consider a combination of both.

Recent question on this topic

• Gary20006 asks:

  What is is the best thing I can do to get a retirement income?

  • 
    MikeGG1 answered "Gary If you are working abroad, you probably don't qualify for adding to your ISAs or for pension..."
  • 
    MikeGG1 answered "Make sure you don't overpay by more than the terms of your mortgage allow.  Typically,..."
  • Read more answers

There are pros and cons to either. With a pension, for example, the future tax situation is particularly uncertain, your money is tied in, claiming benefits is not flexible, and it's difficult to pass the pot to your children.

On the other hand, your employer will often contribute, instantly boosting your investments' performance, and the fact you can't get at the money for decades is good for those with low willpower.

Those two advantages for pensions are disadvantages for ISAs: your employer generally won't contribute and you can be tempted to blow the money before you retire.

On the other hand, ISAs are more flexible, they're less susceptible to retrospective raids from the taxman (but not necessarily immune) and you can pass your pot to your children (subject to inheritance tax for larger pots).

Both pensions and ISAs are currently tax advantageous in different ways, although that is subject to change (giving ISAs another plus, as you can withdraw your money were the change to be too horrendous).

You might consider using any contributions that your employer adds to a company pension scheme, and otherwise contribute to a shares ISA, but I encourage you to read further on this subject to make a suitable individual decision.

As for what your actual investments could be, we don't believe most people will go too far wrong with index trackers and ETFs.

Related how-to guide

Build up your savings

Here's how to get into the savings habit, find forgotten money, work out the real value of a savings rate and build up that emergency savings pot.

See the guide

3. Savings

We come to the most simple part of our simple plan, but an equally important one. Let's say you save £100pm for 35 years. You might over the years eat into half those savings for luxuries and emergencies but, at the end, you'll still have more than £20,000 after inflation. Expressing that as a retirement income again, that's about £100pm till you die.

Returns from savings aren't generally as high as from investments; you'll have to regularly switch accounts just to stay even with inflation. However, there's less risk of sudden falls than in the stock market. This cushion makes us feel safer and so we're less likely to have heart problems when our shares plunge. It also keeps some of our money more agile.

Plus, on nearing retirement, you'll probably want to preserve your investment gains by switching at least part of your investments away from the stock market to cash or other less risky things, such as government bonds.

What will our bonus be?

So, with such a three-pronged approach and no help from the government, we could perhaps hope for £960 from our savings and investments, and around £200pm from our property (although it depends on the property you have and whether you downsize or release equity).

Now we can make conservative estimates about what the government will give us. We don't know what we can expect from the state in the future and unless your retirement is imminent you shouldn't rely on it, but even if we halve the full basic state pension you'll get about £210pm, or £340pm for couples. That means we could achieve perhaps £1,370pm to £1,500pm.

These figures may seem low, but remember that you'll have paid off your mortgage and you'll have fewer bills as you get older. What's more, I've used quite conservative savings and investment figures. If you estimate you'll need more, you'll need to put more money in!

Open a better savings account at lovemoney.com

*All the monthly income figures in this piece are based, for simplicity's sake, on current annuity rates. An annuity is what you get when you cash in a pot of money for an income for the rest of your life (which is what most of us currently choose to do when we cash in our pension pots, for example). It may not be the most suitable way for you to generate an income from your home though, so do your research.