Property or pension: Where downsizing could pay off

With a large proportion of household wealth tied up in property, many intend to free some of it up at retirement to fund all or part of their financial needs in old age.

A report by insurer Royal London, 'The downsizing delusion', based on Baring’s annual retirement survey, found that circa 3m people, or 8 per cent of the UK’s working population, are planning to use the value of their home – after downsizing – to fund their retirement, rather than using a workplace pension. This is an increase from 7 per cent in 2014 and 5 per cent in 2013.

The average DC pension pot is not that large. Why not tap into an asset you already have?

Damian Stancombe, Barnett Waddingham

But if looked at in terms of income replacement, some could end up being disappointed. While an average detached house in the UK is worth £310,000, a smaller semi-detached house is worth £197,000; this downsizing example would create an income of £13,700, the research showed.

This compares with an average UK annual income of £27,400, which would essentially mean a downsizer’s income would on average be halved at retirement.

Market slumps

Royal London also warned there are significant obstacles to downsizing. House prices are volatile in the UK following Brexit and might be low at the date someone plans to retire. A report by the Royal Institution of Chartered Surveyors for June said activity in the housing market was at its lowest since mid-2008. The Royal London report also said that ever more people are expected to still be paying off their mortgage at and beyond typical retirement age.

The report found that using a downsizing strategy instead of a pension would result in a UK average income slump of 50 per cent, but that in some areas the reduction would be even greater.

Northern Ireland, Scotland, Wales, and the North East of England would all see downsize proceeds constitute less than 50 per cent of an average national income.

Driven by distrust

Steve Webb, director of policy at Royal London, noted that this strategy would not be feasible in areas with low property prices, and added: “This is mostly a London and South East phenomenon.”

He said the strategy is being driven by those who “don’t trust pensions” and see property as “easy money”.

He conceded that the retirement income from a downsize “is probably not less” than a defined contribution pension would offer, but stressed that a pension “gives an immediate leg-up through tax relief and employer contributions”.

Webb stated that people are “absolutely not” sufficiently aware of the obstacles to downsizing listed in the report, claiming they have “an idealised notion” of the property market.

In this environment IFAs, employers and pension providers all have a responsibility to better inform people about the risks of a downsizing strategy, Webb said.

Double-edged sword

Mark Hayward, managing director of the National Association of Estate Agents, said his agency is not seeing a downsizing trend at the moment as there are few properties that would “match the expected quality of life at the right price”, and persistently low interest rates are not generating good returns on property.

At the moment, he said, retirees “are staying closer to friends and especially to family”, rather than relocating to smaller properties.

Moreover, in the UK, “retirement housing is at the lower end” and unappealing, he explained.

Hayward agreed that people are largely unaware of downsizing obstacles. He said that while “employers have a part to play” in raising awareness, it is a double-edged sword for them, because more people are unable to retire using only a DC pension.

Damian Stancombe, partner at consultancy Barnett Waddingham, said downsizing to fund retirement “is nothing new”.

He added: “Property has always been seen as part of someone’s holistic savings” in the pensions industry.

Stancombe said downsizing has its benefits. “The average DC pension pot is not that large,” he said, and added that having other assets outside a workplace pension is a good diversifier. “Why not tap into an asset you already have?”

Stancombe agreed that while downsizing can pay off, there are risks. He said workplace education can be a starting point to raise awareness, but added that the UK has a widespread problem of pensions education that employers and the Pensions Regulator alone cannot solve.