New pensions legislation risks further increasing pressure on Britain’s housing market. The new rules give people retiring on defined benefit (DB) or defined contribution (DC) schemes the ability to spend their pension pots how they want. However, I believe enough of them may put that cash into property and inflate house prices.
Since the new pension freedoms were announced by the chancellor in April last year, there has been a dramatic fall in the purchase of individual annuities by members of defined contribution schemes. Legal & General has estimated its sales of new annuities this year will be around half those of 2014 (1). Meanwhile research by Direct Line for Business estimated that almost a third of people aged 45 to 64 who have a pension would consider investing some, or all, of their pension in buy-to-let properties (2).
There are two further reasons why the pot of retiree funds available to spend on real estate is set to grow. Firstly, and for the foreseeable future, an ever-higher proportion of those reaching retirement will be in defined contribution, rather than defined benefit, schemes. In 2014, retiring DC members spent around £12 billion on annuities (3). That volume of investible funds is set to rise significantly, while the sharp decline in annuities sales will only amplify the effect.
Secondly, I estimate some £250 billion of funds could potentially become available on transfers from DB schemes over the next 10 years.
If £10 billion of that cash pool wound up in property each year, that is equivalent to almost 4% of the £254 billion that was spent on UK residential property in 2013. Such a large injection of cash into property, particularly tight markets such as London and the south east, is bound to drive up prices.
Bricks and mortar
Is it plausible to think so many retirees would invest their precious savings into property? Annuities may have dwindled in popularity but retired people are still looking for the kind of regular income that rental property might provide.
And for many people, a tangible investment like the purchase of a house is a lot easier to understand than many investment funds or flexi-access products for example. In the aftermath of the credit crunch, many still distrust these kinds of financial products that are administered by third parties (4).
Recent research from the National Association of Pension Funds showed pension scheme members don’t like paying for financial advice, despite the fact their pensions are probably their second largest asset. Buy-to-let is seen to offer a tangible and better trusted investment alternative.
The new legislation should also make it substantially easier for older people to get a mortgage since they can now, in principle, access significant amounts of capital from their pension pot. Given the UK’s long-standing obsession with home ownership, investing in property is the obvious choice for many.
Pensioners should keep in mind the potential pitfalls however. Aside from the social cost of higher house prices and the risks of a perpetual cycle of housing inequality in Britain, investing in the hope of higher yields on property brings with it higher risks. Failing to diversify their sources of income, as financial advisers would advocate, could lead to grim repercussions for individuals if property values and yields suffer sharp reversals.
Whether or not retirees invest a significant proportion of their wealth in property depends, in part, on pension providers designing straightforward alternatives. Ultimately, however, the government may need to consider ways to dissuade pensioners from investing in property.
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