Recent fluctuations in the housing market mean people can no longer look with certainty at using their property to fund retirement. David Millar discusses the situation
A survey taken by Friends Provident before the credit crunch began showed that a third (33%) of consumers were depending on property or equity release to fund their retirement. At the time of the survey, the average property owner probably believed that their house would be worth more in a year's time, felt that property prices would continue to rise and would have been confident that there would be someone around prepared to offer the asking price if they wished to sell. The market today is a very different place, with house prices falling as sellers are obliged to cut their asking prices in order to find buyers. So, against this economic background, what is the effect of relying on property to fund a retirement?
To understand this we need to consider just how a person relying on the value of their property would convert this into a retirement income. The two most common ways are equity release (effectively taking out some of the value of the property to provide an income) or downsizing to a cheaper property. Under 'downsizing' we can also include someone selling and moving to a house of similar size but in a cheaper location. In recent years this has started a rush to mainland Europe, as retirees compare what the inflated value of their UK home could buy in France or Spain while still boosting their bank balance.
However, releasing enough income to live happily in retirement is no mean feat even under perfect financial circumstances. The average man at age 65 is now expected to live almost 20 years in retirement, and the average life expectancy of a 65-year-old woman is even older. Over that period of time, how much capital would you need to fund a reasonable lifestyle? Even freeing up £100,000 from property would only provide an extra £5000 a year over that period, ignoring interest, inflation and the 'then what' question of what happens when the money has gone. A more secure method of converting this amount to an income that would last for however long you lived would be to purchase an annuity. £100,000 could provide an annual income of £7,901 for the average 65-year-old man (figure varies depending on annuity provider).
Falling property prices
What happens when property values fail to rise, or even fall? The erosion of equity by falling property values could have a serious impact on anyone, but imagine that you were planning to retire in the next year, and had anticipated you would live off the equity. Your retirement plans depend entirely on the value of your property, and putting all your hopes on a market that is subject to circumstances beyond your control is surely a risk that most people would baulk at in ordinary circumstances.
Looking at an example, let's assume that the £100,000 equity mentioned above was from the sale of Mr Smith's £300,000 house. Assuming his mortgage debt has been repaid, £200,000 remains that can be used to buy a smaller property for Mr Smith to live in. If the property market falls by 25%, the value of Mr Smith's current house becomes £225,000 - which means that he now needs to find a house for £125,000 to retain the same standard of living he had anticipated before the market fell (i.e. £100,000). But the value of the £200,000 house Mr. Smith intended to downsize to, assuming it also falls by 25%, is now worth £150,000. This is £25,000 more than Mr Smith can spend. Does Mr Smith find somewhere cheaper to live, or reduce his standard of living in retirement by only taking £75,000 in equity? A tough choice, and as if this wasn't bad enough, the hypothetical scenario gets worse if Mr Smith was planning to move abroad. In that instance it is highly probable that the housing market would not fall by the same amount in the overseas location, and exchange rate risk could further reduce the buying power of Mr Smith's money.
So there lies the risk. It may seem an obvious risk now that falling house prices are easier to imagine but, even in a time of rising house prices, the idea of putting all your eggs in one basket would always represent a large risk. Yet the same survey showed that two thirds of the respondents had not yet started saving for retirement. Why have so many people looked to property values to provide for them in retirement to the exclusion of the more traditional method of saving for a pension? There is an obvious reason - despite the risks, property investment is simple, commonplace and understandable, whereas pensions are complex and confusing. It could be a case of better the devil you know rather than the devil you have no experience of and can't make head nor tail of even when it's explained slowly.
Of course there are other reasons why people don't save for a pension. For many the cost of saving is a significant barrier. Others will point to a vague notion that they are not to be trusted. But on these measures, is it true to say that saving via property is a more attractive option than saving via a retirement plan? Or could it be that property is just an easier option. Unless you are lucky enough to be given somewhere to live, it is a fact of life that in order to put a roof over your head you will have to spend money (either in rent or mortgage payments). For most people in the UK spending on property is not an option, and taking on a mortgage is more attractive than renting in perpetuity. Saving for retirement by joining the company pension scheme just doesn't have the same obligatory nature - for many people, saving for retirement is simply an optional expense. Pension saving also suffers because there is no immediate impact. Anyone not putting money into property would only need to spend a few nights without a roof before reconsidering their decision, whereas you can spend 30 years not saving for retirement without any impact on your life - right up until you decide you would like to retire. Then your decision bites, but it is too late to go back.
What more can be done? Well, saving in general is about as fashionable as powdered eggs and ration books. Putting money aside each month to buy something you need, rather than borrowing to pay for something you want, is a notion as quaint as dance cards, chaperones and sixpence and going without something today to pay for life tomorrow is completely alien for an entire generation of adults and their children too. There are no easy fixes that can reverse a steady decline in saving rates and changes in cultural values built on rampant consumerism.
However, there is more that can be done to advertise the benefits of joining the company pension scheme, and making regular savings a habit rather than a chore. The population has been fortunate that employers have continued to provide pension scheme benefits even though these have gone largely unappreciated by employees. Now that the Government is placing increased focus on pension provision it may be the case that good employers will start to be rewarded with some appreciation by their employees.
It will only take a few hard luck stories from people affected by the current house price dip to make people realise that when it comes to saving for retirement, taking advantage of all available opportunities to save makes more sense than burying your head in the sand.
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