By the time you reach your 50s or 60s you may have money tied up in your property if you’re a homeowner, alongside retirement savings if you’ve paid into a pension. While your pension is specifically aimed at providing you with an income in retirement, your property could also have a valuable role to play.

Property is often considered one of the hardest assets to draw an income from, but there are a growing number of ways you can release money that may be used to supplement your retirement income. These include equity release, retirement interest-only mortgages, downsizing, or using the government’s tax-efficient rent-a-room scheme.

Meanwhile, pensions are more flexible than ever, as you can usually use your retirement savings as you wish from age 55. Used carefully, you can produce a tax-efficient income stream from your pension. Ultimately, though, how you decide to take your retirement income depends on your personal situation, and what is right for one person won’t necessarily be right for another. Find out more in our article Your pension options at retirement.

Here, we run through some of your options, considerations and potential scenarios to help you decide on the right course of action for you.

Taking tax-free income from your pension

Since the introduction of pension freedoms in 2015, you have more options than ever when it comes to how you use your pension pot. But with that comes a greater risk of getting things wrong, making getting the right advice particularly important.

Under current rules, you can draw up to 25% of your defined contribution pension as a tax-free cash lump sum once you reach the age of 55. Bear in mind, however, that you don’t have to take this all at once, and drawing a big lump sum from your pension early on could have a major impact on your future retirement income. Find out more in our article Should I take my tax-free pension cash at age 55?

Rekha Desor, pensions advisor at Rest Less, says: “It always used to be the case that you’d use your pension first for your retirement income, but you could, for example, take your tax-free cash in small tranches as a supplementary income, while leaving the rest invested for the future –  and consider ways to use your property to meet any income shortfalls.”

There are plenty of different factors to consider when taking tax-free cash from your pension, so you may want to seek professional financial advice to help you with your decision.

Drawing an income from your pension - while remaining invested

You can usually draw a flexible income stream from your pension from the age of 55, known as ‘drawdown’. This can be a flexible way to boost your income during, for example, years when you have other sources of income from part-time work. However, withdrawals greater than your tax-free 25% cash need to be carefully managed as they will be taxed as income.

Beware, too, that taking more than your 25% tax-free lump sum out of your pension could affect how much you can contribute. Once you start taking money out of a defined contribution pension, your pension Annual Allowance falls from £40,000 a year to just £4,000 – and becomes the ‘Money Purchase Annual Allowance’ (MPAA). Learn more about how the MPAA works in our guide What is the Money Purchase Annual Allowance?

Different pension schemes come with different rules around drawdown, too, and there are various investment options for your pension pot. Read more in our article What is pension drawdown and how does it work?

Sarah Coles, personal finance analyst from Hargreaves Lansdown said: “The key to a tax-efficient income from your pension is often to take just enough to take you to a tax threshold, but not over it. So, if you hold individual savings accounts (ISAs) alongside a pension, or use the rent-a-room scheme (see below), you can top it up with tax-free income from either.”

Buying an annuity to provide an income

You can usually buy an annuity with all or part of your pension from age 55 to provide you with a guaranteed taxable income. An annuity is basically a long-term contract with an insurer, in which they agree to pay you an income for a set period, or for life in return for handing over some, or all, of your pension savings.

However, buying an annuity is a major financial decision that could have a long term impact on your retirement income. It could also affect how much you can continue paying into your pension, depending on which type you choose. You should take care to choose the best option for you to provide a retirement income, and shop around for the best rate. Over recent years annuities have fallen in popularity as rates fell, but they still have their place in some scenarios and a guaranteed income for life may appeal. Find out more in our guide Annuities explained.

As an example, if you have a £30,000 pension, you might take £5,000 as tax-free cash, and use £15,000 to buy an annuity, while leaving the remaining £10,000 invested. The remaining sum would hopefully grow in value over time, enabling you to take a greater amount as tax-free cash in the future.

Depending on the overall value of your estate, however, you might want to consider leaving a defined contribution pension relatively untouched to reduce your overall IHT bill. Desor says:  “Most pensions are outside of your estate for IHT purposes, so you might, depending on your circumstances, want to leave your pension relatively intact, and use your property as your main source of retirement income.”

Taking an income (or lump sum) from your property

Property is considered an ‘illiquid’ asset, which means it’s not easy to turn into an income stream as it can be difficult to sell quickly. However, there are ways you can use your property to provide you with an income, without selling up. Here are some of the available options:

1. Equity release

You may want to consider using an equity release plan to unlock some of your property wealth, while continuing to live in your home. Before doing so, though, it’s vital to consider the pros and cons of this approach and to seek professional advice from a qualified equity release adviser who belongs to the Equity Release Council (the trade body for the equity release sector).

The most popular type of equity release plan is a ‘lifetime mortgage’. With a lifetime mortgage, you can usually either take a lump sum, or draw down funds as and when you need them, for example, if you want to regularly top up your income. As with other types of equity release plan, interest on the amount you release rolls up over time, instead of being paid monthly like a standard mortgage, although some lifetime mortgages enable you to repay the interest to stop it accumulating over time. Usually, however, the loan, and any interest owed, is only repaid when you sell your property, pass away, or move into long-term care. Find out more in our article Lifetime mortgages explained.

Desor says: “Some interest rates are quite low at the moment, at around 3%, which may enhance the appeal of equity release. It’s certainly an option if you don’t ever plan to downsize, but you have to be careful as there are pitfalls. It’ll reduce the amount you have to pass on to your family, and interest charges build up.” Bear in mind that even with a low rate such as 3.5%, your debt will double over 20 years.

However, provided you seek professional advice and use a provider that belongs to the Equity Release Council, which offers customer safeguards, equity release can be the right choice in some scenarios. Read more in our guide Equity release – what is it and how does it work?

Some pros of equity release

  • You can stay in your home and avoid the expense and stress of moving.
  • There’s no need to repay capital or interest during your lifetime.
  • You can use the money released however you like, for example to boost your pension income, or cover unexpected expenses.

Some cons of equity release

  • Interest charges soon mount up due to compounding (when you pay interest on top of the interest you’ve already been charged) and may be more than expected. Have a look at our compound interest calculator to understand how much a lifetime mortgage might cost you over 10, 20 or 30 years.
  • Taking a lifetime mortgage will reduce the value of your estate, and see your family potentially owe a large lump sum to the equity release provider when you pass away.
  • The amount of inheritance your family receives may be smaller as a result.
  • Using equity release could potentially impact your entitlement to state benefits. For more information on this, have a look at our article How lump sum payments and savings can affect your benefits.

We have partnered with Key Advice Group, a member of the Equity Release Council who have an excellent customer service rating on Trustpilot. If you are interested in a free, no obligation conversation with one of their equity release specialists to see whether equity release might be suitable for you, you can request a free callback here.

2. Downsizing to release money

As your home is likely to be your most valuable asset, selling up and moving to a cheaper property is another way to release funds to increase your overall income.

Coles says: “Your priorities may change over the years. Right now you may be desperate to stay in the family home, but in 20 years’ time, you may be equally keen to downsize. If you’ve taken an equity release plan, by then you may have eaten into the equity so much that you cannot afford to move somewhere smaller. So it’s vital to think ahead, too, when considering how to produce additional income.”

The impact of the pandemic on people’s finances has prompted 1.8m over-55s to consider downsizing to release money, or supplement income, according to research from Audley Villages. If you’re moving to a smaller property, this can also reduce the cost of household bills such as gas and electricity, and council tax. However, there are no guarantees that you’ll release as much as you’d hoped for on sale, as the selling and buying process is expensive, and you need to factor in additional costs such as Stamp Duty which can add thousands to your costs.

Before considering downsizing, think about whether it’s really the right move for you. It can be quite an emotional upheaval leaving a home you’ve lived in for many years, and perhaps also raised a family in, so it’s vital to weigh up the pros and cons first. Find out more in our article Five Questions to ask yourself if you’re considering downsizing your home.

3. Using the government’s Rent A Room scheme for tax-free income

You can earn up to £7,500 a year tax-free by renting out a furnished room in your home, under the Government’s Rent a Room Scheme. That amounts to £625 a month, which is a substantial amount that could be put towards bills or overall income.

The Rent a Room Scheme can be a good option, provided you’re happy to share your home with someone, and the compromises this involves. You don’t even need to own your home to qualify for the scheme, but you’ll need your landlord’s permission to sublet a room if you’re renting. You can find out more about the Rent a Room Scheme here and read our article to find out about other ways your home could work for you in our article Five ways your home could make you money.

4. Retirement interest-only mortgages for a lump sum

If you’re aged 55 or over, and still working or have an income you may qualify for a mortgage that won’t need to be repaid until you die or move out. Known as retirement interest-only (RIO) mortgages, these fall somewhere between a standard mortgage and an equity release product, and are specifically designed for borrowers in their 50s and 60s.

RIO mortgages are typically easier to qualify for than standard interest-only mortgage deals, which usually come with age restrictions for when the debt must be repaid. However, you’ll probably need a significant chunk of equity in your property to qualify.

Some key differences to equity release plans include:

  • You make interest payments each month, unlike equity release plans where interest rolls up over your lifetime. This means that a RIO mortgage could potentially be a cheaper way to provide you with a lump sum to supplement your income than equity release over the long term, but you’ll be paying interest out of your income each month.
  • You have to meet the lender’s criteria to qualify for a RIO mortgage, and this can be strict, as you’ll need to demonstrate you have enough income to cover your interest payments. These criteria can often be more stringent than with an equity release plan.

Find out more in our articles How retirement interest-only mortgages work and What’s the difference between a lifetime mortgage and a retirement interest-only mortgage?

There are a number of fee free RIO mortgage brokers available in the market, but if you’re considering this as an option, we’ve partnered with Tembo Money. They can provide you with fee free advice on retirement interest-only mortgages and research the various deals that might be available to you, to help you decide whether a RIO mortgage might be right for you.

5. Buy-to-let property income

When you invest in a buy-to-let property, you simply buy a residential property, like a house or a flat, in order to rent it out to tenants. This means that you become a landlord, which comes with various responsibilities, such as regular maintenance and keeping your property safe for tenants.

As with many other types of investment, the hope is that your investment will provide you with a regular monthly income, which could be used to supplement your retirement income, or any other sources of income you might have.

There is also the prospect of capital growth – in other words, that your property will appreciate in value over the long term, so that you make a profit when you eventually come to sell it.

Bear in mind though that owning property to rent out is generally not very tax efficient. You may have to pay capital gains tax on any increase in value when you sell, as well as income tax on rental income, with fewer expenses that can be offset since the tax benefits of being a landlord have been reduced over recent years.

Coles says: “As a general rule of thumb, an investment property is one of the least tax-efficient ways to invest. You’re taxed on the way in, you’re taxed on the income, and then you’re taxed on any profit too. If you’re dreaming about retiring and living off investment property income, there are two things you need to be comfortable with: a high level of risk, and the work involved.”

Read more in our article Is buy-to-let a good investment?

Where to go for advice

Some people decide to shun pensions in favour of property altogether, or the other way around, but it’s often a good idea to take a mix-and-match approach to generating a retirement income, rather than relying on a single asset or investment.

If you’re not sure how to proceed, or which option or options could be best for you, it’s worth seeking professional financial advice. If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service.

However, if you want personal recommendations or advice about your specific circumstances, you’ll need to speak to a financial advisor. If you think you might be interested in speaking with a financial advisor.

VouchedFor is currently offering Rest Less members a Free Financial Health Check with a trusted, well-rated advisor in your local area so you can see if you think advice might be for you.  There’s no obligation, but once you’ve had your check, the advisor will discuss the potential for an ongoing paid relationship if you think it might be useful to you. For more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.

Have you taken an income from your property or pension, or both? How did you decide which was the best option for you? We’d be interested to hear from you. You can join the money conversation on the Rest Less community or leave a comment below.

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