Renting can swallow your pension so you’re better off scrimping to buy a home, warn experts

People should be allowed to spend up to half their pension or borrow against it to buy a home and avoid a retirement rent trap, urges a new report.

Innovative ways of using your pension to get on the housing ladder would eliminate the need to choose between buying a property and saving into pension or changing your lifestyle, it says.

Rent can swallow your entire private pension and leave you living on just your state pension in retirement, according to the study by pension consultant Hymans Robertson.

That means owning a home can make the difference between a basic and a moderate lifestyle in old age.

A single person needs an income of £32,700 a year and a couple £45,400 for a decent retirement, according to a widely used pension industry benchmark from trade group Pensions UK.

This ‘moderate’ lifestyle covers the essentials plus some splashing out on food and entertainment, trips abroad and running a car.

But these headline targets don’t include housing costs if you are still paying a mortgage or rent, income tax or care costs in later life.

Middle-aged and younger people need to aim even higher to take account of inflation.

Those who rent in retirement could use up their whole pension built up under minimum auto-enrolment contributions simply to pay for housing, according to new calculations by Hymans Robertson.

‘This means their workplace pension won’t help to fund any of their lifestyle in later life and they’ll only have the state pension to pay for all other outgoings,’ it says.

‘The number of renters in retirement is set to increase threefold over the next 20 years as home ownership falls and the population ages.’

How rent can absorb your pension

Under auto enrolment, employers are required to put a minimum of 3 per cent of your earnings between £6,240 and £50,270 into your pension. Tax relief from the Government provides another 1 per cent.

You must put in at least 4 per cent on your own behalf, and if you opt out all the above is lost.

You can choose to make higher contributions, which some employers will match, and pension experts believe people should aim to contribute 12-15 per cent for a comfortable retirement.

Hyman Robertson models the case of a 22-year-old working 40 hours a week on the minimum wage and earning £26,437 a year, and found ending up a renter in retirement was the poorest result. All the figures below are in today’s money.

If you pay 4 per cent into a pension scheme but forgo buying a home, your total wealth at state pension age would be a £229,934 pension pot.

Your private pension would generate an annual income of £10,452, but annual rent would be £10,246, making your total income including the state pension £12,753.

‘A lifetime of saving into pensions to pay for rent in later life isn’t a great outcome,’ says Hymans.

But it warns: ‘The auto-enrolment minimum isn’t enough for a low earner to buy a home without making other lifestyle changes.’

If you reduced day to day spending to afford both a pension and a home deposit, Hymans estimates it would take you 13 years to save a deposit, but by state pension age your total wealth including home equity would be £490,075.

You would pay no rent, your annual private pension would be £11,414, and your total income including the state pension would be £23,962.

‘After the mortgage is paid off, pension savings improve income in later life. This improvement comes from cutting back on other spending earlier.’

Opting out of a pension early on to focus only on a home deposit could make you a homeowner in seven years, and your total wealth in pension and home equity at state pension age would be £459,223.

With no rent to pay, and an annual private pension of £10,012, your total income including the state pension would be £22,559.

What about using your pension to buy a home?

The idea of letting people buy a home using pensions either outright or via a loan is being floated by Hymans Robertson.

‘Allowing a saver access to 50 per cent of their pension savings could help them secure a larger deposit or get onto the property ladder sooner,’ it says.

‘Once the mortgage is repaid, some of these housing costs can be redirected into pension savings.’

In the same scenario of the 22-year-old on the minimum wage above, Hymans estimates a seven-year period to save a home deposit, and total wealth at state pension age of £478,528.

In retirement that means no rent, an annual private pension of £10,889 and total income including the state pension of £23,437.

Another option is to use a pension to release a home deposit loan. Hymans explains: ‘The loan available would be a set proportion of the value of their pension pot when they take out the loan, for example, 50 per cent.

‘Repayments would be deducted automatically from income above a set threshold, and pension savings would be untouched.

‘At retirement, if the deposit loan isn’t paid off, the borrower would have the option of paying it off in one payment from the pension pot’s tax-free cash, or carry on taking it in instalments from retirement income.

‘If the saver doesn’t have enough in their pension or enough wealth elsewhere the loan would be written off. If the loan is from the government, any write-off might just replace what’s being spent on housing benefit for pensioners.’

In this case, it would take the same seven years to build the home deposit, but total wealth at state pension age would be £510,807.

With no rent to pay, the annual private pension would be £12,356 and total income including state pension £24,904.

Hymans adds: ‘If pension savings were a condition of getting a loan for a home, more people would probably be encouraged to save into their pension and engage with it.

‘There are of course separate challenges on the supply of affordable housing, which our proposal doesn’t look to solve. 

‘The challenge of supply must also be resolved in parallel, so that house prices are managed sustainably for generations to come.’

The firm is calling on the Pensions Commission, currently looking at ways to address under-saving for retirement, along with industry, the financial sector and the Government to look at bold and innovative approaches to retirement adequacy.

Partner Calum Cooper says: ‘Renters retiring will need the full 8 per cent minimum pension contribution savings to provide an income just to cover the cost of rent.

‘This shows how fragile the pensions and property systems have become. If we fail to do something during this period of pensions reform, then there’s a risk of a “lost generation” of impoverished renters in retirement. And they will wonder why they saved into pensions rather than buying their own home. 

‘We know that home ownership is one of the strongest foundations for financial security later in life. This is why we need to think differently; pensions and housing cannot be treated in isolation.’