Housing ladder: Can you use your pension savings to buy a home?
I realise this is a very broad question, and one which will depend on a number of factors, but I wonder if you have a view on what would constitute an acceptable pension fund heading into retirement.
I’m 45 this year, and don’t own a house (my ex-wife has it), but I have a fair sized amount saved in a few different pension plans.
I’m trying to decide whether to reduce pension contributions and put money into getting on the housing ladder instead.
Also, is there a way to use my pension savings to help in buying a house? Can the house be put into the pension in lieu of funds? What are the penalties involved?
Steve Webb replies: The question as to how much money is ‘enough’ to provide for your retirement is a very important one.
Whilst the answer will be different for each individual, there are a few ways in which you can get a rough idea as to what you will need.
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How much is ‘enough’ to have in your retirement pot?
The first thing to do would be to think about how much regular income you will need in retirement. For most people this is likely to be a smaller income than when you were in work.
When you are in work you will be paying National Insurance Contributions, you may be paying into a mortgage, you may be paying into a pension, you will have travel to work costs and so forth, and many of these costs will stop or reduce when you retire.
A general rule of thumb is that if you can secure a total income in retirement of about two thirds of the amount you were earning in work, then you should be able to maintain the standard of living that you are used to.
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In your particular case, unless you have bought a house and paid off the mortgage by the time you retire, then you would need to allow extra income to cover housing costs through retirement.
The next thing would be to look at where that income might come from. For someone of your age, the state pension after you have put 35 years into the system is likely to be a little over £8,000 per year in today’s money.
If you are earning around about the national average wage, which official statisticians reckon is £512 a week or £26,624 a year, then to get near the ‘two thirds’ target I mentioned earlier, you would need an additional £8,000 to £9,000 or so.
In the past, many people would have built up one or more company pensions which paid a guaranteed rate based on how much you used to earn. These would obviously count towards the £8,000-£9,000 target if you have any of these.
From what you have said, you probably have a number of pension funds each with pots of money. One option when you retire is to exchange these pots of money for a regular income in retirement – an annuity.
How much you will get depends on annuity rates at the time, and they do fluctuate a lot. However, a very rough rule of thumb is that for every £1,000 you have in a pension pot you should expect to get roughly £1 per week in income from age 65.
So, to deliver a weekly income of £160-£180 (the equivalent of an annual income of £8,000-£9,000) you would need a total pension pot of roughly £160,000-£180,000.
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These days you don’t have to buy an annuity with your pension pot, and you could leave the money invested, drawing down an income when you need it.
However, the size of pot you would need to support yourself is probably still roughly the same amount as you would need to buy an annuity.
If you find that you haven’t built up a big enough pot by the time you reach pension age, you could consider working longer and putting off your state pension.
This means you will get a bigger state pension when you do retire and should also mean you get a better annuity rate for your pension pot.
Should you divert pension savings into buying a house?
You asked about reducing your pension contributions and spending the money on buying a house. There are various pros and cons of each.
If you reduce your pension contributions you may find that your employer does the same, so your pension wealth will build much more slowly.
You will also be missing out on the tax relief that your contributions would have attracted, as well as the ability to take a quarter of the final fund as a tax free lump sum.
On the other hand, obviously if you can buy a house this will save you on rental costs whilst you are at work and gives you the chance of having cleared the mortgage by the time you retire, leaving you more disposable income in retirement.
In addition, any growth in the value of your own home is not subject to tax. In theory you could free up some cash by ‘downsizing’ at retirement, but in reality most people are so attached to their home and the area they live, that very few want to contemplate doing this.
You are not allowed to invest the money in your pension fund by buying a home to live in. However, once you are over 55 you are free to take cash out of a pension fund – including the 25 per cent tax free lump sum – and there would be nothing to stop you using that money to help pay off the balance on a mortgage.
How do I avoid paying a hefty tax bill when I take my pension cash?
Unwary retirees can find themselves heavily taxed for withdrawing big sums from their retirement fund. Read more here on how to dodge the traps.
Bear in mind though that after you have taken that 25 per cent tax-free cash, further withdrawals will be taxed as income. If you take a really big sum at once, it could push you into a higher tax bracket for that year.
So in other words, a big pension fund, built up in part by contributions from an employer, could actually help you with your goal of buying a house and paying off a mortgage.
It is a big decision as to whether to buy a house and/or to cut your pension contributions, and you should certainly consider taking impartial financial advice before deciding what to do.
Many advisers would see you on a fixed fee basis, and good advice could save you many times over the cost of advice by helping to make the best choice for you.
ASK STEVE WEBB A PENSION QUESTION
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Since leaving the Department of Work and Pensions after the May 2015 election, Steve has joined pension firm Royal London as director of policy.
If you would like to ask Steve a question about pensions, please email him at firstname.lastname@example.org.
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0300 123 1047.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.
If you have a question about state pension top-ups, Steve has written a guide which you can find here.
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