Annuity. It's one of those dull financial terms designed to confuse and frighten people into giving their money to bankers to make the scariness go away.
However, with George Osborne's budget speech focusing on reforming the pension system, annuities have been driven to the forefront of the news agenda and could alter the way we view finances leading up to retirement.
There used to be no choice but to take out an annuity. Osborne has changed this and pensioners can now take their pension in one lump sum, following in the footsteps of the US, Australia and Denmark. While some suggest this may all go on Ferraris, the more financially-savvy could be about to cause a buy-to-let boom.
Is buy-to-let a feasible pension plan?
The average one bed flat in London costs around £350,000. If you take your pension as a lump sum you'll lose around 30 per cent in tax. This means you need £500,000 to buy such a property without a mortgage - a sum that is 15 times higher than the national average pension.
Despite the high initial outlay, a buy-to-let can be a sound investment for a pension pot. A one bedroom flat would earn you around £13,500 a year through rental income, although this would increase to around £31,000 when taking into account London's annual price inflation of five per cent. In comparison, an annuity with the same value would see you take home £27,000 a year, before tax. Perhaps more importantly, finances stored in annuities ultimately cease once you pass away, whereas buy-to-let property can be passed down to other family members as inheritance.
Why the boom could happen
Clearly buy-to-lets have the potential to support people through their retirement across London and with the low risk associated with property investment, it is a very attractive prospect for the capital's pensioners. Even when the property market is in trouble, house prices always rise over time.
For those with a larger pension pot, investing in property is an even more astute decision - the bigger the property, the bigger the financial return and this is even more true in central London, where housing value increases at a much higher rate than other parts of the capital. This, on top of the sorry state of the annuities market could give people the confidence to take a leap of faith, causing a buy-to-let boom across London.
Why the boom may falter
Although there is clearly money to be made in the buy-to-let market, there are numerous factors which may put prospective landlords off of investing in property.
Property is not a short-term project you can complete and then forget about. Even if the property doesn't need to be redecorated before it is let out, maintenance costs can eat into the profit margins pensioners would otherwise be enjoying. This, alongside the fear of an ill-timed market crash could cause people to play it safe when it comes to retirement.
It is also worth noting that buy-to-let is not an option which is open to anyone - property demand results in continuously rising prices, which could put many out of the market. The average pension pot in the UK is a mere £33,000; scarcely enough to get your foot in the door of a London property, let alone buy it! Getting a mortgage is of course an option, but such financial commitment so late in life may be unpalatable.
Buy-to-let may not be to everyone's taste as an alternative to annuities, but one thing is clear, it has the potential to have a profound effect on London's rental market. Taking advantage of the property market in this way makes sense, but it is questionable whether it will replace annuities, particularly if the annuity market improves again.Suggest a correction