Yes, the Housing and Communities Secretary James Brokenshire really did suggest that first-time buyers should be able to use their pension schemes as a house deposit. There’s been wide criticism since, but why? What on the surface may seem like a rational decision for generation rent, could cause long-term financial insecurity.
As house and rental prices continue to climb, many are finding that home ownership is an aspiration that’s out of reach. There are several reasons for this, but one of the first obstacles that younger generations come up against is building up the sizeable deposit needed to secure a mortgage.
Typically, first-time buyers need a deposit of 5-10%. According to research from Zoopla, first-time buyers need a deposit of more than £38,000 to buy in one of the UK’s major cities. When you consider that wages have largely been stagnant over the last decades and many hoping to purchase their first home are paying rent, it can be a tall order. As a result, the opportunity to dip into a pension to boost a deposit might be attractive.
However, there are two key drawbacks here:
- First-time buyers are unlikely to have large pensions to dip into. The average age of a first-time buyer is now 31 and, they may have been contributing to a pension for only a relatively short period of time. As a result, the option to use pension savings may do little to address the challenge.
- Secondly, it’s important to remember the purpose of a pension; to create an income in retirement. Using even a portion of savings earlier in life could mean a retirement that is significantly less comfortable and financially secure.
Measuring the impact of accessing pensions early
It’s hard to imagine how taking a lump sum out of your pension in your 20s or 30s will have an impact on retirement income. You may think it’ll be easy enough to put back over time, especially when you factor in promotions and salary increases. However, making a withdrawal is likely to have a much bigger impact than you’d first think.
- Pensions are typically invested, with the aim of growing your savings over your working life. As a result, taking out a lump sum can affect the growth potential of savings and, therefore, retirement income. Investments experience volatility, and if you make a withdrawal during a dip, the impact can be even more significant.
- In addition to this, you can’t usually withdraw gains made from a pension fund, so returns are reinvested. This is known as the compound effect and over a long period of time, say a career spanning 40 years, it can help your savings grow at a faster pace.
If you were to use cashflow modelling to visualise the impact of taking a lump sum out of a pension, it’s likely that it would demonstrate why alternative options for building up a house deposit should be considered first.
The above is even further compounded by increasing life expectancy. In the past, planning for a 20-year retirement was the norm. Today, those approaching retirement need to consider how their pension will provide for them for the next three to four decades as more people than ever celebrate their 100th birthday. For the generation just stepping on to the property ladder, their pensions are likely to need to stretch even further.
Undoing the positive impact of auto-enrolment
Auto-enrolment can largely be considered a success, even if there is some concern that minimum contributions aren’t enough. Tens of thousands of workers are now saving into a pension for the very first time. Allowing first-time buyers to use these savings to act as a deposit could undo some of the positive impact that auto-enrolment has set the foundation for.
Being able to use pensions for other purposes could set the precedence that workers should focus on short-term financial goals at the expense of those that look further ahead. In some cases, this can make sense, but in others, it could seriously affect financial security.
If you’d like to discuss your pensions savings and lifestyle aspirations, please contact us. We’re here to help you balance short, medium and long-term goals.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.