Most of the money that flows into institutional real estate around the world is targeted at providing individuals with retirement income or long-term security. Many of those placing that money in the form of regular contributions to pension plans or insurance policies may not realize that their money — or a portion of their money, as dictated by asset allocation strategies — is being invested in real estate. But it is, it performs, and it makes a significant contribution to their ultimate wellbeing.
That could change. In the United Kingdom, for example, a new system will take effect from April 6 that will allow investors in defined contribution arrangements to take assets out of their pension pot as they wish from age 55, taxable at their marginal rate. Such investors will no longer be obliged to take out a lifetime annuity on retirement. That development has been welcomed — annuities give retirees certainty and security, but annuity rates are low and an annuity may not always be the best or sole route to retirement income — but the law of unintended consequences is also set to play a role. There will be winners and losers, and people may have to be saved both from themselves and from unscrupulous fee- and commission-driven advisers.
Hailed by some commentators as a revolutionary approach to pension provision, the new U.K. system will bring both advantages and disadvantages — and a principal disadvantage, once again, is that it will require individuals to have a clear idea of what they are looking to achieve from their pension assets and some reassurance that they know how best to go about doing this. “Free and impartial advice” will be available to inform decision making.
Eligible members who were told some time ago that their guaranteed defined benefit pension plan was being closed to new contributions and replaced by a less secure defined contribution plan that involved choosing where to place regular contributions are now being told that they can do what they like with their pension pot. You can see how unfettered access to a potentially large sum might look, and you can also see how tax implications and other financial aspects might get overlooked. Let alone what it might all mean for retirement income years down the line.
Does the U.K. government trust people to make the right decision, not to blow the pot on extravagant purchases and then have to fall back on the safety net provided by the state? Maybe, but can we trust a future government not to change everything again? The current U.K. government is in power only until May 7.
The new freedom will only be available to members of defined contribution arrangements. Fears have been raised, too, that members of defined benefit pension plans will be tempted to transfer out to defined contribution arrangements, and then exercise their right to freedom. (In the United Kingdom, few large plans remain open in the private sector, but they still dominate plan design, either final salary or career-average, in the public sector; invariably, many have large deficits and are severely underfunded.) Valuable pension benefits could be sacrificed on the altar of pension freedom.
It is unfortunately part of the human psyche that, given an opportunity to increase personal wealth, many people could be pushed in the direction of making a mistake. In a classic case of the “which is better: pension or property?” conundrum that has exercised the minds of investors since pensions were first invented, some investors are looking afresh at using their newly available pension assets after April 2015 to purchase buy-to-let properties, to become landlords of residential dwellings and to take the income from tenants. It’s a pension — regular income in retirement — of another kind. But we know only too well that property investments can be risky, values volatile and income from tenants uncertain. And those assets are then lost to institutions and fund managers — forever.
The pension-or-property question may be answered by actual and would-be pensioners voting with their fleet feet, cashing out their pensions and adding buy-to-let properties to their retirement income portfolios. Wouldn’t it be ironic if, in so doing, they were potentially exposing themselves to the very risks that the institutional investors who were previously managing their pension funds would eschew on their behalf? Wouldn’t you then have to ask who has the better take on those risks?
Give people an opportunity and many will make a mistake. There are precedents and people have form. The United Kingdom has had its fair share of financial scandals and missteps over the years, and these have contributed to a large loss of faith in the pension system — personal pension misselling, the Maxwell affair, Equitable Life, Gordon Brown’s abolition of the dividend tax credit for pension funds. I’ll ask again: pension or property?
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Richard Fleming is editor of The Institutional Real Estate Letter – Europe.
