'How do I use a £500k pension to buy a bigger home?'

Retiring after a lifetime of hard work can be the perfect time to fulfil one’s long-held ambitions, be it going on a cruise or buying a cottage in the countryside. But figuring out how much one can afford to spend, while still having enough for a good retirement can be tricky. Extracting lump sums from a pension pot in a tax-efficient way requires some forward thinking.

Nick is 59 and has big plans for 2025. He intends to fully retire and buy a bigger home with his partner, William, 67, who is already retired. The two have been together for 35 years but are not married.

“Most people at this stage are probably looking at downsizing. We are a bit different,” Nick says. “To upsize, we will need to make the most of our investments while minimising tax.”

This will be complicated. Most of the couple’s investments are held in their self-invested personal pensions (Sipps). “I slightly regret not contributing more to individual savings accounts (Isas) as I think our pensions are bigger than we need,” says Nick. “We plan to rebalance them by making use of our full Isa allowances for the next three years.”

The couple have other income but will need to use their Sipps to top it up, especially until Nick’s state pension kicks in in 2031. William owns their current home, which they estimate is worth around £160,000, while their combined pensions are worth £488,000 and their Isas £60,000.

“Ideally we would want a gross income of around £50,000 once I stop work," Nick says, to provide the couple with around £46,000 net using their personal tax allowances. "I think we need about £250,000 in our combined pensions, leaving us with roughly £290,000 to put towards a home. We are hoping to buy a place costing between £450,000 and £600,000 excluding moving expenses, depending on what happens to house prices between now and 2025.”  Some £109,000 can be taken out as tax-free cash or income.

The couple would need to take out £80,000 from their personal pensions, at £16,000 a year, just to bridge the gap from 2025 until Nick's state pension kicks in. This would mean a 3.3 per cent withdrawal rate from their total pensions, or 6.4 per cent from the remaining £250,000 pot. After 2031, the couple will only need to draw £4,400 a year, as the chart below shows.

“If we push the boat out a bit too much on a new home, we could use equity release later on, to fund care later in life. We don't have dependents, although we would like to pass on something to relatives and charities in our wills.”

The couple are hoping for a real return of about 4 per cent after fees. “I have quite a relaxed attitude to risk and am prepared to lose up to 30 per cent,” says Nick. “My partner is more risk averse but is happy for me to make investment decisions. My opinion is that our pensions and the annuity are low-risk assets which enable us to take more risk with our investments.”

The portfolio, below, currently has a UK bias, which Nick would like to reduce by adding to their US exposure. Over time, he would like to increase the use of passive investments and he is wondering about adding an emerging market tracker.

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES

Preeti Rathi, senior investment director at Investec Wealth, says:

You are clearly a knowledgeable and experienced investor, with some fantastic holdings across the portfolios. Your investments are dominated by stocks, which account for 89 per cent.

Global equities have returned more than 60 per cent over the past five years alone, so I would hope that your portfolio performance has been great. But I would think about de-risking now and not invest any money you will need in the next three years. Considering you are so close to retirement, such a stock-heavy portfolio is not the best option. You say you have a “relaxed" attitude to risk: I would use a circa 60 per cent stock market weighting as a starting point.

The remaining building blocks of the portfolio are important too. I would allocate around 20 per cent to bonds and a similar amount to property and alternative investments. Alternatives are there to provide a buffer if stock markets drop. Holdings such as BH Macro (BHMG) had some fantastic returns in 2022, which was a difficult market for most asset classes.

Listed infrastructure funds would be a smart addition to this portfolio – their revenues tend to be long-term in nature, inflation-linked and backed by AAA-rated government bonds and they offer a juicy income yield of around 5 per cent. International Public Partnerships (INPP) and BBGI Global Infrastructure (BBGI) have had negative returns over the past six months and now offer superb value, trading at significant discounts. 

Part of your portfolio should also focus on income. Infrastructure funds and bonds would help you significantly. I would suggest siphoning off any cash required for a house purchase in 2025 immediately – you never know when a sudden event might shake the markets. You could look at some cash-like or more stable ideas for this pot.

There are some attractive opportunities in the UK government gilt market. The UK Treasury Gilt 0.25 per cent 2025 issue, which matures on 31 January 2025, can be bought significantly below par at around 93p [at time of writing] and will redeem at 100p. The capital gain on this is exempt from tax.

Emerging markets look especially attractive right now, both from a demographics and growth perspective and also because of valuations. I would choose a specialist emerging markets active fund manager, ideally that can do due diligence on the ground. You could add to your existing holding Templeton Emerging Markets Investment Trust (TEM), or consider an alternative such as the Lazard Emerging Markets Fund (GB00B8QHFR21).

Finally, you can’t clap with one hand. Your partner is more risk averse than you, and less involved in the investment decisions. If something were to happen to you, would he be comfortable with this portfolio? A common conundrum, but perhaps another reason to dial the risk down.

David Gibb, chartered financial planner at Quilter, says:

You wish to fully fund your Isas, but I would be concerned as to whether this can be achieved from your current combined income. You hint at using funds from pensions, such as uncrystallised funds pension lump sums and the £109,000 tax-free cash, but there is simply no good reason why you would use your pension to top up your Isas in that way.

Running through the figures suggests to me that you could buy a house, but at the lower end of your range, such as for £450,000 (plus £10,000 stamp duty) and have a net income per year until 2031 of £42,000. This will allow you to withdraw circa £104,000 net for legal expenses, moving costs and additional work on the house.

I appreciate my figures vary from yours. I have assumed that you will leave the smaller Isa and the cash alone as an emergency fund and use the larger Isa, your pension tax-free cash and the house sale proceeds for the new property, and then take a lump sum from your pensions to bridge the shortfall.

By doing so you will have to incur a higher rate of tax on your withdrawals. There is no way around this, unless you stagger the withdrawals over two or more tax years, which may not work from a timing point of view for purchasing your desired property. While pensions are very tax-efficient, especially when your income tax rate drops in retirement, in this case you would be withdrawing at a higher rate of income tax but have been funding your pots as basic rate taxpayers. This means your pensions are not the most tax-efficient vehicle you could use.

You should also be mindful that this level of expenditure on the property would mean you will have little to no money left for anything else going forward, such as ad hoc capital requirements, unless you are saving from your income. It also means that your plan is open to the risks of inflation, with little flexibility.

When assessing the figures, I have allowed for a 10 per cent increase over the next two years due to performance but I have ignored any potential increase in the Isa values (except for growth) as I cannot see how they will be funded.

If you are going to use your pension to fund a property upsize, consider a smaller property, perhaps worth £300,000, which would be double the cost of your current property and still constitute a noticeable upsizing. It would leave you with some money in your pension and, importantly, some flexibility in the future.

Otherwise, you will have to use nearly all of your pensions and main Isa, with little in the bank and therefore little scope to meet unexpected costs or life changes.

I understand why you want to take a relatively high level of risk within the portfolio, but what you are suggesting is a little on the high side. While it could work out for you, there is little leeway in the plan. You say you are okay with a drop in value of up to 30 per cent, but I don't think you can actually afford that level of loss. Particularly if this happened close to when you want to buy. I would say your capacity for loss is minimal, and also note that your partner is more risk averse.

You have some good holdings in the portfolio, but I cannot see a strategy in place. With this amount of money, it would be a good idea to review the holdings and consider the overall approach to portfolio management and level of risk.

Finally, equity release could be an option in the future. It could be used to provide future capital and flexibility but is an expensive way of doing so.