Monday 25 September 2017

Hidden dangers of funding your retirement through property

A bricks-and-mortar investment could make up for lost earnings but relying on it solely could cost you your pension

'Like any investment, it is never wise to have all your eggs in one basket' (stock image)
'Like any investment, it is never wise to have all your eggs in one basket' (stock image)
Louise McBride

Louise McBride

Lining up property to provide for your retirement might seem like a clever idea - particularly given the recent recovery in the market and the steep rent being pocketed by many of today's landlords. For many people, a bricks-and-mortar investment is easier to understand than the vagaries of the stock market and this can sometimes increase the appeal of property as an investment.

However, any decision to line up property to finance your retirement should be not be taken lightly. If your property investment were to go wrong, it could ultimately cost you your pension.

Direct ownership

Should you already personally own - or be in a position to buy - a second property, you could earn rental income from it in your retirement (as long as you can secure tenants) - or you could sell it when you reach retirement age, and use the sale proceeds to fund your pension.

However, there are a number of problems that you could run into. "If you're planning to sell a second property in retirement and to use the sale proceeds for your pension, you could get caught," said Jerry Moriarty, chief executive of the Irish Association of Pension Funds (IAPF). "For a lot of people, a pension is about having assets in retirement which they can realise the value of. However, you could find yourself in the middle of a property slump when you retire."

You could struggle to sell your property as a result - or you might secure a lower sale price for it than you had hoped. This could see you being less well off in your retirement than you expected. Timing is important with property so the inverse is also true: retire in the middle of a property upturn and you may sell your property for a lot more than expected. Remember, as your second property isn't your principal private residence, you must typically pay Capital Gains Tax (CGT) at 33pc on any profits you make from the sale of that property (though you can deduct certain costs from those profits when calculating your tax bill).

Rental income

The rental income earned from a second property in retirement could replicate some (or all - if you're earning a lot of rent) of the income you previously made in work.

However, you will have responsibilities as a landlord and maintaining a rented property can be costly and time-consuming. There could also be times when you struggle to secure tenants or when the property must be vacant to allow for renovations - and so you will be without rental income on those occasions. Should your property be located in an area where rental demand is poor, you could find it hard to secure tenants at all.

"Buy somewhere where you will always have a strong rental market," said Moriarty. "Make sure it's a solid investment which will provide you with a pension." Tax is another major issue as it could gobble up around half of your rental income. You typically pay tax on any profit you earn from rental income and that tax consists of your higher rate of income tax (which could be 40pc, depending on how much rental and other income you're earning in retirement) and the Universal Social Charge (USC). PRSI must typically be paid on rental income too - though you do not have to pay PRSI once you are aged 66 or over.

There are income tax exemptions for people aged 65 who earn no more than €18,000 (for a single individual) or €36,000 (for a married couple). So if the amount of rent you earn (combined with other taxable income you have) is below these limits, you should not have to pay any income tax on your rent. Furthermore, your rental income should be exempt from the USC if your total income (that is, income typically liable to the USC) is below €13,000. (Certain types of income, such as the State pension, are exempt from the USC.) There are also reduced USC rates for people aged 70 or over whose aggregate income for the year is €60,000 or less. (Aggregate income for USC purposes does not include social welfare payments, such as the State pension).

There is a big tax disadvantage to buying a property outright for the purpose of a pension. Unlike contributions into a pension scheme, you cannot claim pensions tax relief on the money.

Accidental landlord

Should you be an accidental landlord and be considering holding onto your 'accidental' property so that you can have it as a pension for your retirement, only do so if it is a good investment. (Indeed, this rule of thumb applies to anyone who owns a second property.)

"If the rental income pays the mortgage and other expenses, including tax, then it makes sense to invest in the property," said Peter Griffin, director with the Dublin pension firm, Allied Pension Trustees.

"But if the rental income doesn't cover those costs, it's a bad investment."

Many accidental landlords have recently emerged from negative equity and so could now be in a position to clear their mortgage by selling their property.

"The question for these people is: is it worth holding onto the property - or do they want an albatross around their neck," said Griffin.

Your pension scheme

Some companies offer products that allow people to buy property through their pension scheme. Pensionproperty.ie, which is run by the Independent Trustee Company (ITC) Group, is one such company. With pensionproperty.ie, you must set up a self-administered pension scheme with ITC if you wish to buy property with the money in your pension. "We do not provide the specific property - but a system of arrangements and procedures to ensure that the investment will be done in a manner which observes Revenue rules," said a spokeswoman.

Although self-administered pension schemes have traditionally been opened by company directors and the self-employed, it may be possible for you to set up such a scheme if you are an employee with a company pension.

There are a number of tax advantages to investing in property through a pension scheme. Any rental income earned from property is exempt from income tax (as long as the scheme has been approved by Revenue as a tax exempt one). Similarly, any profit earned from the sale of properties is exempt from CGT. Furthermore, you can get pensions tax relief on your pension contributions into the scheme.

Another way to invest in property through your pension is to do so through a property fund. Should you have defined contribution pension fund, you could put some of your pension savings into a property fund - or into a fund with exposure to a range of investments, including property.

Avoid pouring all of your pension savings into a fund which is solely invested in property though as this would be unwise.

Caveats

Get independent advice before buying property through your pension scheme - and be sure you meet all the rules so that you get the tax advantages. Investing in property through a pension scheme can be expensive so understand the costs. Be careful about borrowing for property through a pension scheme. "You'd be a very brave person to borrow to buy shares," said Griffin. "Property is a bit different to shares - but it's still an asset which can go up or down in value." Be sure too that you can afford the mortgage repayments.

Like any investment, it is never wise to have all your eggs in one basket. Having property in the mix can be wise, but having all, or too much, of your pension savings or expected retirement income tied up in property can be a very bad move.

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