It appears that appetite for investment in the property market is back. Various different economic commentators have predicted residential house price growth of between 6% and 8% for the year. In addition it seems that we have had a severe under supply of homes in Ireland over the last 10 years and nothing increases prices like scarcity and demand.
Having seen what can go wrong with property many people are reticent to get involved in a market that has proven to be much more volatile than anyone had previously dreamt it could be. So with that in mind why would anyone in their right mind even consider purchasing an investment property using their hard earned and hard saved pension funds.
Well there are a few issues about both property investments and pension funds that we must consider separately before we assess whether they go together or not.
Purchasing a property as an investment:
The primary goal is to purchase an asset that will provide an income to repay any mortgage over the term of the loan and thereafter give you an income
The property should increase in value at least in line with inflation so protecting the owner’s investment
Rental Income is subject to an income tax computation
Property tax has to be paid on the property
On the sale of the property Capital Gains Tax is applicable to any profit made
Saving money into your pension fund:
The primary goal is to save enough money during your working life to one day be able to retire and have enough income so that you no longer have to work
The maximum amount you are allowed have in the fund at retirement is €2m (not reached by many)
Once you draw down your cash lump sum from the pension fund you must withdraw at least 4% from the fund each year
All individuals are subject to a maximum contribution allowance by revenue that they cannot exceed each year (see table below)
So with the above considerations in mind let’s analyse how purchasing a property within a pension fund would work and assess if it is a beneficial concept or not.
The downfall of many who invested in property in the past was the proportion of the purchase price they had borrowed. Because banks were allowing people borrow 90% upwards aspirational landlords were making very small investments and leaving themselves very heavily exposed to any sort of a glitch in property prices and also with insufficient rent to pay the mortgage. Therefore we must consider it prudent not to borrow more than 50% of the purchase price of a property (whether in a pension or not!). Once this is adhered to, a yield of 5% of the purchase price should be enough to repay a 50% mortgage over 15 years.
One significant advantage that a pension property purchase would benefit the investor is that the rent is not taxable within their pension fund. To give a live example, an investor who receives rental income of €20,000 per annum could be liable to up to 52% of that in tax (€10,400) leaving them with only €9,600. A pension fund that receives rental income of €20,000pa has no income tax liability on it. This leaves it with far greater capacity to repay a mortgage on the property.
Because the property should increase in value in line with inflation it may assist you in getting closer to the maximum you are allowed have in your fund at your retirement. If you buy a property value at €400,000 with a 50% mortgage of €200,000 on it and a rental yield of 5% you will own the property in its entirety after 15 years. If the property value increases at a rate of 2% per annum over 15 years it would be worth €538,347.
Rental Income Pre-retirement One of the great advantages of the rent being paid into the fund is that it is not included as part of your maximum contribution allowance – it is separate income from the table below. The rent is not classed as an actual pension contribution and the full limits remain available.
Creating Income in retirement As I noted above you must take a minimum of 4% from your approved retirement funds once you have taken your cash lump sum. With bond yields and interest rates currently so low it can be difficult for traditional pension funds to provide that for you without eroding the original sum invested. But with capital values and rents moving in line with inflation this should be achieved using the rental income coming into the fund. This will mean that as the 4% is paid out the capital value of the fund is protected.
While all of the rent on a property held outside of a pension is taxable, only income taken from a pension fund is taxable meaning that you may have less tax to pay depending on how much you take from the fund.
Arm’s Length Rule One very important consideration that must be remembered is that the revenue has an ‘arm’s length’ rule which means that neither you nor family member or friend can use the property either as a home place of work or as any other facility. This rules out your holiday home, student accommodation for your children or your own surgery building. The answer goes “if you need to ask then it breaks the rules”!