Property purchases and your pension
John O’Connor of Omega Financial Management recently wrote for the Engineers Journal about property as an investment option for your pension, here are some of his main points.
There are a few primary concerns about both property investments and pension funds that we must consider separately before we assess whether they are suitable partners.
Purchasing 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 €2 million (not reached by many);
- Once you draw down your cash lump sum from the pension fund you must withdraw at least four per cent from the fund each year;
- All individuals are subject to a maximum contribution allowance by revenue that they cannot exceed each year.
Purchase price proportion
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 per cent upwards, those ‘would be’ landlords were making very small investments and leaving themselves very heavily exposed to any sort of an upset in property prices and also with insufficient rent to pay the mortgage.
Therefore we must consider it prudent not to borrow more than 50 per cent of the purchase price of a property (whether in a pension or not). Once this is adhered to, a yield of five per cent of the purchase price should be enough to repay a 50 per cent mortgage over 15 years.
One significant advantage of a pension property purchase that would benefit the investor is that the rent is not taxable within their pension fund.
To give an example, an investor who receives rental income of €20,000 per annum could be liable to up to 52 per cent of that in tax (€10,400) leaving them with only €9,600. A pension fund that receives rental income of €20,000 per annum 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 valued at €400,000 with a 50 per cent mortgage of €200,000 on it and a rental yield of five per cent you will own the property in its entirety after 15 years.
If the property value increases at a rate of two per cent 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. As I noted above you must take a minimum of four per cent 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 four per cent 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.