The Irish insatiable appetite for property has not gone away, with property transactions in some form happening on a daily basis.
Additionally, it appears the appetite for investment in the property market is back. Various economic commentators have predicted residential house price growth of between 6% and 8% for the year. It also 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 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?
With the lack of financing available, at least the gearing risk has been taken out of this area. With this in mind, many people are now using their self-administered pension scheme as the purchasing mechanism for property investments. With the Irish rental market for property currently very strong, many investors and their financial brokers feel that there is value to be found in the property market at the moment.
One of the key features of a self-administered pension scheme is the ability to take control, so you can identify and acquire various property investments. This means that you have the ability to use your own market knowledge to access opportunities and significantly enhance your retirement asset. These types of pension schemes have the ability to invest directly in residential and commercial property located in Ireland.
Recent times are showing more of an appetite for commercial properties, such as pubs, hotels, shopping centres, retail outlets and so on, with an emphasis on income.
There are a few issues about both property investments and pension funds that we must consider separately, before we assess whether or not they go together.
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 4% from the fund each year;
• All individuals are subject to a maximum contribution allowance by revenue that they cannot exceed each year.
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.
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% and 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 of a pension property purchase that 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 €20,000 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% 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.
All costs incurred by the property purchase are met by your pension scheme – stamp duty, solicitor fees and so on.
In addition, there is no Capital Gains Tax on the sale of the property, nor is there any income tax liability on rental income received.
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.
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”.
Upon retirement, the purchase property can be transferred to an Approved Retirement Fund (ARF). No stamp duty will be incurred on the transfer and all rental income will continue to be paid to the ARF.
Property purchases through self-administered pension schemes have set guidelines and restrictions issued by Revenue governing what is permitted. Such restrictions include all purchases being on a totally arm’s length basis from the beneficial owner of the pensions scheme. This means that you cannot purchase a property from any person or entity connected to you in any way. There are also rules prohibiting property purchases with the view to development and immediate disposal. The purchase of holiday homes is permitted, so long as neither the beneficial owner nor any connected party uses the property.
There is an opportunity for you to use your pension fund to secure some long-term income and an asset that should provide tax free capital appreciation so you can enjoy the fruits of your labour in your retirement.
Talk to Carey Corbett Financial Solutions today, to find out more about making the most of the investment opportunities available and taking control with your self-administered pension scheme.