Key Post Article: Integrating pensions and home ownership

[Brendan Burgess]

This is an article I had in the Sunday Times on 27 July

Integrating pensions and home ownership

Owning one’s own home should be an integral part of retirement planning. If the mortgage is paid off, there will be no accommodation costs in retirement. In addition, the owner can realise cash through trading down or through some forms of equity release.

The tax treatment of home ownership is probably as generous as the tax treatment of pensions. Any increase in value of the family home is exempt from Capital Gains Tax while the value of the home is ignored when applying for a means tested social welfare benefit such as Jobseekers Allowance or the Old Age Pension.

So a person’s financial priority should be to save up the deposit to buy a home and having bought a home, the next priority should be to reduce the mortgage to a comfortable level. When the person’s mortgage repayments are down to a low level, they can then begin contributing to a pension.

Likewise, for someone struggling with their mortgage repayments, the first priority will usually be to keep their home. They should prioritise making their repayments and clearing the arrears ahead of making pension contributions. However, if they are in such deep arrears and extensive negative equity, they may be better off isolating their pension fund from their mortgage difficulties by opting for one of the insolvency arrangements.

So what should the Government be doing to help integrate home ownership and pensions?

The priority should be to help people who are in danger of losing their home. A borrower who has positive equity and a cheap tracker mortgage who is struggling with their mortgage repayments is likely to be targeted by their lender for repossession. In one fell swoop, the lender can get rid of an arrears case and a loss making tracker. It would make huge sense if these borrowers were allowed early access to their pension funds to meet their repayments. If they manage to keep their home and their cheap tracker, their future accommodation costs will be much lower than they otherwise would be which will free up money for pension contributions. If they lose their home and their cheap tracker mortgage, their long term accommodation costs will be much higher and so they will have little surplus income to contribute to a pension fund in the future

The state should allow people early access to their pension funds to provide the deposit to buy a house. It’s very hard to interest a person in their 20s in pensions as retirement is 40 years away. However, many people in their 20s are thinking of buying a house and worrying about getting the deposit together. If they could use their pension fund for the deposit, the level of pension contributions among this cohort would rise considerably.

At present, most first time buyers have a deposit of around 10%. This creates big risks for them and for the lender. If people are allowed access their pension fund for the deposit, they will probably have bigger deposits . Because a higher deposit reduces the risk, lenders charge borrowers a lower rate for lower loan to value mortgages. For example, a borrower with KBC will pay 0.5% less if they borrow less than 80% LTV. That is a reduction on the whole amount of the loan for the whole term of the loan.

Allowing access to pension funds for the deposit, could bring many more buyers into the market and cause an artificial spike in house prices. This could be countered by simultaneously setting a ceiling on mortgages of 80% of the value of the property.

The Minister for Finance amended the legislation in early 2013 to allow people to withdraw 30% of their Additional Voluntary Contributions. Any such early withdrawal is taxed as income at the person’s marginal rate. This should be extended to all defined contribution pension schemes but it should be restricted to people who are using the money to buy a home or to reduce the capital on their mortgage.

However, the state should go further. On retirement, a person is generally entitled to take 25% of their pension fund tax-free. They could be allowed to take an advance on this before retirement if the proceeds are used to buy a house, to pay down a mortgage, or to clear arrears.

If a person has the option of accessing their pension fund, then they may be able to pledge that money to a mortgage lender instead of actually withdrawing it from the pension fund. If the lender knew that they could call on the pension fund in the event of a borrower going into arrears, then their security would be increased and they could charge a lower interest rate.

One objection to these proposals is that the tax treatment of home ownership is already too generous. Those who are well off enough to aspire to home ownership will have an investment which is exempt from Capital Gains Tax and means testing. These generous exemptions should be restricted to fund the reforms proposed above. For example, the exemption from CGT on the family home could be restricted to €100,000. Any gains in excess of that would be subject to CGT in the normal way.

In conclusion, increasing the level of long term saving through home ownership and pensions is of benefit to the individual and to the state. Using pensions to facilitate home ownership will help achieve this.

Brendan Burgess is the founder of the consumer website askaboutmoney.com

 

[Steven Barrett]

Never going to happen Brendan.

A pension plan is a savings plan for retirement. It is not a saving mechanism for house purchases.

There are different demands on our money based on the different stages of life that we are at. Some can afford pension funding as well as saving for a mortgage. Others can't, so they have to prioritise. There is nothing wrong with saving for a mortgage deposit and then starting a pension later in life.



Steven
www.bluewaterfp.ie

 

[Brendan Burgess]

Never going to happen Brendan.

Hi Steven

I think it's important to make proposals as to what is correct, whether there would be a political will to do it or not.

It should happen, which is why I am proposing it. I think it might happen.

A pension plan is a savings plan for retirement. It is not a saving mechanism for house purchases.

This is the conventional thinking which the article is trying to challenge.

Long term savings is savings, whether it is true a pension fund, savings outside a pension fund, or house purchase.

Some can afford pension funding as well as saving for a mortgage. Others can't, so they have to prioritise. There is nothing wrong with saving for a mortgage deposit and then starting a pension later in life.

Any my proposal would allow people get their housing needs sorted out earlier, which would then allow them contribute more to a pension.

It's interesting that you say "there is nothing wrong with saving for a deposit and then starting a pension later in life". The conventional wisdom was for many years "You can't start a pension too early". I was a heretic on this one and insisted you could start a pension too early. My heresy has now become the conventional wisdom.

Maybe it will again.

 

[mandelbrot]

I'm a civil servant, making mandatory contributions to the occupational scheme, about 6% of my gross. I'd gladly lose a couple of years' service in the scheme now, to have access to that amount of my salary for a couple of years to help get a decent deposit together... Later, when I'm in a better position, I could make AVCs or buy back the service.

 

[Purple]

Hi Brendan,

How would it work with DB schemes?

 

[Brendan Burgess]

Hi Brendan,

How would it work with DB schemes?

It would be difficult to work with the DB bit, but the AVCs are, in effect, a DC scheme. So they could give full access to AVCs. So a young person , could save up for the deposit through making AVCs.

It would be quite difficult, but not impossible to make early withdrawals from the DB bit.

1) They could give the member a loan to be repaid
2) They could give them an advance on their tax-free lump sum, but a severely underfunded scheme would be reluctant to do it.

Brendan

 

[Steven Barrett]

Long term savings is savings, whether it is true a pension fund, savings outside a pension fund, or house purchase.

There are too many terms and conditions to pension funding to make it a simple thing to do. Part of those terms and conditions is that for the tax relief, you keep the money there until retirement age.

There is a retirement income time bomb that is being completely ignored by this current government. Giving people the opportunity to cash in some of their pension is, in my opinion, a bad idea.

Introducing something like the UK ISA would be more agreeable to me. But with a minister who is insistent on punishing people for saving through huge taxation, that would never happen.

The conventional wisdom was for many years "You can't start a pension too early". I was a heretic on this one and insisted you could start a pension too early.

With the power of long term compounding, it is better to start a pension in your early working life and then stopping than not contributing at all until later on in life.

But we have to live in the real world. When people start their working lives, they are on relatively low salaries and their interest is on going out. Then saving deposits for homes, kids etc.

If most people had the choice, they wouldn't contribute to a pension in early years like mandelbrot has said. When they get to retirement though, they will be thankful.


Steven
www.bluewaterfp.ie

 

[Joe_90]

Brendan,

I think there is merit in the discussion, I personally think than in cases people should be able to access their pensions early (pay the tax ect) in order to deal with issues with their family home.

I wonder about the practicalities of your proposal for deposits.

If anyone has any statistics on the average age of FTB and the average salary of a person of that age I'd welcome a link.

Ok so a quick google search says BoI recon that it's 33 (that's higher than I expected) and 40% are single.

Don't know how much they would have earned at the higher rate to make a contribution feasible.

 

[Steven Barrett]

From experience, I have come across very few people in their 20's who want to start their own pension. It is always an employer based scheme that they go into. It would be a safe assumption to say that at least 50% of the money used to pay the deposit will be paid for by the persons employer.

If the member of the employer scheme went down the annuity route at retirement, they have to take the 150% final salary lump sum. As the lump sum paid is based on years service, how can you know their entitlement when they are only a few years into their career? Is there a clawback if they leave?

Steven
www.bluewaterfp.ie

 

[Duke of Marmalade]

Interesting debate. I saw the article Boss, was it really three weeks ago?

I think it's a "no brainer" that people should be allowed to access their pension funds in the case of unforeseen financial hardship (UFH) - I think that is the US position. I suppose the subjectivity of what would qualify as UFH has prevented the Irish and UK pension rules from going down that road.

But allowing access to the pension fund for deposits on house purchase - that is a different matter. At the very least this must be no better than tax neutral. Any cash flow tax advantage in funding house purchase in this way would greatly distort the market and would be unfair to those who can't avail of it (public servants to name but a few).

So at most we are talking about early access to the pension pot on a tax neutral basis. But this was hardly a UFH. Anybody voluntarily taking out a pension before they had taken care of their housing needs have themselves to blame. Or possibly their financial advisor to blame as any credible fact find would reveal that securing the deposit on a house was an absolute priority. Thankfully most folk in their twenties instinctively make this their priority anyway and are not unduly exposed to predatory pensions salespersons convincing them otherwise.

The other point on which I find it difficult to make up my own mind, is the advice to pay down the mortgage to a comfortable level before starting a pension plan. There is something a bit "half pregnant" about this statement. If it makes sense to pay down your mortgage surely it makes sense to pay it down completely. Yet that would mean folk starting their pension plan at earliest in their 40s and that seems wrong. In other words there does seem to be some case, and I shudder to admit it, for people having a geared position - owing say 100K on their mortgage but having accrued a pension pot of €100K.

 

[Steven Barrett]

My gut feel is that a mortgage equal to your gross salary and less than 50% of the value of the property would be comfortable.

We are not too long after a time where people were given many multiples of their salary as mortgages. Getting it down to their gross salary is a pipe dream.

A comfortable level is going to differ from person to person. A lot depends on what their lifestyle and the cost of it. If you can do the things you want to do and pay your mortgage, that is comfortable. If you are paying your mortgage and don't have any money to do anything else, that is uncomfortable.

It does seem wrong to wait until one is 40 to start a pension. But that would only be wrong if one was not saving at all. Paying off one's mortgage is a great form of tax-efficient saving.

If you are willing to sell your home and move to somewhere smaller when you retire. Will everyone want to do that after living somewhere for 30 years?

If I live in my home mortgage free, should I remortgage to contribute to a pension scheme? Probably no, at 4.5% mortgage rate. Probably yes at 1.15% cheap tracker.

Adding another level of risk to your investment by borrowing for pension investment. Rates go up, that low interest loan repayments aren't quite as attractive.


Steven
www.bluewaterfp.ie

 

[noproblem]

In theory the idea may sound fair but in reality, will it work? Giving large amounts of money to people to help them solve a problem of their own making, could and, might just tempt them to find avenues for the "largesse" that they shouldn't even contemplate. While the idea is indeed a good one, there's a breed of citizen in this country that will find this scheme a great opportunity for the wrong reason.
When you say there's a possibility this might just get the nod, I'm presuming this is being discussed by the relevant top people in the PS, regardless of what Goverment is in power?