Key Post "My investment property is my pension."

[Brendan Burgess]

I hear variations of this from time to time. Where people believe that if they have an investment property, they won't need a pension. Or they trade up and keep their former home "as a pension."

Here is a simplified example of why you should prioritise having a pension over an investment property.

Take a 45 year old with a small or no pension who has €100k equity in an investment property. They can continue to keep the property or they can sell it and max their contributions to a pension fund.

	Keep property	Contribute to a pension fund
Net investment	€100k	€100k
Tax relief assuming a 40% tax payer	0	€66k
Gross investment	€100k	€166k
Rent (5%)/Dividends(2%) over 20 years	€100k	€ 66k
Less income taxes @50%	(€50k)
Capital gain - say 100% over 20 years	€100k	€166k
Capital Gains Tax	(€33k)	0
Value of investment after 20 years	€217k	€400k
Tax on pension on drawdown 25% €100k tax free 25% €100k @25% 50% €200k @50%		€125k
Net value of investment	€217k	€275k

Explanation and assumptions
If you contribute €166k to a pension fund, you will get 40% tax relief which is €66k which brings the net cost down to €100k.
I have assumed that the person invests €166k in their pension fund immediately. Of course, they will have to spread it out over a few years to maximise their tax relief.
For the sake of this exercise, I have assumed that the pre-tax return on property will be higher than the pre-tax return on a pension fund.
The dividends and capital gains within the pension fund are not subject to tax.
On retirement, 25% of the pension fund is tax-free. The balance is taxed at your top rate of tax. Many retired people have no income taxed at 50%. But for the purposes of this example, I have assumed that half a person's income is taxed at 50%.

Conclusion 1
Under assumptions most favourable to property investment over pensions, it still is better to prioritise your pension over an investment property.

If you make more normal assumptions about the rate of return being the same over the next 20 years and if most of your income is taxed on retirement at less than 50%, the advantage of a pension is even bigger.

Conclusion 2
It is extremely risking relying on just one property as your source of income in retirement. Even if you own it outright without a mortgage. Rents can fall. You might find it difficult to get a tenant.

 

[Brendan Burgess]

Some factors which argue in favour of keeping the investment property

If you are not paying 40% income tax at age 45, then it's less clear that you should be investing in a pension
You will not get the benefit of €166k invested on you behalf. However, on retirement you will be paying a lot less tax than in the example above.

But if you are not a 40% income tax payer, you probably should not be investing in property either, as you would be less able to deal with the risks involved.

If you have a cheap tracker mortgage on your investment property
A cheap tracker mortgage makes property investment much more profitable.

If you may need to access your money before retirement
If you might need to access your investment to trade up your family home or to fund your children's education, then this would tilt the balance towards keeping the property.

If the property might be used by your kids when they are in college
For example, if you have an apartment in Dublin and you expect your kids to go to college in Dublin but you live outside Dublin, it might be worth keeping.

If you are going to have a very big pension fund anyway on retirement, then it might tilt the balance towards keeping the investment property
The above example assumes that you will get 25% of your pension fund tax-free on retirement. However, if your fund exceeds €800k, the tax impact will be higher.

 

[Brendan Burgess]

You could invest in a property through your pension fund

The example above compares a direct investment in property and a pension invested in equities. Because, in practice, that is what most people do.

However, if you believe that property is the best long-term investment, you can buy a property through your pension fund and get all the tax benefits of a pension fund.

"But borrowing increases the returns on property investment"
Some will argue that they can increase the real return on their property investment by borrowing money to invest more than €100k.
For example, let's say that the €100k equity represents a €300k property with a €200k mortgage.

The capital appreciation will be on the €300k rather than €100k.

While this is true, borrowing also magnifies the risks.

 

[moneymakeover]

Useful post Brendan because most people I think purchase investment property with a view to retirement.

I don't think the equity is the thing that is uppermost in people's minds

That could increase simply through rise in prices without any contribution by investor.

What people most concerned with I think:

• Rental income
• Any mortgage payments
• Tax on rental income

It would be useful if you could consider that

Eg imagine person bought property 300k
Reaches retirement age with 75k remaining owed to bank and repayment of 1000 3 years remaining
Project forward, rent per month is 3k year 2030 age 65
Tax, 20% on 24k=4.8k tax
Only 24k falls into tax net
Net income 19.2k= 1600/month

After mortgage fully paid off income 3k age 68
24k falls into tax net
Tax 4.8k (20% of 24)
Net income 31.2k =2600/month

I'm ignoring expenses, repairs
And assuming the income puts taxpayer only on 20% bracket

Also you can see when the mortgage is fully paid off the income increases significantly

 

[Bronte]

BB
- where is the income from the pension v the rental
- where is the value of the rental when you die v the pension
- where is the cost of the rental, paid out of capital repayments from rent v cost of pension from taxable earned income, albeit with an employers contribution, and tax relief

 

[Bronte]

Useful post Brendan because most people I think purchase investment property with a view to retirement.

I don't think the equity is the thing that is uppermost in people's minds

That could increase simply through rise in prices without any contribution by investor.

What people most concerned with I think:

• Rental income
• Any mortgage payments
• Tax on rental income

It would be useful if you could consider that

Eg bought property 300k
Eg When I retired I have 75k remaining owed to bank and repayment of 1000 3 years remaining
Project forward, rent per month is 3k year 2030 age 65
Tax, 20% on 24k=4.8k tax
Only 24k falls into tax net
Net income 19.2k= 1600/month

After mortgage fully paid off income 3k age 68
24k falls into tax net
Tax 4.8k (20% of 24)
Net income 31.2k =2600/month

I'm ignoring expenses, repairs
And assuming the income puts taxpayer only on 20% bracket

Also you can see when the mortgage is fully paid off the income increases significantly

How did you pay the 300k investment?

 

[Freelance]

I hear variations of this from time to time. Where people believe that if they have an investment property, they won't need a pension.

Really thought provoking, thanks. But is the "either/or" thing not the real issue. In terms of future planning, asset diversification is always a good idea. Having a property and a pension would surely be the optimum if it were achievable.

 

[moneymakeover]

How did you pay the 300k investment?

We'll my post was hypothetical

But what I'm getting at is if an investor buys rental property and pays it down over the years.

And even if there is residual loan at retirement age

If he keeps paying then there is a payoff when fully paid down: ready cash on retirement and the tax should be lower if income is lower.

I'm highlighting the advantages I see in property in retirement.

 

[Brendan Burgess]

It would be useful if you could consider that

I don't see this as adding anything much, but feel free to do it if you think it worthwhile.

If the tax rate is lower on retirement, it's lower for both the person drawing down the pension and the landlord.

The mortgage is a red herring and an unnecessary complication.

I show that an investment of €100k at age 45 is better in a pension than in a property even when you make assumptions in favour of the pension.

The €100k figure is for the example. Of course, the same applies to an investment of €1,000 a month whether that is the repayment of the capital on a mortgage or an additional investment in a pension fund.

If you have €100k but decide to borrow €200k and buy a property for €300k...

You are taking a huge amount of risks which may well pay off

1. Property investment is risky anyway - so borrowing to invest magnifies that risk
2. If interest rates are below the return you get on your investment, borrowing will increase your return
3. If interest rates are above the return on your investment, you will lose money or reduce your return. This could arise duet to
   1. Difficulty in finding a tenant
   2. Difficulty in collecting rent
   3. An increase in interest rates
   4. A fall in rental income
   5. A long-term sustained fall in the value of your investment

Investing in property is risky. Investing in shares is risky. Borrowing to invest magnifies that risk.

 

[Brendan Burgess]

- where is the income from the pension v the rental

Before retirement I show the rental income as 5% of the investment and dividend income as 2%

I show the net value of the investment at age 65 to show how investing via a pension is superior. One could extend the example further but the principle remains the same.

- where is the value of the rental when you die v the pension

That is an interesting question. If you die while you own the property, the Capital Gains Tax will disappear.

If you die while you own the pension fund, what happens? If it goes into your estate, your beneficiaries will get it subject to the normal CAT thresholds, I think? But I am not sure.

- where is the cost of the rental, paid out of capital repayments from rent v cost of pension from taxable earned income, albeit with an employers contribution, and tax relief

I am sorry, but I don't understand this question.

 

[Brendan Burgess]

If he keeps paying then there is a payoff when fully paid down: ready cash on retirement and the tax should be lower if income is lower.

I don't see how that is an advantage over a pension? If you have an ARF after retirement you will have ready cash.

Actually, an ARF is far more flexible. With a rental property, you get your annual rent. If you want more, tough. If you want less for tax reasons, tough.

With an ARF, if you need more money you can draw down more money and pay the tax accordingly.

As long as you take 5% of the ARF, you can leave the rest there accumulating tax-free.

Brendan

 

[Brendan Burgess]

Having a property and a pension would surely be the optimum if it were achievable.

Hi Freelance

This thread is aimed at people who say that they don't need a pension because they have a property.

It is clear to me that having a well-funded pension is absolutely the first priority.

As I point out in the second post, if you already have a well-funded pension, then by all means consider investing in property.

The problem with buying an investment property with borrowed money, is that the mortgage repayments can absorb all your surplus cash thus preventing you from contributing to a pension.

Brendan

 

[Steven Barrett]

The mortgage is a red herring and an unnecessary complication.

This thread is aimed at people who say that they don't need a pension because they have a property.

Interesting analysis Brendan, thanks for posting it. From nothing more scientific than talking to people about their finances as part of my job, the people who think they don't need a pension because they have a property have debt on that property. I think it is required in showing calculations as mortgage payments plus tax is usually greater than rental income, so there is a cost to the property owner while they have a mortgage. And that is before other payments.


What I usually say to people who tell me that the property is their pension is "Is what your net income from the rent enough to live off?"

And with the State pension payable at 68 and likely to be extended in the future, people have to wait longer to get the OAP to boost their retirement income. You can always have a property and a pension.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[Bronte]

That is an interesting question. If you die while you own the property, the Capital Gains Tax will disappear.

If you die while you own the pension fund, what happens? If it goes into your estate, your beneficiaries will get it subject to the normal CAT thresholds, I think? But I am not sure.

This thread is a great idea. My point is though that you ought to factor those points into your table. My understanding of the pension pot is that much of it disappears when you die. Some have a survivors pension and some have it for the children too, if they are dependent.

On the point you didn't understand. I think it should be pointed out that an investment property can be purchases out of rent, whereas pension has to come out of PAYE income.

I also think you have to point out the freedom one has with an investment property, to do with what you will, whereas you're very restriced with pensions.

I am not negative to pensions, as it happens myself and my husband will have the best of both worlds, defined benefit pension at that. But I've yet to see a property comparison.

 

[Bronte]

We'll my post was hypothetical

But what I'm getting at is if an investor buys rental property and pays it down over the years.

You misunderstood me. I was pointing out where was the 300K paid from. The investor in a normal rental, one not bought outright, from PAYE income, the actual property is paid for by the rent. But a pension has to be purchased over a long time period from your actual work income.

 

[Bronte]

If you have €100k but decide to borrow €200k and buy a property for €300k...

You are taking a huge amount of risks which may well pay off

1. Property investment is risky anyway - so borrowing to invest magnifies that risk
2. If interest rates are below the return you get on your investment, borrowing will increase your return
3. If interest rates are above the return on your investment, you will lose money or reduce your return. This could arise duet to
   1. Difficulty in finding a tenant
   2. Difficulty in collecting rent
   3. An increase in interest rates
   4. A fall in rental income
   5. A long-term sustained fall in the value of your investment

Investing in property is risky. Investing in shares is risky. Borrowing to invest magnifies that risk.

Been there done that. As in high interest rates, hard to find a tenant, low interest rates, increasing interest rates, property falling in value, rental income falling, rental income increasing, rent caps.

However I do not think property is risky in comparison with shares and nobody on here ever has convinced me of that. The reason is that what care I if property falls in value, it makes no difference to me, if rents go down, I've enough lee way to cover that, voids, enough to cover those, interest rates hikes, similar (BTW that doesn't apply when the mortgage is paid off)

My point is you'd need to have so many of those things to happen at once to make it risky. Now if you buy at the top of the market at 100% interest only for the first 10 years in a falling market, with job losses and falling rents plus a void, than that's risky. But I respectfully suggest that if you borrow prudently, with rent to more than cover the mortgage and increasing interest it's not half as risky as your post would suggest.

 

[Bronte]

Steven how does the debt on a property matter when you retire. For BB's table. You should have it well paid off before then surely.

 

[Brendan Burgess]

I think it is required in showing calculations as mortgage payments plus tax is usually greater than rental income, so there is a cost to the property owner while they have a mortgage.

While that might be true, it's misleading.

The main issue to look at is whether or not the investment is profitable. Take the following

Value of property: €300k
Rent: €15k
Mortgage €200k
Interest rate: 4%
Tax on profits 50%

	15 year mortgage	25 year mortgage	Interest only
Rental income	€15,000	€15,000	€15,000
Interest	€8,000	€8,000	€8,000
Capital repayments	€10,000	€7,000	0
Taxation	€ 3,500	€3,500	€3,500
Cash flow	(€6,500)	(€500)	€3,500

The term one chooses makes no difference as to whether this is a good investment or not.

Brendan

 

[Bronte]

That last table. In year 16 of column 1 you now have zero capital repayments, which changes the table. With the last column you still have to repay the entire capital. And your cash flow of 3.5K is frittered away on life.

 

[Brendan Burgess]

On the point you didn't understand. I think it should be pointed out that an investment property can be purchases out of rent, whereas pension has to come out of PAYE income.

While I now understand the point, I don't see its relevance. Can you put some numbers behind it to show how it is relevant.

People use expressions like "The tenant is paying my mortgage". Others say "I am losing money on my property investment." Both expressions are misleading. One has to crunch the numbers.

The person with the 15 year mortgage above might well sell the property as they "are losing money on it". That could be a mistake.



Brendan