You may have heard the ads on national radio recently urging you to use your self-administered pension fund to buy property. With rents, especially in Dublin, on a rapid upward trajectory, it might seem like a no-brainer.
Many of the advantages to buying property through one’s pension stem from the special tax treatment of pension fund. So, for example, the rental income you would earn is tax free. Of course if and when you draw down the fund in your retirement, you will pay income tax on those allowances.
If your plan is to sell the property on retirement, there is no Capital Gains Tax (CGT) to be paid should you make a profit, which of course is your ultimate goal. (This is not a given. I’ll come back to that later.)
It gets better; when you buy through a pension fund you don’t have to cough up stamp duty.
You get to choose the property you want – it can be commercial or residential (though certain ts and cs apply), which is not the case with a property fund, where the fund manager is making that decision for you.
Even I’m beginning to think this is a great idea!
Why isn’t everybody doing this?
Until recently, banks were not prepared to lend for pension-related property purchases, probably because the rules stipulate that the lender has no recourse to the borrower in the event of default. The property itself is the security.
That’s all changing because ITC has just announced that ICS Mortgages (a trading name of Dilosk DAC) is going back into the pension property market.
But hang on – before you dive into Daft.ie to select a property in a good area with strong rental potential, there are some things you should know before making a decision like this.
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- Property is arguably over priced. The time to invest in property in Ireland was between 2010 and 2015. This was the period when capital appreciation was greatest. Evidence suggests we are approaching peak property prices right, which means the only way is down.
- Property does not fare well in recessions. “Who said anything about a recession?” you may well ask – “Aren’t our growth rates really healthy?” They are, and they were also very healthy in 2006 and 2007. And then something happened to affect the economies of a number of nations to which Ireland was closely connected. Could something like that be about to happen again? I’ll give you a clue. It starts with B and ends in exit.
- The proposition here is a single-security investment. If you use the bulk of your pension fund to buy a 3-bed semi-D in Longford, you really are putting all your eggs in one fragile basket.
- In order to hold the property and the liability, ITC sets up an Exempt Unit Trust. This Exempt Unit Trust is bespoke in the sense that it’s designed to work for that particular pensioneer trustee, and that’s fine, but if you fall out with ITC over fees or charges or whatever, you’re kinda stuck with them. You can’t easily move your Exempt Unit Trust to another pensioneer trustee. It just won’t work in any other ecosystem.
- Bear in mind that investment property is often seen as low-hanging fruit when it comes to annual budgets. A change in minister, not to mention a change in government, could make owning investment property more or less attractive overnight.
- You can borrow up to 50% LTV for a pension-funded property but bear in mind that that borrowing ties you to the investment for its lifetime. If your fund was invested in some kind of mixed-asset fund, you can simply stop your contributions if you need to but with geared pension-funded property, you are on the hook to the lender until the debt is paid off.
Things are cyclical, and you need to consider how economic conditions will affect your investment at the key dates for you. What happens in ten years, or example, when you want to retire and need a cash lump sum to draw down but your fund is tied up in this property?
Always consider the worst-case scenario
I always ask my clients to consider the worst case when contemplating any big financial decision. If they can handle that Doomsday scenario and still achieve their financial goals, then they have the capacity to handle the risk.
If doomsday means disaster for them, their business or family, they should walk away.
What is that doomsday situation in this case?
If recession hits and you find it impossible to find a tenant, or are forced to lower your rent to below your repayments, you have another outgoing to add to your everyday expenses. Somebody has to pay back the loan to ICS Mortgages. Can you afford it? Instead of accumulating wealth for your retirement, you are eroding your wealth. If you’re already retired, this may seriously reduce your income.
Where property values have tanked and you need to sell the property to keep your business afloat or give yourself an income at retirement, your gamble will not have paid off. The investment that you had hoped would give you a comfortable living for 30 years post-retirement might suddenly only last 15. Remember that property values were halved in the 2008 crash.
In and out
You may be thinking that there are still a couple of years of price growth in the housing market, and that you could make a quick buck by buying now and selling in 12 months, but the high fees, and the not inconsiderable hassle involved in buying a property through your pension, make this an unsuitable option for such a plan.
Works for some
In certain circumstances, buying a property (or more than one) through your pension fund could be a good idea. Let’s say you have a pension fund of €1 million, setting aside one quarter of that to purchase property should not leave you exposed, should the worst-case scenario befall you. If you can do it without borrowing, even better.
But if you have €250,000 in your fund, you would be taking a gamble with very poor odds.
Just to clarify, I’m not against property. Property increases one’s net worth at the end of the day and there is certainly a place for property in an investment portfolio. Give me a call if you want to explore adding property to your portfolio in a way that will work for you.