Paul and his wife are considering buying an investment property, but want to know if this really is a wise way to make money for retirement.
Q My wife and I are in our early 50s and are looking at ways to boost our retirement income. We have enough equity in our home to enable us to buy an investment property and hold on to it for the next 10 years. As we both work, we could consider salary sacrificing directly into our super as another option. What would work best for us?
A As people progress toward retirement many look at different ways and options to increase their retirement nest egg. They might be at a stage where the mortgage is paid off, the kids have left home and their disposable income is higher than before. At this stage people can consider ways to make effective use of that disposable income for their retirement years. This is the scenario for YourLifeChoices readers who, with retirement not too far down the track, are looking to boost their retirement income.
So what options do people have? The most common option for those looking forward to retirement is superannuation as most Australians already have some form of super savings and many find the advantages worthwhile. But investments not held in superannuation may also offer advantages. It is important to remember that superannuation is an ‘investment vehicle’ and most investment assets can be held either within or outside superannuation. In some cases using a number of strategies can be effective in achieving this goal.
In determining which course of action is best, you need to consider your own needs and objectives. For example, how much do you need to keep aside for emergencies? Do you want to achieve higher returns or is safety and low volatility more important? Do you want to manage it yourself or would you prefer to have it professionally managed? In this article we will look at the readers question and list the common needs and objectives as well as other issues that they should consider when looking at boosting their retirement nest egg options.
Security – This refers to the safety of the investment. It is not just a question of ‘Can I lose my money?’ but also ‘Will the value and/or returns of my investment fluctuate?’ The security of superannuation can vary according to the member’s chosen asset allocation. In other words holding cash and fixed interest assets within super will offer less risk and/or fluctuations than growth assets such as shares and property. The level of safety in buying an investment property will be determined by the area, the ability to maintain good tenants, interest rates and overall market conditions and sentiment. Investment properties, like shares, are growth style assets which can fluctuate in value. It is important to note that even if the chosen asset isn’t growing in value it still may produce a decent income. During the Global Financial Crisis (GFC) some property and shares still produced quality income despite the value of the asset reducing.
Income – With either form of investment the level of income will vary according to the type of asset and market conditions. The income consideration here though is more about if they need access to the income produced. Income produced in superannuation will remain preserved until a condition of release is met whereas income produced by an investment property can be accessed and utilised.
Liquidity – This refers to the ability to access the capital when required. Either option put forward could prove problematic if liquidity was of high importance. To access superannuation, members must meet a condition of release. You must be 65 to permanently retire and access capital or, if accessed through a Transitional Retirement Pension (TRP), would have restrictions on amounts accessed. Investment properties can also have liquidity issues as you generally cannot access capital unless the whole asset is sold ie; you cannot sell a portion of the property to access a small amount of capital.
Capital growth – This refers to the value of the assets increasing over time. If this is a priority then they will generally need to think long term and be prepared to ride out the ups and downs. This applies to both investment properties and growth assets held within superannuation.
Fight inflation – The term inflation refers to the general cost of living increasing over time. It is generally accepted that even with events such as the GFC, growth assets over a long period have more chance to fight the effects of inflation than non-growth assets such as cash or fixed interest. Investment properties can offer capital growth over time when market conditions are favourable as can growth assets held within superannuation.
Flexibility – This refers to the ability to change investment options during the investment term. This may be due to a number of reasons such as an unexpected life event or a change in investment attitude. With most superannuation funds you can switch investment options and/or change the assets that make up the members fund. An investment property however doesn’t really allow for this.
Potential tax advantages – This is often a major selling point in determining which option is best however other objectives listed here shouldn’t be overlooked. Both courses of action may offer some taxation benefits but the extent of the benefit depends on personal circumstances.
Salary sacrificing money into super (taxed fund) reduces the tax paid on that portion of the wage sacrificed, from their marginal tax rate (MTR) to 15 per cent. Any earnings the fund generates is taxed up to a maximum of 15 per cent. As with the super guarantee, salary sacrifice contributions are concessional contributions which are capped at $30,000 pa for those below 50 and $35,000 for those over 50. So care needs to be taken not to exceed the concessional contribution cap or penalty tax will apply. If they then wait until they reach 60 years before accessing the funds then no tax will apply to the withdrawal. This strategy is more advantageous to those on higher MTR.
With regard to the taxation treatment on investment property, any rental income received is taxed at the individuals MTR although an offset for allowable costs (deductions) can reduce the liability. Upon sale, capital gains tax applies which is charged at the individuals MTR but a 50 per cent discount applies if the asset was held for more than 12 months.
Ease of management – For some, the time and effort they put into managing their finances can be rewarding. Others would prefer to have the money/funds professionally managed. This involves reviewing and maintaining the asset as well as ensuring that all the documentation requirements are met.
Both of the options put forward can allow for either scenario as superannuation can be managed and administered by a professional super fund or run by the member with a Self Managed Super Fund (SMSF). Investment properties can also be managed by the owner or with assistance from professionals such as property managers or agents and accountants.
Apart from considering these objectives, questions such as the following need to be answered:
- What is their current income? Is their income high enough to see a benefit to salary sacrificing and/or cover loan repayments?
- How long do they expect to continue working for? Are they likely to work past 65 leaving the door open to super contributions or if they continue for a short period will they need to change strategy?
- Are they willing to borrow and carry debt if they buy an investment property? Will this be a burden on their cash flow?
- Can they meet the repayments if the property is vacant for any length of time? Are they willing to, and do they have the resources to cover the debt obligations?
- Do they wish to utilise income streams, access the funds as a lump sum or keep the money in property during their retirement? If they sell the investment property will they want to consider using super with the proceeds?
- Are there estate planning considerations?
- Is their employment income likely to change leading up to retirement? Will this allow for higher contributions and/or debt repayments later on or will a reduction affect the value of the chosen strategy?
- Will contribution caps hamper the investment property strategy if they wish to use the proceeds from the investment property to purchase superannuation income streams down the track?
At the end of the day either option or a combination of both may help toward building wealth for retirement, but what seems like a straight forward choice is quite a complex one.
The best option for them depends on their personal situation, attitudes and aspirations. The best option chosen can only be determined after much consideration is given to the above points. Seeking professional advice with this would be highly recommended so the various strategies can be compared taking into account all of the above.
All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this advice you should consider its appropriateness having regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that impact your financial and legal circumstances.