Written by Kris Wrenn
This is a question that has naturally arisen in my conversations with Hudson clients many, many times over the years and I think will always continue to do so.
It’s often the case that investors will accumulate one or more properties throughout their working career, due to higher (taxable) income, and benefit from the various tax-deductible expenses related to property. They may also take this to the extent of having the property “negatively geared”, i.e. costing them to hold, but relying on the eventual capital growth to outweigh the net losses in income.
As retirement approaches, and the prospect of not having as high an income gets closer, the question arises to these investors should they 1) attempt to convert the properties to being neutral or positively geared or 2) sell the properties. A third option could be a combination of both, where they sell one property in order to use the proceeds to reduce/eliminate the debt in order to make the remaining properties neutral/positive.
Hanging on to property in retirement may have its advantages:
- In terms of capital growth, property is arguably unparalleled in terms of an investment option, if done right. It might be worth keeping an investment property to sell at an advantageous time to boost your retirement savings.
- It may provide diversification, assuming that the rest of your retirement assets are invested in a more traditional manner within Super, i.e. in cash/ bonds / shares / commercial property/infrastructure etc).
- You may wish for your beneficiaries to inherit the properties. There is no question that in Australia property it is more difficult for first-time buyers to break into the market compared to 20 or 30 years ago.
- Money/income permitting, retirees may make personal use of an investment property from time to time – perhaps it’s a lifestyle property on the beach and it could be leased for 9 months a year and lived in for 3 etc.
On the flip side, there are also some really strong reasons to reduce property exposure prior to or after retirement.
- Tax is key. Unless you have purchased the properties inside Super (a SMSF), then the biggest risk you run is having a property portfolio that yields a net income that results in your taxable income being above the tax-free threshold. Paying tax in retirement is NOT ideal and can usually be avoided. How? By moving your assets into Super and then into Pension phase. Earnings in your personal name are taxed at marginal income tax rates. Earnings in Super are taxed at up to 15% p/a. Earnings in Pension phase are tax-free.
So, a common strategy is to sell one/more properties and move the proceeds into Super and then into Pension phase. Recent changes to legislation make this strategy even easier with the ability for those aged 67 to 74 year to contribute to Super without the requirement to be working. $110,000 a year OR potentially $330,000 in one go using the “bring forward rule”. A further strategy may be to sell a property/properties after retirement so that the capital gains don’t have as large a tax implication.
- Due to all the associated costs of property, the NET YIELD can often work out quite poor. Even assuming there is no debt against the properties, a 5% gross yield can quickly be eroded to say 3% once you take into account rates, water, agent fees, body corp fees, insurance premiums and of course maintenance. Superannuation, and the usual investments therein, on the other hand can usually be maintained at significantly lower cost.
- Property is a very illiquid investment. Therefore, should the above happen and there comes a point a few years into your retirement where the net yield is not adequate to fund your retirement, a sale will be required, and you cannot sell a room or a floor of the property, you have to sell the whole thing. You are then left with a lump sum of funds that you potentially cannot put ito Super and may even have a tax implication on the earnings outside of super.
- My final potential negative is .. hassle. You have to ask yourself if dealing with tenants/real estate agents is something you want to do into your retirement. The reality is that things break … tenants vacate … and the rent continually needs to be revised/negotiated, etc.
There is no right or wrong answer as to whether to keep a property/properties in retirement and as always it depends on the situation and goals of the individual. If an investor has multiple investment properties it may be a case of a “middle ground” and choosing the best property to keep and the best to sell. The timing of sales can also be very important. If this article has got you thinking, book in with a Hudson adviser today on 1800 804 296 to discuss your situation and how we may be able to assist.