Fancy owning a buy-to-let with no tax, no tax returns and no hassle? And what’s more, you can even borrow to purchase your property, which could, if chosen and managed correctly, offer you an income into posterity.
As landlords across the State continue to campaign about a perceived high tax burden, it’s no surprise that many are choosing to take advantage of strong rental yields by buying with their pension fund.
"We've been very busy on it in the last 12 months, and it's getting busier all the time," says Joe O'Regan, director with Blackthorn Capital. Killian Nolan, head of business development and marketing with ITC, agrees.
“Demand has been very significant. We’ve seen a 50 per cent increase in numbers year on year,” he says, noting that in one recent week alone, ITC received 22 application forms.
Why buy in a pension fund?
If you’ve already decided that you want to make an allocation to property to prepare for your retirement, the decision to buy through your pension fund – as opposed to buying directly – may come down to the tax benefits.
If you buy an apartment through your pension fund for example (and remember this has been built up thanks in part to tax relief on contributions), then all the rent flows directly into the pension fund. It does not pass Revenue and does not result in a tax liability.
Should you sell it at a later stage, any capital gains which might arise are again distributed to the pension fund tax-free. The rent that comes in can be invested back into the equity or bond markets.
It is only once you draw income from your pension fund in retirement that there will be a tax liability.
Outside of the pension fund, if you’re a higher-rate taxpayer, almost half of your rental income can go on tax, while gains are subject to tax at 33 per cent.
“It’s as bullet-proof a solution as exists, once you can live with the fact that the property value will fluctuate,” advises O’Regan.
As our example shows, the tax benefits mean that someone buying a €200,000 property can enjoy a return of €236,905 more than if they had purchased it outside their pension fund.
As with all property investments, the typical risks, such as an empty property apply, as do additional concerns around maintaining liquidity in your pension fund. A single property purchase could account for a disproportionate share of your pension fund, depending on how much you have saved.
Who can do it?
If that all sounds attractive, the first thing to consider is whether you are eligible to operate as a landlord through your pension scheme.
If you’re self-employed, own a company or have an older pension fund with considerable assets in it, you may be in a position to go down the route of a self-administered/self-directed fund. This path does, however, typically exclude employees of an occupational pension fund.
“You need to have control of the fund. You’re not going to be able to self-direct if you’re working for a large employer,” advises O’Regan.
Typically this means having about €250,000 in such a pension, although O’Regan notes, “there are clearly people who would do it with less”.
Fiona Conroy, a solicitor with ITC, puts the breakeven point at about €180,000, noting that savers should keep a minimum of 5 per cent of their fund in a liquid asset such as cash.
Funds can also be pooled – for example between a husband and wife.
However, while you may not have enough for a self-administered fund yet, this can change over time. If, for example, you agree a transfer on your defined-benefit pension assets into a defined-contribution scheme, you might seek to self-direct it at that time.
Or maybe you’ve left a company, as Nolan notes, and put the funds into a buyout bond, which can then be used for a property investment.
It can also make sense when you’re approaching retirement, as you can set up an approved retirement fund (ARF), should you go down this route, to acquire a property.
“It’s as close to perfect for an ARF that exists,” says O’Regan, noting that many ARF investors will be too conservative and only achieve a return of about 3 per cent a year. If they do, a drawdown of 4 per cent a year – the minimum mandated by Revenue once you are over the age of 61 – will start to see their capital erode.
With a property, however, you could be getting a 5 per cent net yield which would preserve your capital.
“The longer you do it for, the better it’s going to work; this is all about you buy and you hold,” advises O’Regan.
If you do buy with an ARF however, Nolan advises that higher liquidity requirements will apply as the fund would be in drawdown.
“Sufficient cash funds must be retained to ensure that the client’s annual distributions can be paid,” he says.
Picking the property
Identifying the right property or properties will be a key element in your strategy being a success.
“You’re trying to acquire a property that will produce a consistent rental income,” says O’Regan.
This may mean forgoing some ritzier locations – which may have higher capital appreciation potential (if you can afford them) – but lower yields. As our table shows, on a one-bed apartment you’ll get a far higher yield in Cavan than you will in Dublin 2 or 6. But, of course, there is a greater risk of vacancy in such a location.
If you’re hoping to capitalise on the soaring Airbnb market in urban centres, tread carefully, however. While holiday lets are now eligible, because of the way income on Airbnb rentals is taxed, they aren’t.
If it is for you, you don’t have to limit yourself to just one property.
“There are no restrictions on the number of properties in the fund,” says Conroy, noting that some pension savers will build up a portfolio of buys-to-let in their pensions.
Properties can be based in Ireland or abroad but, as O’Regan notes, 99 per cent of what his firm is involved in relates to Irish properties, given the uncertainties in the UK of Brexit, for example, as well as the currency risk of buying in sterling. “Why would you go to the UK at this point? Why would you take that risk?” he asks.
It can also be a commercial investment, so if you have a shop or small office in mind this can be a possibility. For bigger investments, Conroy says people will tend to pool pension funds together to make an investment in an office block for example. “We are absolutely seeing people doing that,” she says.
The costs
Assuming the idea interest you, what are the costs involved?
A self-directed fund will typically cost in the order of about 1 per cent a year (as a percentage of fund assets) to run but, as with any property, you can also expect additional costs, such as management fees.
“It’s important to note that a property manager has to be assigned; it can’t be individuals managing it within the pension structure,” says Nolan, adding that the funds to fix things will come out of your pension fund so there can be savings on this end too. All these costs can eat away at your returns, so O’Regan suggests you look for a property with a gross yield of about 7-7.5 per cent if you’re trying to target 5 per cent net yield.
Lend to your pension fund
Another point to consider is borrowing to fund your purchase, as lending can beef up your pot of funds.
“Instead of buying one property, you may be in a position to buy two,” notes Conroy.
Last year Dilosk/ICS started lending specifically for this purpose and currently offers loans of between €40,000 and €500,000, with rates starting at 5.45 per cent based on a maximum loan-to-value of 50 per cent, over a 15-year term based on capital and interest repayment/interest only. The property must be worth at least €80,000, but there is no maximum value.
According to Fergal McGrath, chief executive of Dilosk, this type of lending is limited to about 20 per cent of its mortgage book and it’s already at about 15 per cent.
“A lot of people think this is for larger pension pots, which isn’t necessarily the case,” says McGrath, pointing to an average loan size of €140,000. However, he does note the 50 per cent LTV rule which means that, if you want to buy a €200,000 property, you will need to bring at least €100,000 from your pension fund to the purchase.
Such a hefty deposit is there for a number of reasons. Revenue rules determine that lending to a pension fund should be “moderate” while, for its part, ICS also lends on a non-recourse basis. That means that if your buy-to-let goes bust, your own home won’t be at risk.
“As a lender, you have to be comfortable with the actual property, as there is no recourse to the person, and no recourse to the assets outside the property,” says McGrath. As such, ICS will typically lend for properties in Dublin and surrounding commuter counties, as well as Galway, Cork, Limerick and other urban centres with populations greater than 10,000.
Of the typical customer, McGrath says it is usually an individual or married couple aged 45-58 buying a one- or two-bed apartment.
Whether borrowing is right for you may depend on your circumstances however.
“We’d be saying don’t borrow, as the cost of money is too high,” says O’Regan, adding that if you’re borrowing just to buy a bigger property, you might end up getting double the rent but that excess rent will go largely towards servicing the mortgage. “The only point of borrowing is the capital appreciation play, and getting a bigger return,” he said. “But I would be saying to people ‘you’re not buying to sell you’re buying to hold’.”
‘Accidental landlords’
Tapping your pension fund is one thing, but what about accidental landlords – those people who never intended to enter the rental market but found themselves there as the property market meant they could not sell their homes? It’s a question O’Regan hears on a daily basis. “Half the people I’d talk to ask ‘can I put something in I already own?”
Of course for cash-strapped accidental landlords and their ilk, withered from handing over almost half of their rent to the Revenue, and most of the rest to their lender, getting tax-free rent seems like a veritable utopia.
But it’s not so simple.
“It’s certainly not a panacea for accidental landlords,” says O’Regan, noting that you can’t shift a property you already own into a pension fund.
However, what could be done is once the existing property or properties are sold, the capital is transferred to a pension fund, and then another property bought through the pension fund – provided the owner can afford to do so.
Under the arm’s length rule, you are also barred from bringing a property you directly own into an ARF upon retirement. And, if you want a member of your family to live in your pension property, or to use it for holidays, this is also disallowed.
