Am I daft to consider migrating to a SSAP and property investment?

[gnf_ireland]

I appreciate some people will think I am attempting to time the market, but it is not the case. My question is is more about looking at how best to plan around moving to a different pension structure over the next 2 years. The current pension fund has early withdrawal penalties for the next 2 years [until October 2020], so am looking to trigger a different pension structure beyond this point.
I am in my early 40's, and approximately 20 years away from retirement. I have two policies within my pension fund, one I transferred in when I swapped providers a few years ago (effectively a single premium policy), and the other the one I am actively paying into on a monthly basis (recurring policy). They both have a risk profile weighting of 5 (out of 7), and are very heavily invested in equities.
As a pension strategy, I would like to move to a Small Self Administered Pension structure in 2 years time (once I get beyond the early withdrawal penalties), and invest the funds currently sitting in the single premium policy into property investment(s). With a small level of gearing (say 33%) [which I would look to pay off within 10 years] I could have an income generating asset(s) within my pension fund. I fully understand the complexities of the residential rental market in Ireland at the moment, and impact of regulation, but at least I would be spared the taxation impacts within the pension structure.
With this plan in mind, I would look to reduce the equity exposure of this element of the pension fund over the next 18-24 months, maybe moving it to less risky investments over time. This is similar to the the approach of de-risking a pension fund closer toward retirement. I am willing to accept I may lose out on some of the upside in this case, but similarly I would protect myself on some of the downside as well. I appreciate I have no way of easily tracking property prices in the intervening period.
I would continue to invest the current pension contributions in the heavily equity based recurring policy for the next two years. Once I move the the SSAP structure, I would continue to invest those funds in equities, although maybe through lower cost ETF's rather than insurance company products - but would take financial advice on this at the appropriate time.
What I am looking to achieve in the long terms is a balanced pension fund between property assets, equities and other investments which will support me in my retirement. I feel that my length to retirement allows me to take on a small level of gearing at this stage. I also feel that 100% investments in equities is very much all the eggs in one basket, and think a more diversified portfolio is more advantageous in the longer term.
And for the purpose of the discussion, I do not consider my home an asset, but rather where I live ! My children can treat it as an asset at a future point in time.
And to answer the question re property investment within the pension vehicle, in my mind the same argument exists for all investments. The taxation benefits of funding the investment (ie tax relief) plus the fact any income made is not subject to tax allows for it to grow within the pension vehicle. It then allows the funds to be drawn down as required on retirement, subject to regulatory minimums, rather than rental income which is taxed at marginal rate in the year it was earned.

 

[Steven Barrett]

You want to go into less risky assets by selling equities and borrowing to invest in a single property in Ireland? Is that not increasing your risk? Borrowing certainly is.

By not having all eggs in one basket, could you give us an idea of your total pension pot and how much you intend to spend on a property?



Steven
www.bluewaterfp.ie

 

[gnf_ireland]

You want to go into less risky assets by selling equities and borrowing to invest in a single property in Ireland? Is that not increasing your risk? Borrowing certainly is.

Yes in the short term it would be both increasing risk and loaded towards a single asset type, but in the longer term I would like to think it is balancing out the portfolio. I am trying to look at where I would like to be in 20 years time, and put some sort of plan together on how to get there.

could you give us an idea of your total pension pot and how much you intend to spend on a property?

I will PM those details if you don't mind !

 

[Marc]

You can achieve a balanced multi asset portfolio within a SSAS at a lower total cost of ownership and with more liquidity than through the purchase of a rental property.

I’ve posted elsewhere my findings on the average annual real return of residential property both nationally and in Dublin and historically there has been no additional excess return above a global equity portfolio. But the downside risk has been comparable.

When compared to a more risky portfolio of say smaller companies, residential property on average has delivered lower returns.

If the next 50 years are anything like the last 50 then residential property inside a pension isn’t the right answer for most people.

 

[gnf_ireland]

I’ve posted elsewhere my findings on the average annual real return of residential property both nationally and in Dublin and historically there has been no additional excess return above a global equity portfolio. But the downside risk has been comparable.

@Marc I do understand what you are saying here. I will go spend some time to find these articles and see if I can make sense of them
But the way I read this statement is the risk and reward of a global equity portfolio roughly matches the average annual real return on residential property. In this case, why would someone not try and include both in their portfolio?

Does the answer change if you are comparing an income based approach? So where the underlying asset is designed to roughly hold its real value over time, with the excess treated as income? I know you professional guys don't look at things this way, but the way I see a residential property in a portfolio is something that remains static - the increase in value is not necessary the primary objective but more the income it generates. The equity portion is the one where growth would be sought...

If the next 50 years are anything like the last 50 then residential property inside a pension isn’t the right answer for most people.

So what is the answer? 100% equities ?
I would hazard a guess that your pension portfolio (and other financial professional on here) look very different to the 'normal' people's pension funds. I might set up a thread to see if anyone would be willing to share their pension portfolio at the highest level..

 

[Marc]

This is the thread

https://www.askaboutmoney.com/threads/what-return-should-i-expect-for-property.206315/

 

[Marc]

I’m not saying not to include some exposure to real assets in your portfolio.

I’m saying that the cost benefit trade off from buying a residential property within your pension don’t make economic sense.

You can achieve a similar risk return portfolio from buying equities and the total cost of ownership is lower.

You also need to ask yourself this question: why has the average return of a residential property in Dublin been equal to the average return of all of global capitalism for the last 48 years?

And

“Should I expect that to be the case in the future?”

Up until 1987 residential property in Ireland lagged the stock market.

But the average return has been nearly the same since 1970.

This really says more about the period 1988 to 2007. And the subsequent collapse of that bubble than it does about what I should expect the return to be.

Put simply. If an average family on an average industrial wage can’t afford to buy an average property then you have a disfunctional market and price will solve everything.

Prices will fall! That’s the thing I can remember about economics.

By way of comparison the average annual return from UK residential property since 1983 was the same as one month treasury bills. That’s approximately cash!!

Yes, add rental income but then subtract higher pension charges, managing agent fees, insurance, depreciation, periods of empty lets......

The diversification benefits from residential property aren’t sufficiently good to justify the cost and lack of liquidity.

In other words, why would you expect the housing market to insulate you from a recession in the real economy?

Especially when you can add real estate through a global REIT fund.

An “income-based” approach makes less sense than a total return approach.

We have written a guide for advisers on this called “yield of dreams”

Focusing just on income yield can lead to poorly constructed portfolios with unintended consequences.

A stock has a value even if it doesn’t pay a dividend. Berkshire Hathaway for example.

We know that asset allocation decisions determine 90% or more of the difference in the expected returns of any portfolio.

So what matters isn’t “hey I’ve found a one bed cupboard under the stairs in D2 with a rental yield of 11%”

For any investor you have three risks to consider

Need to take to risk.

I’m 50 in Jan 2020.
I have a UK pension I transferred to Ireland more than 10 years ago. So I can have my tax free lump sum in a few months, defer income until I’m 61 and continue to fund an Irish pension until I retire.

I have no need at all to take risk with my pension fund as I will be cracking it open in less than 2 years.

Willingness to take risk

I’m perfectly willing to take investment risk but I’d be mad to do so.
Why risk making the pension fund smaller and therefore the tax free lump sum.

Capacity for loss

I’m not planning to retire.
I can continue to save
I’m “only” going to be 50. Jeez!
I’ll most certainly leave the pension in an ARF for the rest of my life so I have a long time horizon.
I have other assets and sources of income and my wife also had pensions.
We both have Irish state pensions and I’m also topping up my Uk state pension.

So I have lots of capacity to take risk.

Given all that I could take more risk but I have no need to do so.

Sean Quinn is the poster boy for that story right?

So now use that framework and see if you conclude that borrowing money to buy a residential property is the right answer.
It shouldn’t even feature as a consideration.

 

[gnf_ireland]

This is the thread

Thanks I will have a detailed read of that

@Marc Thanks for the detailed post above. It is definitely food for thought. But like everything on here, so much depends on personal circumstances. Firstly, you have access to both UK and Irish state pensions - this is a pretty nice place to be come the right age. There are a limited amount of people are in that situation, who can look forward to 'double' state pensions so well done on that one

>>I have other assets and sources of income and my wife also had pensions.
>>I have a UK pension I transferred to Ireland more than 10 years ago.
>>continue to fund an Irish pension until I retire.
Obviously I have no idea of the size of any of these. They could be 20 times your annual income or twice it ! You may have your house paid off, or not as the case may be.
I fully understand you don't need to take the risks on your pension fund for a variety of reasons, so you don't ! That's pretty clear.

I am a bit further off 50 (7 years) and obviously I am keen to build up the pension pot while I am in a clear position to do so. I am not talking about going to a casino with it (aka the SQ approach), but looking to determine are there other ways to "let the money work for me" to quote a phrase you often hear !

 

[Marc]

Exactly. It all depends on personal circumstances.

So how can you reliably achieve a given expected annual return from an appropriate investment strategy.

Fortunately asset pricing theory has the answer.


Between 1970 and 2015 we have the following average annual returns

National residential property in Ireland 8.66%pa
Dublin residental property 9.25%pa

Global equity (MSCI world index net div)
8.88% a 5,346% return

Now let’s compare with global smaller companies over the same period

13.59%pa that’s a 39,779% return

If you need a higher return than the “market” then just take more investment risk.

More smaller companies, value stocks and more emerging markets and emerging markets smaller companies and value stocks.

No need to borrow money and pay Interest costs
No need to be undiversified
No need to be a landlord
No need to suffer illiquidity

It’s actually really easy to build a globally diversified equity portfolio with a higher expected return than the market.

No guarantee that the expected return will show up, but that’s the nature of risk

 

[Brendan Burgess]

As a pension strategy, I would like to move to a Small Self Administered Pension structure in 2 years time (once I get beyond the early withdrawal penalties), and invest the funds currently sitting in the single premium policy into property investment(s). With a small level of gearing (say 33%) [which I would look to pay off within 10 years] I could have an income generating asset(s) within my pension fund. I fully understand the complexities of the residential rental market in Ireland at the moment, and impact of regulation, but at least I would be spared the taxation impacts within the pension structure.

Hi gnf

There are a few separate issues here.

1) If your fund is at least [€100,000] then an SSAP makes sense. That used to be the cut-off a few years ago. It may have changed.

2) Any borrowing increases your risk. There is a strange conundrum here. You are 43. You have a low mortgage. You have a good salary. You have a well funded pension scheme. So, you have a capacity to handle risk. But, against that, you have no need to take risk. You will retire comfortably if you continue the way you are going.

So you should not borrow to invest - either inside a pension fund or outside a pension fund.

I hate timing the markets, but there is a reasonable chance that all markets are overvalued at the moment. I am not selling off any of my investments, but I would certainly not be borrowing to buy at the current price levels. If you borrow to buy a residential investment while you own shares, then you are borrowing to invest in shares. That is madness.

3) Residential property or equities? As you own your own home, you have a significant stake in the property market. It is wrong to say "This is my home - I don't look at it as an investment." You may well trade up or down at some stage in which you will be converting it into cash. You must look at your total assets. If you have a house worth €400k, then you should not be buying any more property until you have a total wealth of probably €1.5m to €2m.

4) So in summary - what you are proposing is not de-risking at all. It's accentuating the risk significantly.

Brendan

 

[gnf_ireland]

If your fund is at least [€100,000] then an SSAP makes sense. That used to be the cut-off a few years ago. It may have changed.

Anyone know if this still is the benchmark? or what the benchmark should be? The current pension fund is multiple times this amount, so this may be something I need to consider when the early penalty clauses expire in 2 years time.

Any borrowing increases your risk. There is a strange conundrum here. You are 43. You have a low mortgage. You have a good salary. You have a well funded pension scheme. So, you have a capacity to handle risk. But, against that, you have no need to take risk. You will retire comfortably if you continue the way you are going.

The question here is more whether contributions of 20% of salary for another 20 years is sufficient to give me a comfortable retirement, especially if I would like to retire in my early 60's rather than my late 60's.
If not, I either have to increase contributions or increase risk. Its likely I have the capacity to take on the risk, but the question is more whether I need to.

What is very difficult to ascertain anywhere is what is a reasonable expectation (for planning purpose) of growth in real terms over a 20 year window for a pension fund. With the usual caveats around past performance etc. Should someone expect 0% real growth (match inflation only) or 3% or 5% etc. Without this, planning is very difficult and everywhere you look, you get a different answer.

I hate timing the markets, but there is a reasonable chance that all markets are overvalued at the moment.

I think most people would agree in general with that statement, especially after the longest bull run in history. As I said initially, I am not looking to time the market here, but more investigate whether I should consider a change in pension strategy

If you borrow to buy a residential investment while you own shares, then you are borrowing to invest in shares. That is madness.

I understand what you are saying, but I doubt it is as simple as that. That's the same as saying while you have a mortgage you would not invest in a pension fund or any other investments. I think this decision is more based on the level of risk and borrowing undertaken.
Would i invest 100% to buy a place while investing in shares - absolutely not! Would I borrow 25%-33% - maybe, on the basis the investment property could cover itself and is therefore a relatively low risk play.

It is wrong to say "This is my home - I don't look at it as an investment." You may well trade up or down at some stage in which you will be converting it into cash.

Potentially, but based on my current situation I have no plans to do either and definitely would not be planning to do either as part of any 20 year strategy. If I won the lotto, chances are I would not move house. I understand it has the potential to be an asset in the future, in the case of emergencies or if circumstances change, but for the purpose of retirement planning the assumption is we will continue to live in this house in retirement.

If you have a house worth €400k, then you should not be buying any more property until you have a total wealth of probably €1.5m to €2m.

Can I ask where these numbers come from? is it that 20% of your asset allocation should be property only? I am guessing a large number of people in Ireland who treat their 'starter homes' as their retirement funds have it all wrong in that case !!

what you are proposing is not de-risking at all. It's accentuating the risk significantly.

I am not sure I am trying to derisk at all. I think its the opposite, in that should I consider taking on additional short term risk now (in my early 40's) that will allow me a better balanced portfolio once I reach retirement....

I think both @Marc and @Brendan Burgess hit the nail on the head - in do I need to take on this additional risk. The question to that is tied into the real rate of return that should be used for planning purposes and that would be likely to give me my answer if anyone has something to use as a benchmark

 

[Brendan Burgess]

With this plan in mind, I would look to reduce the equity exposure of this element of the pension fund over the next 18-24 months, maybe moving it to less risky investments over time.

That is where I got the idea that you were trying to de-risk. But yes you are consciously increasing your risk. It's good to know that you are aware of this.

Can I ask where these numbers come from? is it that 20% of your asset allocation should be property only? I am guessing a large number of people in Ireland who treat their 'starter homes' as their retirement funds have it all wrong in that case !!

There is no hard and fast rule.

It is just plain wrong for people to own a house worth €500k with a mortgage of €300k and an investment property of €300k with a €200k mortgage.

It is also wrong to have a mortgage of €500k with a €300k mortgage and €100k in equities (unless the mortgage is a tracker.)

My gut feeling is that if you
€400k of your house
€600k of equities

you have 40% in property which is excessive but as it's your home it's ok.

If you have
€400k of your house
€1.6m of equities
you could start looking at increasing your property content to 30% which would be about €200k.

I still wouldn't do it. But I would say that 20% to 30% should be your max.

Brendan

 

[Bronte]

It is just plain wrong for people to own a house worth €500k with a mortgage of €300k and an investment property of €300k with a €200k mortgage.

Wouldn't agree with this.

 

[Marc]

The question to that is tied into the real rate of return that should be used for planning purposes and that would be likely to give me my answer if anyone has something to use as a benchmark

This is the crux of our issue

You need to do the planning before you build the house so to speak.

Work backwards from three expenditures

Core - what you need to spend today to “keep on the lights and avoid eating dog food”

Discretionary - what you spend today to support your lifestyle but could do without

Luxuries - do you need a home cinema?

That’s your base line target net income in retirement

Gross that up at 30% - because you don’t know what tax will look like in the future

Now how big does your fund need to be to support that level of income after costs and allowing for inflation - say 2% is the ECB target

How big is the fund now?

How much are you contributing?

Solve for the required growth rate

The investment decision is then simply a case of using an investment model to find the portfolio with that expected return.

If the required growth rate is too high your choices are very simply

• Retire later
• Save more (spend less now)
• Adjust your expenditure in retirement (spend less later)

It would take me literally minutes for the first cut of this and probably 2 or 3 two hour meetings to get to the right answer for you

 

[Steven Barrett]

If your fund is at least [€100,000] then an SSAP makes sense. That used to be the cut-off a few years ago. It may have changed.

A self admin with property is minimum fee to the Pensioneer Trustee of €900 a year plus VAT. An fund/ etf style self admin can be set up for less and still be cost effective.


My issue is people thinking it is a good idea to depart from the investment principle of having a diversified portfolio in quality assets to concentrating on one asset and adding borrowing to the mix. If I suggested you put the entire value of your pension portfolio in IBM stock and borrow another 33% of that value and plough that into IBM shares, you'd say that was bad advice. And you'd be right.


Steven
www.bluewaterfp.ie

 

[gnf_ireland]

Thanks everyone for the commentary above - plenty to think about over the next 2 years !

 

[Marc]

Just one point on the 2 years.

There is likely to be a revision to pension legislation in the near future and it takes several weeks to obtain approval from Revenue.

If you are looking for some continuity you should probably apply under the current rules sooner rather than later

 

[gnf_ireland]

If you are looking for some continuity you should probably apply under the current rules sooner rather than later

thanks - I will keep that in mind