Which is higher priority? Property or pension?

[command]

One or two items in Brendan's article struck me.

The vagries of the rental market are surely no worse than the property market. Rental yeilds are lower than interest rates which must translate into tennancy being good value for money.

he also said that gains on ones PPR is expempt from CGT, so are gains made by the pension fund.

Certain self administered schemes can avail of borrowings which allow the individual with the pension to take advantge of low cost credit.

The tax relief on pension contributions outweigh the tax relief on mortgage interest payments?

And finally the notion of borrowing money to start a business, I know when I started my business the one condition of giving up a nice PAYE job to become self employed, take 2 hour luches and play golf 3 times a week was that under no circumstances could the family home be used to finance the business venture.

The argument for property is an emotional one. In fairness there are very few people out there who could hand on heart say that they would pick pension over home.

If I set up a self administered scheme when I first start work, gearing it up and then purchasing a rental property with my pension fund I would getting the best of both worlds. I could probably buy a more expensive property, with tax relief my depost would grow a lot quicker. I could then rent an appropriate property, probably in Dublin City rather then somewhere in the midlands.

 

[Brendan Burgess]

This is an argument that people use. "My mortgage is so big, that there is no point in increasing my repayments".

To me it's very clear. If your mortgage is very big, then you absolutely must prioritise getting it down to a more comfortable level. Most people are uncomfortable for a few years, but then things ease off.

Someone on €30k should not be borrowing €300k in my opinion. If they do manage to get a mortgage of that size, it will be on the assumption that their salary will be rising very quickly. They should be making inroads on that mortgage well ahead of any pension provision

Brendan

 

[Purple]

This is an argument that people use. "My mortgage is so big, that there is no point in increasing my repayments".

To me it's very clear. If your mortgage is very big, then you absolutely must prioritise getting it down to a more comfortable level. Most people are uncomfortable for a few years, but then things ease off.

Someone on €30k should not be borrowing €300k in my opinion. If they do manage to get a mortgage of that size, it will be on the assumption that their salary will be rising very quickly. They should be making inroads on that mortgage well ahead of any pension provision

Brendan

What if someone has a €1'000'000 mortgage and earns €300'000?
Does scale change the advice above?

 

[Brendan Burgess]

he also said that gains on ones PPR is expempt from CGT, so are gains made by the pension fund.

The gains are not taxed within the pension fund itself, but will be taxed as income when you draw it down - probably at an effective rate of around 30%.

The rent or buy argument is a separate argument. At the moment it is cheaper to rent than to pay a mortgage. I doubt if many people believe that this will be long term structural position of the Irish market. It may well turn out to be a good idea to rent rather than buy at the moment. But you should still be accumulating your savings outside a pension fund, so that you can buy a home when you decide that buying is more attractive than renting.

Brendan

 

[command]

A large percentage of people in the age bracket between 40 and 20 will have to use their property to support them in retirement. If we take this as a given in light of the pensions deficit in that age group then does it not make sense to use your pension fund to purchase the appreciating asset and for you to live in the area that you want to as opposed to the area you can afford to.

I am never going to be able to afford to buy in Ballsbridge no matter how attractive buying is over renting or how hard I save, but I might be able to rent there.

 

[ClubMan]

A large percentage of people in the age bracket between 40 and 20 will have to use their property to support them in retirement. If we take this as a given in light of the pensions deficit in that age group then does it not make sense to use your pension fund to purchase the appreciating asset and for you to live in the area that you want to as opposed to the area you can afford to.

Is this realistically an option for many people - i.e. having a pension fund that can invest directly in a property which they then occupy? Is it even possible to do this at all even in limited circumstances? I thought that where you structured your pension fund to invest directly in peoperty there were certain "arm's length/hands off" limitations on what you could do? Or do you mean having a pension mortgage (pension and interest only mortgage) to buy your PPR (again presumably an option only available to a small subset of the general population)?

 

[New_Buyer]

I cannot understand the logic in your article Brendan. In the article you say the following:

You should now be making the maximum possible contributions allowed to your pension scheme, as it is simply the best way to save for the long term.

Surely this refutes all of your earlier arguments! If contibuting to your pension is the best way to save long term then why would any decide to pay off more on their mortgage prior to this.

n Brendan Burgess is the founder of consumer finance website Askaboutmoney.com where you can discuss the issues raised in this article.

And are we really allowed to discuss ALL the issues raised in the article!

 

[ClubMan]

I cannot understand the logic in your article Brendan. In the article you say the following:

Haven't you omitted the key bit preceding the bit that you quoted:

So get your mortgage down to a comfortable level and then you can start your pension. In fact, if your mortgage is comfortable, you can go in the opposite direction and switch to an interest-only mortgage.

You should now be making the maximum possible contributions allowed to your pension scheme, as it is simply the best way to save for the long term.

 

[New_Buyer]

Haven't you omitted the key bit preceding the bit that you quoted:

But if the aim is to have the highest funds available for retirment then why pay off your mortgage any faster than you have.

 

[MugsGame]

Is this realistically an option for many people - i.e. having a pension fund that can invest directly in a property which they then occupy?

command is suggesting buy an investment property somewhere you can afford it, and then rent a PPR where you actually want to live. Buying the investment property inside a pension scheme is just a way to benefit from some of the associated tax breaks.

 

[ClubMan]

Ah - I see now. Thanks.

 

[Brendan Burgess]

New Buyer

If you have a point to make about the article, you can do so well within the Posting Guidelines.

If you use it as an excuse to discuss the future direction of house prices, your post will be deleted, as has been explained to you many times before.

Brendan

 

[SidTheDweeb]

A few things struck me with the article.

Let me go through them.

getting on the housing ladder is more important, writes Brendan Burgess

I dislike this phraseology immensely. The housing ladder? What the hell is that?

When Johnny starts his first job at 23, his main financial objective is to buy a house...
Apart from the security and psychological advantages of owning your own home, there are huge financial benefits also.
It's more tax efficient than renting and you won't be subject to the vagaries of the rental market. The gain in value of the house will be exempt from Capital Gains Tax.

Wouldn't it be more tax efficient and save money if instead of Johnny hoping on this 'ladder' at 23, he waited a year or 3, and started on the second step of the ladder?
What I am getting at is, is it more fiscally prudent to 'jump' on the ladder at a young age (23), because that is the 'done' thing, than to gain some life/job experience and purchase a home slightly later on in life.
A simple example.

Scenario 1
Johnny, single @ 23, salary €30k
Purchases starter home, €200k
Mortgage, €200k
Mortgage rate, 5%
Mortgage term, 25years
Stamp, €zero

Assume 'normal' house price inflation, at wage inflation rate of 3%

At the end of year four, house price will have increased by €25k
At the end of year four, you will have paid off the capital amount of €18k
At the end of year four, you will have paid off the interest amount of €38k
TRS relief will be maxed out during first 3 years, benefit, €1.6k*4

Scenario 2
Tony, single @ 28, salary €80k
Purchases starter home, €500k
Mortgage, €500k
Mortgage rate, 5%
Mortgage term, 25years
Stamp, €zero or €37.5k

Assume 'normal' house price inflation, at wage inflation rate of 3%

Similar to Johnny, Tony pays no stamp duty on first home and TRS is maxed out.

OK so after 4 full years of living for Johnny he decides he wants to move up one step on the ladder, and he follows in Tony's footsteps, buying an identical home under identical conditions.
Cost for Johnny, €500k + €37.5k + extra costs (bought and sold first house) = ~ €550k
But shrewd Johnny was on the ladder, therefore has €18k in equity + €25k in capital appreciation. This is €43k. Therefore Johnny pays €507k net

Other/different variables:
How long does Johnny remain in first home.

Does Johnny/Tony partner up. Tony could technically avail of increased TRS band if partnered up. Johnny wouldn't benefit to the same degree.

House price inflation, conservative at 3% ?
I don't think so.

Where did Tony live for 4 years?
Well while Johnny was paying interest of €38k, Tony lived in a variety of accomodation both in Ireland and abroad - sampling different cultures and sampling different lifestyle choices. He spent €9.5k a year on this.

Is Tony's €9.5k a year accomodation comparable to Tony's €200k abode?
I'd imagine so.

So my question is

When Johnny starts his first job at 23, his main financial objective is to buy a house...
Apart from the security and psychological advantages of owning your own home, there are huge financial benefits also.
It's more tax efficient than renting and you won't be subject to the vagaries of the rental market. The gain in value of the house will be exempt from Capital Gains Tax.

Is it more fiscally prudent for Johnny to buy at 23?

 

[GeneralZod]

As someone that followed the conventional advice of starting a pension first and then buying a home I'd agree that doing it the other way would have been better. This may be coloured by the fact that my pension dropped massively with the market collapse in 2000. If I'd bought property earlier I'd be sitting on a bigger capital gain now. I subsequently changed strategy by paying down the mortgage and then shifting to AVCs.

I think the main difficulty with implementing the article's advice is determining and getting to the "comfortable level" at which the focus can be shifted from accelerating the paydown of the mortgage to boosting the pension. With the bubble in property prices between 2002 - 2006 mortgages have grown much more than salaries so it's harder now to get it down to a comfortable level. A lot of people will struggle for years to pay most of it off and then have little time to build up a pension. They're losing out on a lot of favorable tax treatment of pension contributions over those years. I'd start to feel very uneasy without a pension while approaching retirement.

 

[hmmm]

This is very much non standard and unorthodox investment advice and should have come with a big health warning. Everyone else isn't wrong with only BB seeing clearly.

Of course property would have been a better investment over the past 10 years, but there is no guarantee it will be over the next 10 years.

Advising people to hold off on a pension until they are "comfortable" with their mortgage is amateur hour advice. I'll be comfortable with my mortgage the day I pay it off and everyones comfort level will vary.

 

[Brendan Burgess]

Hi Sid

I have read that a few times, but I am confused between Johnny and Tony.

You seem to be implying that a 23 year old should wait until he is 28 to buy the house because he will be better off because the stamp duty will be lower on the more expensive house?

That is a very good point but it does not conflict with the point that I am making at all. I am saying that buying a home is a higher priority than starting a pension. If the figures work out that you are better off waiting 4 years and buying a bigger home, or the second step on the ladder, then that's fine. But save outside a pension scheme for those four years so that you will have as big a deposit as possible available.

I made this very point to someone in person today who is trading up. I told them to wait a while until they can trade up 2 steps of the ladder, rather than trade up now and trade up again in 5 years.

Brendan

 

[stuart]

This is very much non standard and unorthodox investment advice and should have come with a big health warning. Everyone else isn't wrong with only BB seeing clearly.

I'm not sure it would be unorthodox investment advice

With the level of today's mortgages (in excess of €400k would not be unusual) and the long term risk of interet rate levels (mortgages granted for 30-40 years), personally you'd be crazy not to try and get a grip on your mortgage as soon as is reasonably possible

No one can predict what interest rates will be in 5 years time never mind 20 years
e.g €400k mortgage for 30 years at 5%, balance outstanding in 20 years is still €204k

I wouldn't like to bet what interest rates would be then, I wouldn't have a clue

Stuart

BTW, I havenlt been on AAM in a long time now but I never thought I see someone argueing with Brendan that he has pro-property ideas

 

[comanche]

As someone that followed the conventional advice of starting a pension first and then buying a home I'd agree that doing it the other way would have been better. This may be coloured by the fact that my pension dropped massively with the market collapse in 2000. If I'd bought property earlier I'd be sitting on a bigger capital gain now. I subsequently changed strategy by paying down the mortgage and then shifting to AVCs.

Would this not have been the time to shift money into your pension? I presume that your pension was well enough diversified not to all be tech stocks! So if stocks were going cheap, sure this was the time to get in? ... I'd say your pension has just about recovered by now, however if you were paying in your avc's you would be been ahead sooner!

 

[SidTheDweeb]

Hi Sid

I have read that a few times, but I am confused between Johnny and Tony.

You seem to be implying that a 23 year old should wait until he is 28 to buy the house because he will be better off because the stamp duty will be lower on the more expensive house?

That is a very good point but it does not conflict with the point that I am making at all. I am saying that buying a home is a higher priority than starting a pension. If the figures work out that you are better off waiting 4 years and buying a bigger home, or the second step on the ladder, then that's fine. But save outside a pension scheme for those four years so that you will have as big a deposit as possible available.

I made this very point to someone in person today who is trading up. I told them to wait a while until they can trade up 2 steps of the ladder, rather than trade up now and trade up again in 5 years.

Brendan

Hi Brendan,

I agree entirely with the premise of the article.

The article, however, seems to tackle more than just this issue. Assertions made in the article that I believe to be not relevant include:

it is absolutely critical to look at the financial objectives of the person and take all factors into account. When Johnny starts his first job at 23, his main financial objective is to buy a house and then to get his mortgage under control.

Shouldn't the argument be; Johnny wants to prepare/provide for the future - he wonders if he should start a pension or purchase a home first.

Apart from the security and psychological advantages of owning your own home, there are huge financial benefits also.
It's more tax efficient than renting and you won't be subject to the vagaries of the rental market. The gain in value of the house will be exempt from Capital Gains Tax.

These benefits will exist whether you buy a home before you start a pension or not. What is their relevance to the argument?

Soon after the article becomes an information piece on approaching paying/getting a mortgage.

So don't think about contributing to a pension until you are on the housing ladder. And when you do get on the housing ladder, your next priority is to get your mortgage to a comfortable level. Only you can decide what level of mortgage is comfortable for.

I would say that soon after the above paragraph there is no more argument put forward about pension versus 'ladder'. Including this paragraph this is 365 words.


Within the next 512 words, the following 115 words may be viewed as relevant

So get your mortgage down to a comfortable level and then you can start your pension. In fact, if your mortgage is comfortable, you can go in the opposite direction and switch to an interest-only mortgage.
You should now be making the maximum possible contributions allowed to your pension scheme, as it is simply the best way to save for the long term.
You get tax relief on the contributions as they go in. There is no tax paid on the income within the fund. Any increase in value of the fund is not subject to Capital Gains Tax. When you retire, you will be able to take around 25pc of the fund tax free.

To me, a reader, the article seems to take on more than the pension versus 'ladder' debate, and I fear the message looks quite like a 'why buying property is a good idea' article. Of course you do throw in a disclaimer about irish property prices

Some will argue that now is not a good time to buy a home as prices will fall and therefore it's better to put your money in a pension.
But this argument is not valid. If you believe that house prices will fall, by all means defer the decision to buy a house.
But save your money outside a pension scheme so that you will be ready to buy a house when you think that prices are more reasonable.

The disclaimer itself is flawed though. Could it not be more tax efficient to save the money in a pension and then take out a 100% mortgage? Then you could pause future pension payments for a time to help bring the mortgage under control?

 

[Brendan Burgess]

Hi Sid

I thought my article was clear but obviously it's not. The following is by no means a disclaimer.

Some will argue that now is not a good time to buy a home as prices will fall and therefore it's better to put your money in a pension.
But this argument is not valid. If you believe that house prices will fall, by all means defer the decision to buy a house.

I am not arguing that every 23 year old should buy a property. The objective is to get on the property ladder. I should have added in a sentence along the lines you suggested - i.e. prepare to get on that ladder even if you have to wait until you are 28 or 30.

You ask what the relevance of the tax advantages of buying a house is? And these apply before and after your pension.

The whole point of the article, which you seem to agree with, is that buying a home is a higher priority. It is important to explain why buying a home is important. If buying a home is not important, then it would not have a priority over starting a pension.

I have heard the argument before that it's better to start a pension now and borrow 100% when you buy your home. 100% mortgages may not always be available. Even if they are available, they should really be a last resort. With a 100% mortgage, you are really constrained. If you need to move house for a job or for some other reason, you might not be able to.

You can probably cut the figures to show that it is more tax efficient over 40 years to contribute to a pension from the start. Take out a 100% interest only mortgage. Put every spare cent into your pension. But I am arguing that this is not a good idea because you lack total flexibility.

Brendan