Property investing for many Australians is an important component of their saving and retirement planning. It provides tax benefit, an income stream and hopefully over a period of time a growth in the value of the original investment.
I am not going to try and discuss the pros and cons of property investing in this week’s blog, I will leave that to the more qualified experts within our industry.
However, with the property market apparently booming, according to the media, and interest rates at all-time low, I find I am talking to a growing number of retirees or pre-retirees who are looking at property as a way of increasing the income return on some of their investments.
For those retirees who are in receipt of Age Pension or those pre-retirees who believe they will be eligible for the Age Pension when they reach the appropriate age, there are several issues to consider.
The first consideration is how does Centrelink (Social Security) treat the rental income a person receives on their investment property?
When a person first invests in an investment property and does not have a previous tax return which outlines their ongoing expenses, the Social Security guidelines allow a person to deduct one-third of the rental income to cover these expenses. It will then also deduct the interest on the money that has been borrowed to purchase the investment property.
As an example, if you were receiving $450 per week in rent – which is close to the current median rent – then $150 would be allowed to cover expenses reducing the assessable rent to $300 per week. In addition to these expenses if you had borrowed $350,000 to purchase the property at an interest rate of 3.5%, the $300 would be reduced by another $235.50 per week – the interest payable on the loan – bringing the assessable income for age pension purposes to an amount of $64.50 per week.
This all seems reasonable but be careful; like all good legislation, Social Security legislation is not necessarily that straight forward.
If you have been reading my blog for some time you will know that the Age Pension is assessed under both an income and an asset test. Whichever test reduces the Age Pension to the lowest fortnightly rate, this is the test which is applied to assess a person’s entitlement.
So, we have looked at how the rental income is assessed under the income test, but how is the asset value of the investment property assessed under the assets test?
As a good friend of mine often states, “it depends”. The following scenarios are quite common but can all have a different impact on a person’s entitlement under the assets test.
- You have borrowed $350,000 to purchase an investment property valued at $550,000. The loan is secured against the investment property. Under the assets test, the value of the investment property is reduced by the amount of the loan to $200,000. This seems reasonable and logical?
- The same situation, except the borrowings of $350,000 have been secured against your principal place of residence, which is an exempt asset, and not the investment property. The asset value of the investment property is now assessed to be $550,000. No longer reasonable or logical?
- From a bank’s perspective, the $350,000 can also be secured against the investment property and your principal place of residence. How does this work? We know the investment property is worth $550,000; if your principal place of residence is worth $850,000, the total value of all your property is $1,400,000. Your home is 60.7% of the total value, so this is the amount of the loan which is assessed to be secured against your home and the balance of the loan 39.3% or $137,550 is assessed to be secured against the investment property. This means the value of the investment property under the assets test is assessed to worth $412,450. This is complex, I know, but this is how the Social Security legislation operates.
As these examples show, how you secure your loan to purchase an investment property can have quite an impact on your age pension entitlement.
The difference between $200,000 or $550,000 being assessed as the asset value of your investment property and depending on your other assets can mean – for a single homeowner age pensioner – either having a full age pension entitlement or no age pension entitlement.
So heed my warning; talk to an expert before you decide to invest in the property market, not only to understand the pros and cons of investing in this asset class, but also to ensure you understand how it may affect any age pension entitlement now or in the future. Call us at (08) 8211 7180 or send us an email at firstname.lastname@example.org for an expert advice.
Article by Mark Teale on 24 February 2021 – centrepointalliance.com.au