Changed risks and tax scenarios in retirement can decrease the relevance of familiar wealth-building strategies and cast familiar investment opportunities in a new light. So how does retirement change the view on investing in property? And what are the main risks retirees should consider when updating their investment strategy?
Entering into retirement doesn’t just require adjusting to new tax obligations, it also calls for a shift in mindset around investing. Individuals often become more cautious and risk averse when it comes to investing after they retire, driven by a concern that they will outlive their savings.
This concern, referred to as longevity risk, is well founded. The average Australian male will live to 80 years old, the average female to 84 years, and both will need enough savings and investments, including super, to provide an income for up to 20 years after they retire1. New tax scenarios and obligations mean investors must recalibrate familiar investment strategies around property, shares, bonds and annuities as they prepare for retirement.
Australians’ love affair with property ownership
Property represents one of the largest components of household wealth in Australia2. By the time they reach retirement age, 77% of Australians will own the home they live in3. But, reports on household wealth indicate that the majority of retirees do not have adequate diversification across their pool of assets.
When it comes to disposing of a property, whether it is a retiree’s home or investment property, sequencing risk needs to be considered. Timing can make a significant difference to retirement income for investors looking to fund their retirement with the profit from a property sale.
Crystallising wealth during a downturn in the market can mean investors will have much less to fund their retirement and may have to keep working for longer to make up for the loss. Selling at the top of the market could mean boosting a super balance with a large lump sum, but this could be problematic from a tax perspective due to the $1.6 million pension balance cap introduced in 2017.
For investment properties, if an investor holds on to their property until they retire, they may not have to pay capital gains tax. However, it may impact their Aged Pension entitlements.
Property investment in retirement
Borrowing to invest may be a favoured investment pathway for wealth accumulators — primarily due to the regular returns and capital growth — but it presents complications for retirees and investors nearing retirement. For example, if borrowing to invest within a self-managed super fund (SMSF), limited recourse borrowing arrangements can increase the amount of debt held by the fund and potentially counteract the financial stability many retirees want.
Given the uncertainty around the timing and nature of retirees’ needs, liquidity can be one of the key drivers for many retirees’ investment decisions. Direct property investment is relatively illiquid, because investors can’t sell a bedroom if they need to raise additional funds for living expenses, travel or medical costs.
Tax minimisation strategies also need to shift as retirees move from high income tax brackets into the lowest, but with a new set of rules to abide by.
For example, holding onto a negatively-geared investment property may be effective while an investor is still working, but less so when they’re a retiree looking to generate positive income from their investments.
Tax on property syndicate investment earnings can be deferred for up to seven years, which can be a helpful strategy when an investor plans to move from a high income tax bracket into retirement’s no-tax environment (within a SMSF in pension phase) during that seven-year period. Investing in a listed property trust also provides greater liquidity than direct property, because it can be partially sold like any other listed investment.
The lack of diversification associated with investment properties can also attract higher levels of risk than many retirees are prepared to accept. A large amount of capital held in the one asset class, commonly contained to a narrow geographic area, can be problematic.
Considering new investment opportunities
Retirement casts a new light on investment choices. It’s important that retirees look beyond familiar investment options in order to diversify and spread their risk across multiple sectors, geographic regions and asset classes. Without a regular source of income, retirees need to minimise their longevity risk by looking for investments that offer both returns and capital growth. The relative security and guaranteed income from term deposits and annuities can be appealing to many retirees, but the trade-off for this confidence is lower interest rates or higher premiums.
Property remains a viable asset class for retirees. Commercial property investment through listed trusts or managed funds (including unlisted property funds or property syndicates) can deliver many of the benefits of the residential sector, but through a fundamentally different investment proposition with potentially advantageous structures and greater diversification.