By Mark Teale
(Realise Your Dream)
For most people, being debt free in retirement is a priority. Others find the concept of ’good debt’ in retirement less stressful.
From an age/service pension perspective the correct structuring of good debt is important to ensure that any entitlement you may receive is not adversely affected.
When it comes to the Social Security Act – loans and encumbrances can be complicated and, in some cases, a little illogical. It is very important to understand that the taxation rules relating to debt are not necessarily the same as social security rules. For example; real estate investments can be considered.
So – let’s consider this real estate investment scenario:
An offer ‘too good to ignore’ comes your way and you decide to buy an investment unit down the road from where you live and rent it out. You then visit your bank (or your mortgage broker) to enquire about an investment loan.
The broker (or bank) are most impressed with you and decide that they will lend you the money to buy the unit. However; in addition to taking a mortgage out over the investment property they also need to secure the loan against your residential home as well.
From a taxation and a social security income perspective this is not an issue as (in both cases) the interest payable is deductible from the rent for the purposes of your tax and pension assessment.
However; there is one very important issue to consider. A person’s pension entitlement is also based on the value of their assets. The fact that the loan is secured against an exempt asset (family home), and an assessable asset means that the portion of the loan secured against the exempt asset (your home) is not used to reduce the asset value of the investment unit.
Care needs to be exercised here – as net rental income being received may not necessarily cover the reduction in a person’s pension in some circumstances.
When it comes to borrowing money to invest into shares or managed funds, the assessment side of things are slightly different.
The value of the asset shares, in this case, is reduced by the amount borrowed. For example – $50,000 is borrowed to purchase a parcel of shares valued at $100,000. Provided the loan secured against the shares – for the purposes of the assets test – the portfolio has a value of $50,000. The ‘hidden nasty’ here is that for the assessment under the income test, the whole value of the portfolio is viewed as a $100,000 share portfolio.
This is treated as a financial asset and it is this value that is subject to the relevant interest rates.
Unlike tax – the interest expense is not deducted from the income being deemed against the $100,000 portfolio.
“Oh…” I hear you say! And that is without I even discussing the issues associated with loans to family trusts and companies, going guarantor, and associated loans.
When you are retired and receiving the Age Pension – borrowing and lending money (as well as going guarantor for loans taken out by your kids) can be a minefield with unwanted consequences.
So before you dive into the world of borrowing to invest – seek out the appropriate advice from an expert in the area.
You can thank us later!
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