An important issue is to understand the need for liquidity in retirement to cater for all circumstances that may arise. So with all our retiree clients we focus on a minimum of five years income needs in highly liquid assets as a core of a portfolio that is replenished each year with dividends, interest and rental income from earnings on longer term assets.
So, if you have a portfolio that can meet that core requirement then we are happy to look at an investment property as part of your longer-term asset allocation.
One of the other reasons we often recommend a property for a retiring client is if they plan to move out of a major urban area like a capital city to a regional or coastal area. We are often concerned that the move may not work out or medical, family or personal ties may mean a move back to the city is required. We often recommend clients look to have a decent investment property as part of their portfolio but also as a back-up plan in case they need to return. That way they don’t get priced out of the market and have options available to them.
Debt in retirement
But then the question arises as to whether a retiree should use leverage to enhance returns or to get a property in a more desirable location.
In most cases, my answer will be no – except in a few limited cases. Debt can be a useful tool for a savvy investor even in retirement but not for the nervous, cash-poor or the desperate.
With most clients, we strive to be debt free before retirement for a few solid reasons:
• Once retired you do not have employment income or ability to take on extra work to cover debt repayments should issues arise with your sources of retirement income. With cash rates below three per cent and rental yields falling in most states the ideal comfort level of five per cent income that many seek has disappeared.
• Should these historically low interest rates rise substantially without a similar rise in rental yields then the gap between rental income and interest payments can widen substantially and eat in to your liquid assets quickly.
• We aim to have clients in a comfortable funding position by retirement so they do not need to take on the added risk that comes with a leveraged investment. Why take additional risk if it is not needed.
• We never want a client’s home at risk in early retirement with what is termed 'bad debt'. This refers to non-deductible debt on the home and is not suitable in your 60s or early 70s. We do see a use for reverse mortgage, equity release products in later life where suitable.
• With superannuation pension income tax free in retirement after age 60 and the ability for members over 65 to earn $28,974 each outside of superannuation tax free, negative gearing is not attractive to retirees unless you have substantial reportable income.
Desperation and debt
It has been said that leverage is most useful to those who don’t really need it and dangerous to those who do. If you do not have enough saved to fund your retirement and want to use leverage because you are desperate to try and play catch up on your wealth building, then I believe debt concerns will only steal your retirement years away from you. Leverage in retirement for those on the fiscal edge can be worrying and removes the 'sleep factor' of not having to worry about mortgage rates rising on a limited income. This can lead to far worse financial and health outcomes than simply budgeting with what you do actually have available and making do.
When is leverage suitable?
Many people have millions of dollars of investments and yet they often have significant debt. The key, however, is that they could pay off that debt whenever they want to, but they make a strategic choice to have it because it empowers them to take advantage of opportunities with their cash. If you have adequate net wealth already and can be disciplined, rational, and deal with the responsibilities that come with debt then it may be a powerful tool for building wealth and dealing with longevity risk. Debt can lead to a more sustainable longer retirement if managed in the right way. The key is not to be too highly leveraged and I mean keeping your debt ratio less than 15 per cent to 30 per cent.
If you are debt adverse or can’t handle the responsibility and risks associated with debt, then you probably should aim to be debt free in retirement and avoid a property purchase that would put strain on your cash flow and eventually even your health.
A final thought: If you take on debt or buy property, have a plan, have an exit strategy and assess, manage and review the risks associated with taking on debt. Property is not a set and forget investment choice and you need to understand the property market cycle in your chosen area.
Liam Shorte, SMSF specialist at Verante and founder at Eviser.com.au