I have R700 000 sitting in a preservation fund from when I resigned from my company. I am considering withdrawing and investing the money in a rental property to supplement my income. What would the advantages/disadvantages of doing this be?
First of all, I must congratulate you for keeping the R700 000 in your preservation fund up to now.
In order to provide you with a meaningful answer, some more details would be required. I will however answer your question in a generic manner which hopefully will provide you with the information you are seeking.
There are two decisions you need to make, each with its own challenges. Firstly, is it wise to withdraw from your preservation fund, and secondly, do you understand all the ins and outs of the residential property rental environment?
The following factors must be taken into consideration during your decision-making process:
- How many years do you have before reaching retirement age? (I assume you are not yet retired, hence the consideration to withdraw from the preservation fund and not retire from it).
- Do you currently own a primary residence? If your answer is yes, do you have a bond registered over the property?
- Do you have debt? (Credit card, overdraft, clothing accounts, motor vehicle and so on.)
- Are you planning to buy the rental property cash or are you going to bond it?
- If you intend to bond the rental property (which you should do), will you be able to afford the bond without a tenant if the interest rate is 5% higher than today?
- Have you previously withdrawn funds from your preservation fund? Regulations allow only one withdrawal from a preservation fund once the funds have been preserved.
- Are you married, and in whose name will the property be registered?
To prevent duplication of a previous article I wrote please read Investing in property: The good, bad and the ugly, which was recently published on Moneyweb.
In the article, I elaborate on the benefit of gearing rental property rather than buying it cash and many of the pros and cons of property ownership.
Rental property is not a bad idea as long as you are aware of the pitfalls and complications that you will experience as a rental property owner.
Withdrawing from your preservation fund will attract tax. Only R25 000 will be tax-free, with the balance being taxed at 18% on the next R635 000 and 27% on the balance up to R990 000.
Remember that preservation funds are tax-exempt, meaning that all growth and interest earned within the fund is tax-free. If you like property, you can up weight your property exposure to 25% of the portfolio value within your preservation fund. If you do decide to follow this route, please make sure you understand listed property before you make such an aggressive move. You can also take up to 30% offshore exposure in your preservation fund.
Preservation funds fall outside your estate, which means no estate duty will be paid on the proceeds in the event of your death. Preservation funds are also protected from creditors.
If it was my money, I would stick with the preservation fund but would make sure the investment portfolio is optimised.
If your main motivator for investing in a rental property is to supplement your income (cash flow), then first start by reducing debt – assuming you have debt.
It makes no sense to use cash to buy a rental property if you have a bond on your primary residence. Rather settle the bond should you have one. Rental property must be geared when you initially buy it in order for it to make sense. Refer to my previous article for an explanation.
The same applies to ‘bad debt’ such as credit cards, overdrafts and clothing accounts. These forms of debt generally attract high levels of interest. Before buying a property or investing in general, allocate a healthy portion of your free reserves to settling bad debt.
Reducing debt is the easiest way to improve your cash flow …
Good debt such as a bond on a rental property is fine, but as I mentioned previously, make sure you can afford the bond when (not if) interest rates increase and when (not in case) you do not have a tenant.
Good luck with your decision. Fortunately, your decision is a win-win situation, but you need to optimise the structure of your transaction to make sure you obtain the best result now and in the future.