Should you pay off investment debt before retirement?

For most people retirement means replacing your primary income source: from taxable employment income to tax free superannuation pension withdrawals.

This change leads a lot of people to ask "Should I pay off my investment debt now?"

Background: Why people use investment debt?

People often use equity within their home to borrow investment debt to purchase investments, most commonly investment properties.

This strategy often works well when:

• The combined capital growth and income yield rate of return is higher than the cost of the investment debt interest rates, which therefore provides a leverage benefit. For instance, if the total rate of return is 8% p.a. whilst the cost of interest is only 6%, you are benefitting by 2% per annum via leverage.
  

• People adopt the strategy for 'negative gearing' benefits. This occurs when the cost of the interest and other investment costs are higher than the income yield, and the differential can be used as a deduction against other taxable income like your employment income. As you are loosing money cashflow wise, this strategy is only effective if the property/investment achieves considerable capital growth rates.

Retirement can make negative gearing ineffective...

When you retire after age 60, most people can convert their super to a tax free pension income account.

If you have no other personal investments, or the income generated is less than the tax free threshold (~$20,000) per annum, then negative gearing is no longer useful as you have no taxable income to be able to deduct.

This means that for many people, retirement is the ideal time to pay off investment debt. Additionally it can be an opportune time to sell the investment property and pay off the debt in the first tax year after retirement whereby you could have no other employment income, and therefore the capital gains tax could be lower.

However, it is important to note that you may instead wish to retain the property and instead pay out the debt with savings or superannuation, depending on factors such as:

• Which investments have the better rates of return

• The tax implications

• Your cashflow requirements

• Your investment risk tolerance

• Your goals

• Centrelink Age Pension: Interestingly if you have an investment property, the full value of the property is assessed for the asset test, not just the amount of equity (value less debt) you have in the home. This is another compelling reason for clients to clear the debt, if they would otherwise be able to receive a partial Centrelink Age Pension.

For clients who will still have taxable income above the tax free threshold, retaining the investment property for negative gearing benefits could still be appropriate, particularly if they are on a higher marginal tax rate.

It should be noted however that with properly pre-retirement planning, it is typically possible for couples to have $5,000,000 in combined tax free pension and personal investments and pay no income tax, if structured correctly.

By contrast, if your assets are not structured correctly, you could pay tens of thousands a year in extra tax. Our optimal retirement wealth structure video helps explain more.

Other reasons for retaining or paying off investment debt?

As Financial Planners, it is easy for us to determine the best course of action based on the rates of return, tax considerations and importantly client goals and preferences.

For instance, we know that there is often a client preference to pay off investment debt to simplify and de-risk in this next stage of life. Many clients do not want to have to worry about dealing with tenants or real estate agents any more, and they want to be able spend more time doing the things they love.

They may not want to deal with the stress of having a property untenanted for a few months, whilst they still need to meet mortgage repayments, or having to find more cashflow to deal with interest rate rises.

Before making major decisions about repaying investment loans, seek tailored advice. A professional financial planner can model different scenarios, consider tax implications, and ensure your choices align with your long-term goals.

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