Loans and Encumbrances

By Mark Teale – Retirement Strategies and Solutions Specialist, Centrepoint Alliance
(Prepare for Life)

For many people, being debt free at retirement is one of their long-term goals.

Others find the concept of ’good’ debt in retirement less stressful. From an age or service pension perspective the correct structuring of the ‘good’ debt is most important to ensure any entitlement that you may have to the pension is not adversely affected.

When it comes to loans and encumbrances, the Social Security Act 1991 (Cth) is complicated and, in some cases, a little illogical. It is very important to understand that the taxation rules about debt are not necessarily the same as the social security rules.

For example, real estate investments.

Say you see a unit on the market that seems like the ideal investment for you – and the opportunity to earn extra income seems too good an opportunity to miss. You visit your bank or your mortgage broker to enquire about an investment loan.

Your lender is happy to fund your investment, but they need to secure the loan against your residential home as well as the investment property.

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, one very important additional issue to consider is that 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 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

– your home is worth $600,000 and the investment unit is valued at $300,000. You need to borrow

$250,000 and as you home is worth twice as much as the investment unit only one third of the loan will be offset against the value of the unit. Meaning the unit will be valued at $216,667 ($300,000 – $83,333) for the purposes of assessing your pension entitlement. Not $50,000, as you may have originally thought (1).

So, do be careful as in some circumstances, the net rental income being received may not necessarily cover the reduction in your pension.

When it comes to borrowing money to invest in shares or managed funds, the assessment is again different. The value of the shares are reduced by the amount borrowed. So, if the total portfolio is value at

$100,000 and the loan secured against the portfolio is $50,000, for the purposes of the assets test, the portfolio has a value of $50,000. The hidden nasty is that for assessment under the income test, the whole value of the portfolio is taken into account (i.e.\ $100,000), and it is this value that is subject to the relevant deemed interest rates.

Unlike taxation the interest expense is not deducted from the income being deemed against the $100,000 portfolio.

When you retire and are receiving an age pension, loans can be a minefield and can have unwanted consequences. Before you dive into the world of borrowing to invest, make sure you talk to your authorised financial adviser so you understand the potential impacts and you can avoid the mines.


1 SSAct section 1118 and subsection 1121(4) – legis/cth/consol_act/ssa1991186/


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