Creating wealth is about KEEPING money, not making money, and changing how you make long-term investments can substantially improve the profits you keep.
Let’s illustrate the point with an example of an investment in a residential property. For the purposes of the example, we will examine the returns an investor can expect purchasing a €300,000 property, with a 70% mortgage over 20 years. The investor contributes cash of €90,000 and the lender provides €210,000, at an interest rate of 4%, which will cost the investor €1,270 per month. Assuming a rental yield of 7%, the rent receivable will be €1,750 per month and assuming an annual capital growth of 3%, the property will be worth €541,835 in twenty years.
While, at first glance, it looks as though the investor will make great profits, tax has yet to be accounted for. Income tax will lower the net rent to €1,045 per month (assuming the top rate of tax & levies, plus taking account of interest tax deduction), meaning the investor must add €225 per month to service the loan. The LPT and insurance will add another €45 per month (after tax deductions) to the costs. Finally, when selling in 20 years, Capital Gains Tax of €79,805 will be paid, leaving the investor with a net amount of €462,030. The Annual Rate of Return on this Investment, after all taxes, will be: -
6.5%
To improve this return, the investor should purchase the property through a pension structure. This will mean lower initial costs, with tax deductions on the deposit paid, plus no tax on the rent will mean no ongoing servicing costs either. Then there will be no capital gains tax on the sale. The annual rate of return on the investment will rise to: -
18.3%
Bu changing HOW the investment is made, the return is increased almost three-fold.
Some may argue that there is tax on the pension fund if you withdraw all the profits, and that is true, but these figures are accurate as the investor does not have to liquidate. Even if we applied the maximum taxes, the annual return would be 16.8%, still two and a half times more than the alternate.
While we have used a leveraged property example here, the same arithmetic applies no matter what investment is chosen.
Notes: 396 words – All Euro Amounts rounded to nearest €5 and all interest and return rates rounded to nearest 0.1% - 26.5.23