Q: We are a couple in our early 30s who own a rental house and live in a rental too. (We like the location of where we have chosen to rent, but don't think it's wise or feasible to buy in the same area.)
We have been paying as much as possible off our mortgage for the past few years and now find ourselves in a position where we are making a profit (taxable) on the rental property. Our incomes mean the taxable income will be in the higher bracket.
Would it be best to consider moving into the house we own to avoid paying tax on the income? Or hold off making extra repayments and invest the money elsewhere?
A: When I was young, my father once said: "There's only one thing worse for a business than paying tax, and that's not paying tax." I was bewildered until he explained that if a business pays no tax, it's not making a profit.
A rental property is a business. But for some reason many people who own rentals seem to love it when the expenses are higher than the income. They have to put extra money in, but hey, they're paying no tax.
It's true that they went into the investment for the gain when they sell the property, rather than for the ongoing income. But is it so bad to earn a profit in the meantime - even if it is taxed in the same way as most other income?
How about looking at tax as your contribution to all the services the Government provides? Sure, there'll be some you don't use and some you don't approve of, but everyone benefits from the fact that we have police, roads and so on. And even if you don't use government-funded education, healthcare and welfare, I hope you appreciate living in a country that offers those.
Okay, I'll get off my soapbox now. But I don't think it makes a lot of sense for you to move from an area you like just to avoid paying tax. I suggest you stay where you're happy and concentrate instead on how to invest the after-tax profits on the rental property and the money you're currently using to pay down the mortgage.
One option is to continue with the extra mortgage payments.
When somebody pays down a 6 per cent mortgage on their own home, that improves their wealth as much as an investment that earns 6 per cent after fees and tax. That's a really good return, and it's risk-free.
It's a bit different in your situation, though. Mortgage interest on a rental property is tax-deductible. So if you're paying 6 per cent, and you're in the 33 per cent tax bracket, that interest costs you about 4 per cent after tax.
(If you want to see how that works, let's say you pay $100 in mortgage interest, and deduct that from $300 of rent income. You've cut the tax from $99 on $300 to $66 on $200. In total, you've paid $100 in interest but saved $33 in tax, so your after-tax cost is $67 - about two-thirds of the before-tax cost.)
In other words, quickly repaying the mortgage on a rental property isn't as good a deal as on your own home. Still, in our example, it's equivalent to earning 4 per cent after fees and tax in a risk-free investment. Not too bad. And as mortgage interest rates rise - as widely expected - that return will improve.
Could you do better investing that money elsewhere? Only if you're willing to take some risk.
One possibility is to buy another rental property. Some people have become wealthy by investing in lots of rentals. But you'll have all your eggs in the property basket, and in the current market it wouldn't be surprising to see property prices fall.
Another possibility is managed funds, which include KiwiSaver funds. If you're not already in KiwiSaver, you should definitely join, to get the government and employer contributions. And given that you probably won't withdraw the money for more than 30 years, I suggest a high-risk fund. Your balance will fall quite often, but you're highly likely to end up with more than in a conservative fund.
If you're already in KiwiSaver, though, it may not be wise to boost your contributions. You're on fairly high incomes so you won't get any more from your employer and the Government, and you tie up the money until retirement. You never know whether you might want to, say, start a business later on, and want access to your savings.
Instead, consider investing in a non-KiwiSaver fund, perhaps run by your KiwiSaver provider.
KiwiSaver on a benefit
Q: I wanted to know if I can join KiwiSaver even though I am on a benefit as I am Mum's caregiver.
I don't really like to join as I would be "double-dipping" in my mind with taxpayers' money, having been a long-time taxpayer myself.
I am 58. Just read your reply to the 61-year-old who joined in 2007 and now has $36,000 in it.
A: You certainly can join KiwiSaver, as can any beneficiary. And I don't see why you shouldn't. It sounds as if you've put plenty of money into the government kitty over the years.
Even if you hadn't — let's say you'd been on a benefit most of your life — that would suggest you hadn't exactly had an easy life. I see no reason why people in that situation shouldn't be in KiwiSaver, enabling them to retire with a bit more dignity and flexibility.
Working past 65
Q: About the first letter-writer last week who is nearing retirement and considering buying a house, I'm curious why you didn't suggest they continue working past 65? There didn't appear from the letter to be any indication that he or she couldn't continue in their job or find a new job or a job with fewer hours if they were so inclined.
If this person has no savings in retirement aside from KiwiSaver (which appeared to be the case), isn't that also a case for working longer?
If we just concentrate on home ownership in this case — and ignore other reasons to have savings in retirement — owning a home incurs additional costs compared with renting (as you've often discussed before with other responses), but your calculations didn't include these costs.
If we assume the person is living on NZ Super alone, isn't it necessary to consider how much in savings they would potentially need for those costs?
A: Indeed it is. But first, let's look at working past 65. I did say last week: "Obviously, if you retire older than 65, and continue paying off the first 10-year loan for longer, that will reduce the [mortgage] payments you make in retirement."
But I'm a bit reluctant to suggest late retirement. Lots of people have trouble keeping their jobs even to 65, and it's not realistic for them to stay on past that age. And if I were one of them, I might get pretty annoyed with someone who blithely says "just work longer".
Having said that, people often find part-time employment or set up their own part-time business in retirement — sometimes based around a hobby. And that can make a surprisingly big difference to the amount they need in retirement savings. So your point is well made.
You're also quite right — I should have mentioned the extra costs of home ownership: rates, insurance and maintenance.
I heard once, years ago, about a bank set up for low-income women in Detroit who couldn't get mortgages through ordinary banks. To most people's surprise, almost all of them met their mortgage payments and kept their homes over the years. The bank boss put it down to determination to keep the one asset they had.
Reading between the lines of last week's letter, I feel confident that man will also find a way to pay the rates and so on — which won't be huge anyway on a modest house or unit. Still, they need to be taken into account. Thanks for writing.
Paying for real estate fee
Q: A quick comment about your answer to the older house buyer last week. You recommend piling all the savings into KiwiSaver. However, KiwiSaver funds are not accessible for the deposit you pay to the real estate agent at the time you sign a sale and purchase agreement, or go to auction. (Or, at least, that was the advice from my lawyer.)
In my case, and I don't know how common this is, the agent wanted 10 per cent of the purchase price from me immediately. The KiwiSaver funds went directly to the lawyer on settlement day several weeks later.
Obviously it is possible to negotiate a smaller deposit to the agent, or pay a specific sum of money instead. But in any case, your older buyer might want to hold some money back from KiwiSaver in order to pay that deposit, and also the inevitable valuations and building inspections on potentially multiple properties.
A: Another excellent follow-up point. I hope everyone whose letter runs in this column reads the columns in the following few weeks. Readers often come up with new perspectives, and sometimes important stuff, like this.
As you say, our correspondent last week — and anyone else planning to buy a first home using KiwiSaver money — would be well advised to keep several thousand dollars out of KiwiSaver.
Matthew Smith, financial operations senior manager at Housing New Zealand, which runs the KiwiSaver first-home subsidies, explains the situation like this:
"There are two deposits involved with a house purchase — the deposit that is paid to the real estate agent when an offer goes unconditional and the financial transaction deposit paid to the vendor on settlement day as part of the overall purchase price."
You can't use either your KiwiSaver money or the first-home subsidy towards the real estate agent's deposit, says Smith. That money is paid directly to your solicitor, and can be used only for the financial transaction deposit.
He adds that "a KiwiSaver member cannot apply for the savings withdrawal approval until their agreement for sale and purchase has gone unconditional, by which time any real estate deposit will have been paid to the agent."
What's more, you can't use the withdrawn money or subsidy for other costs such as solicitor's fees, valuations or building inspections. And these can mount up, especially — as you suggest — if you go through the process on several properties before you actually buy one.
• Mary Holm is a freelance journalist, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her opinions are personal and do not reflect the position of any organisation in which she holds office.
Mary's advice is of a general nature and she is not responsible for any loss that any reader may suffer from following it. Send questions to email@example.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers or give financial advice.