Mary Holm: Ideal way to invest in our kids' future

By contributing to children's KiwiSaver accounts, they can watch their savings grow. Photo / 123RF

COMMENT:

My wife and I have four kids aged from six down to our wee rascal who just had her first birthday — a good time, I reckoned, to ensure we have all the kids' KiwiSaver accounts set up.

I'm now wondering what the best way is to contribute to their accounts, and whether, in fact, we should top up our own KiwiSaver accounts instead.

The rationale here, I think, is sound — wifey and I each have about $25,000 in our respective KiwiSaver accounts and the four kids have about $1000 in each of theirs. If we pay $75 per child a week into our more established KiwiSaver, the dollar returns will be much higher.

And when we turn 65 (in 25 to 30 years) we can withdraw funds to help each child buy their first home or start a business.

On one hand, I like the idea of keeping contributions to each child separate. But on the other, I can't get past the fact that we could be getting much greater returns by topping up our own accounts instead. Your thoughts?

Sorry, but your rationale is not sound — which is good, actually, because you can do what you prefer to do without losing anything.

Let's say the returns on everyone's KiwiSaver accounts are 10 per cent a year. That's too high — we can't expect to earn that much except in high-risk funds in unusually good years. But it makes the numbers easier.

If your account balance is $25,000, you earn $2500 on it in a year. If you add the wee rascal's $75 to your account, the balance will be $25,075, and your return will be $2507.50 in a year. It's $7.50 higher.

Meanwhile, the little girl's account balance is currently $1000. Without any contributions, her return will be $100. But if you put $75 into her account, her balance will be $1075 and her return will be $107.50 — the same $7.50 higher.

Sure, the total return on your account will be higher if your balance is higher. But the extra return from adding $75 to either account is the same.

There's another advantage, too, in contributing into children's KiwiSaver accounts. They can watch their savings grow, which will hopefully encourage them to make their own contributions when they start earning. For inspiration, read on.

Planning ahead

Should I keep KiwiSaver for a house or just for retirement?

I am 24 and have been in KiwiSaver since it began (thanks, parents!), but have only been contributing majorly in the past year. It is at about $5300 in a balanced fund with ASB.

I'm not sure if I should keep it in a balanced fund in the event it might get used in about five years' time, or put it in a growth fund and not touch it until retirement?

The main question is not what to do with your KiwiSaver money but whether you want to buy your own home soon — as opposed to perhaps spending time overseas or being a carefree tenant.

If home ownership is not on your horizon, you could move your money into a higher-risk growth fund, as long as you will stick with it when the markets go down.

But if you start thinking seriously about a home purchase in the next few years, I would definitely plan to use your KiwiSaver money, rather than saving it for retirement. You might as well get some enjoyment out of the money, and having a home is part of most people's retirement plans anyway.

At that time, move your money into a balanced fund, perhaps gradually over a few months. Then, within two or three years of buying, move to a low-risk fund, so your balance doesn't plunge near buying time.

Inflation impact

If I get paid for a day's work, I have more buying power at the end of that day than I had at the beginning, and it seems reasonable that I give a bit to the Government in tax.

If, however, I buy a property and sell it some years later for 50 per cent more that I bought it, but in the meantime inflation (that is, the cost of everything else) has also gone up by 50 per cent, my buying power has not increased.

I have experienced a capital hold, not a capital gain, and I should not have to pay any tax on the sale.

But if I sell it for 60 per cent more than I paid, the last 10 per cent is a capital gain on which some tax would be fair.

The same principle should apply to money in the bank. Tax should be levied only on the portion of the interest that exceeded inflation — not as it is at present, on all the interest. What do you think?

I agree that it would be fairer if the Government took inflation into account when taxing capital gains — and everything else.

I like your inclusion of interest on bank accounts. But I would expand that to cover all income tax.

It's not fair that people pay higher tax when their pay goes up, even though they can't buy any more than they could a year ago.

And what about GST? If a bike cost $200 several years ago, $26 of that was GST. If the same bike costs $250 now, that will include $33 of GST. The Government gets more money but you don't get more bike.

However, the Tax Working Group ruled out inflation adjustments in its recommendations. Writing about capital gains tax, it said: "Consistent with the approach taken elsewhere in the tax system, there would be no adjustment for inflation."

It added that the fact that its proposed CGT would apply when assets are sold — rather than over the years as the assets gain value — "would already confer a significant deferral advantage on asset owners, which would offset the impact of inflation".

That's a fair point. If you pay for anything later rather than earlier, you get the use of the money in the meantime.

Still, given that the working group looked at the whole tax system, it would have been great if it had recommended inflation adjustment across the board. In these times of low inflation, it would be much easier to introduce than if inflation rises again.

The sad thing is that we nearly got inflation adjustment on income tax about a decade ago. And the man behind it? None other than the chair of the working group — then Finance Minister Michael Cullen.

In the 2005 Budget, Cullen announced a significant change. The Government would raise the cut-off points where higher income tax rates kick in, starting in 2008, with further adjustments every three years.

"This means that in future taxpayers will pay more tax only if their incomes rise in real (inflation-adjusted) terms," said Cullen at the time.

The first alteration would have meant $35 a year more in the pocket for someone who earned $10,081, ranging up to $534 a year for anyone who earned more than $63,672.

The amounts were so small for many New Zealanders that some character suggested all they could do with them was buy chewing gum.

The "chewing gum tax cut" was derided by many. And by early 2006 Cullen commented: "I have noted that people have said they don't really think [the tax cut] is worth having. If people say that, then of course they may find their wish has been granted."

Oh, no, I thought back then, and rushed into print. In a column titled "Let's keep that chewing gum money", I wrote: "Please forgive us, Dr Cullen, and don't take away our chewing gum tax cut!

"I know some of us have been scathing about it ... but not all of us are unappreciative of the proposed change. Those who look beyond the short term can see that, in decades to come, it could make a big difference to our taxes."

To no avail. In the 2007 Budget, Cullen cancelled the changes.

If they had gone ahead, they would also apply to the working group's proposed capital gains tax, as the same tax brackets will apply to both income tax and CGT.

But we blew our chance.

Dollar value is key

Recently in the Herald, Sir Michael Cullen gave an example of a farm valued at $3 million (excluding the family home) at the time CGT comes into effect, which is sold for $4m 10 years later. The $1m gain will be taxed. But if the dollar loses value at 3 per cent a year, $4 in 10 years' time will buy the same amount of goods as $3 now.

In the 1970s and 1980s there were periods when the dollar value halved in fewer than five years.

The farm now is not necessarily the same as the farm sold 10 years later, with additions to the family home, improved drainage and fencing, and new sheds.

I think CGT and the present tax regime are unfair unless the decrease in the value of the dollar over time is taken into account.

Your example is a good one. Three per cent inflation can make quite a difference over 10 years.

And, yes, it wasn't long ago when inflation was halving the dollar's purchasing power over five years or so. While it seems unlikely we'll go back to the high-teens inflation of the 1970s and 80s, who knows what the future holds?

It's not correct, though, that under the working group's proposals you would be taxed on gains that resulted from improvements to your farm, or any other asset.

"Costs incurred on improvements would be deductible from sale proceeds," says the working group. "Current law would be used to identify the costs of acquiring or improving an asset."

Switching to shares

Last week's mortgage-free caravan man, renting out two properties worth $1.25m for $500 a week each, will be making a return of 4.2 per cent before tax.

If he sold them and bought $1.25m of listed property company shares, he could diversify his investments and receive higher returns.

The value of the shares would follow the property market. And he would not have to maintain the properties or worry about occupancy or collect the rent.

If he needed extra cash he would not have to sell properties. He could sell some, not all, of his shares.

It's funny the way readers sometimes assume a correspondent's gender. Our caravan man is actually a caravan woman!

Anyway, you make some good points. Last week I didn't go into whether Caravan Woman should sell her two rental properties. She wasn't asking about that.

In any case, it would probably be a good idea if she keeps one property, so she stays "in the market" in case she wants to move into something bigger than a caravan at some stage.

You suggest dealing with that by buying property shares, but that market and the housing market don't always follow the same trends.

Still, I like the idea that she sells one of her properties and invests, not in property shares but shares in all sorts of companies. That way she's not vulnerable to a downturn in a particular industry.

She'll have enough to buy lots of shares directly, or she could keep it simple and use a low-fee share fund. Having half her savings in shares would give her much broader diversification.

And, as you say, she would have fewer worries about maintenance and tenants, and could sell only as many shares or units as she needs to free up cash.

- Mary Holm is a freelance journalist, a director of the Financial Markets Authority and Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. Her website is www.maryholm.com. 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 mary@maryholm.com. 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.