Mary Holm: Unwise to avoid tax in kids' accounts

Inland Revenue won't let you off the hook if an audit shows you've been under-declaring income. Photo / Getty Images

My wife and I are both employed with above-average salaries. We have two children. We don't have any assets except for $200,000 in term deposits. We are planning to purchase a home in the near future.

Our term deposits are invested under the names of our children and therefore paying a lower Resident Withholding Tax rate on the interest earnings (as they have no other income). My questions are:

* Is this legitimate?

* The term deposits are under the name of the child (as account beneficiary), along with their IRD number, but show myself as the account holder. Does this mean that the funds are protected from any claims of a creditor etc, ie being similar to having set up a trust?

I suspect you already know the answer to your first question. But here it is from the horse's mouth: "It is not legitimate for a parent to invest their own money in their children's names in order to pay a lower rate of Resident Withholding Tax (RWT)," says Inland Revenue.

"Not only would RWT be deducted at a lower rate than should be the case, but the parent would also be under-reporting their own taxable income.

"While it is accepted that parents may gift money to their children, if the money were to be taken back it could not be considered a gift."

I think that answers your second question, too. You can't gain protection from a creditor by breaking the law.

So what do you do now? For a start, I suggest you put the term deposits in your own names. That won't let you off the hook, though, if Inland Revenue audits you and finds out what you've been up to.

"It may be appropriate for them to consider making a voluntary disclosure," says Inland Revenue. If you do this - basically coming clean about what you did wrong - you will have to pay the tax you would otherwise have paid, plus interest, but the penalty you would have paid if caught by an audit will be significantly reduced. For more info, go to www.tinyurl.com/voluntarydisclosure.

I can't resist adding that I don't think much of tax-dodging. Some people think it's a game, but it's not much fun for the other players, who just end up paying tax at higher rates.

I wonder if a few quotes might adjust your attitude.

* US president Franklin D. Roosevelt: "Taxes, after all, are dues that we pay for the privileges of membership in an organised society."

* Author Nancie J. Carmody: "I am thankful for the taxes I pay because it means that I'm employed."

* And finally, from writer and academic Oliver Wendell Holmes: "I like to pay taxes. It is purchasing civilisation."

Along with another 5099 households, I am living in Christchurch's red zone and will lose my house in due course.

I am grateful, let me say, that I am not being forced to walk away with nothing. I also appreciate that the cost will be borne by us taxpayers for some considerable time.

What I am wondering about is how to reinvest when I do get paid out. My house is not badly damaged, so will probably get the RV of $310,000. I have a mortgage of $160,000, so will end up with about $150,000 in cash.

I am 55, single, working ($55,000 a year), KiwiSaver, but no other assets or significant debts. Am I best financially to reinvest it all in another house (within Canterbury, or outside and rent), shares, bank (not under the bed!), or a combination? The alternatives are endless and confusing!

All I want is to have a freehold house when I eventually retire, but I'm not expecting it to be a mansion. How can I best achieve that from this point?

Trends in house prices are always unpredictable, but if someone sells their home and buys another at the same time, price levels don't matter much. Either both houses are cheap or both are expensive.

Effectively, you are selling now. If you don't buy soon, you run the risk that house prices will rise in the meantime, and you'll get a lot less house with the proceeds of your sale.

Of course the opposite could happen, with prices falling. But it would be pretty risky to expect that. Buying another place now is the low-risk option, and with your age, income and situation, I doubt if you want to take much risk.

What about your idea of buying outside Christchurch and renting in Christchurch - making you a landlord and a tenant?

Being a landlord suits some people well. They like taking care of property and don't mind tenant and maintenance hassles. But given that you haven't chosen that path up to now, it might not suit you - especially as the property would not be nearby, which can add to problems and worries.

How much should you spend on a house?

Let's say you want to retire in 10 years, in which case it would be good to get a 10-year mortgage. The mortgage repayment calculator on www.sorted.org.nz tells us that you would repay $2200 a month on a $200,000 10-year mortgage at 6 per cent. If you can afford that, you could buy a $350,000 house, with your $150,000 deposit.

You can try out other amounts and terms on the calculator to find what suits you. For example, if you plan to work until 68 and get a 13-year mortgage, monthly payments would drop to $1850.

Keep in mind that mortgage rates might rise, so allow for that.

In case you and your neighbours aren't aware of them, here are a couple of information sources set up to help you:

* A financial decision guide for Canterbury red-zone residents has been put together by the Commission for Financial Literacy and Retirement Income - which used to be called the Retirement Commission.

The booklet "is designed to help people make their financial decisions about the Cera offer and what to do with their settlement payment. It also gives guidance on who to talk to and where to get financial advice," says the commission.

The booklet is available at www.sorted.org.nz/redzone. It should also be available by about now in hard copy from Cera earthquake hubs and other community organisations in Canterbury.

* Information on how a financial adviser can help you can be found on the Financial Markets Authority's website, www.fma.govt.nz. Click on Help Me Invest, and then on "Getting the right advice on your Red Zone payout." If you haven't got access to the internet, you can call the FMA's helpline on 0800 434 566.

Your correspondent last week advised that she made "eight portions of delicious soup from 1kg of parsnips for 99 cents".

What decadence! Why, when we were young, our mum boiled up stones and made soup for a week. Shopping in hospice shops - what luxury! We got our clothes from the tip. As for her driving an old ute, well, that was beyond our dreams. Our dad used to beat us and then yoke us to a sled for transport.

People today just don't know how lucky they are.

The big question is whether your dad got good mileage out of kids nourished with stone soup.

I don't normally get the Herald, but while I'm sitting in the Fleet Centre (as a volunteer for RWC waiting for my next job assignment), I read your last column.

The last section on the danger of predictions doesn't seem a good example. The investor concerned - if indeed they bought gold and silver 50:50 a year ago - has actually made a much better return than any bank deposit, it seems. One could hardly feel sorry for them.

Surely you could find a better example? A 41 per cent return on silver and 9 per cent on gold - that's an average return of 25 per cent after tax (assuming they are investing - buying and holding rather than trading). Could you tell me if any KiwiSaver fund gave that return over the last year? Do you know if any of the KiwiSaver funds invest in the precious metals?

Anyway, let's hope some readers did take the correspondent's advice. They would have done quite nicely.

Indeed they would have - if they bought at the right time and if they sell now. Who knows what might happen to gold and silver prices if they hold on?

But that's not the point. The reader confidently predicted big price rises that haven't happened. Indeed, over the last two months, gold has dropped in both New Zealand and US dollars. For silver it's the same, only over the last six months. Indeed, if you bought silver in late April, you would have watched it lose one third of its value since then. Ouch.

These are volatile, risky investments. They can soar and they can plummet. By publishing the reader's letter and the updates, I hoped to show how unpredictable precious metals can be.

On your KiwiSaver question, thousands of members made returns of well over 100 per cent last year; some well over 200 per cent. That's because, in their first year in the scheme, their contributions are doubled by their employer and also boosted by the tax credit - plus the $1000 kick-start.

In their second year, they don't get the kick-start, but the other incentives still boost their own contributions. However, that's watered down by the fact that their first-year money is earning ordinary fund returns - which usually range between minus 10 per cent and plus 20 per cent.

And over the years, as more and more of their total KiwiSaver money earns ordinary returns while just the current year's contribution is boosted by incentives, their overall returns will decline.

But it's still a really good deal. If your contributions are doubled or trebled, you will get twice or three times as much out at the other end. And because KiwiSaver funds almost always spread your money over a variety of types of assets, it's much less risky than investing in a single asset such as gold or silver.

That's why, I expect, there is no KiwiSaver Gold Fund or KiwiSaver Silver Fund, although some higher-risk funds might include a small holding of the metals for extra diversification.

By the way, I'm not sure where your 41 and 9 per cent came from. My numbers are somewhat different. But it doesn't really matter.

Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and best-selling author on personal finance. Her website is www.maryholm.com. Her 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 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.