A house and savings can set you up well for retirement. Photo / Doug Sherring
They often say that rent is "dead money". It feels better to put that rent money into a mortgage, and buy a house. Right?
But surely mortgage interest is also dead money. That interest is claimed by the bank for years, and can add up to a mighty amount. Only at the end of the mortgage do you actually start paying back the amount you borrowed.
Not to worry, house prices have gone way up. Paying massive interest isn't so bad if your house value soars!
But what would happen if house prices stopped rising? Would you be better off renting and saving some money? Those of us with mortgages pretty well spend our lives working for the bank.
A: I wonder if people who say rent is dead money would say the same about money they spend on food. They both buy basic requirements -- shelter and nourishment. And you don't end up with much to show for either, except perhaps an expanding waistline.
Mortgage interest also adds nothing to your wealth. But paying interest does enable you to buy a home, gain the security of home ownership, and usually also benefit from rises in the property's value.
However, as you point out, if the value doesn't change -- or falls -- it hasn't been a very good deal.
In the current environment, especially in Auckland, it's not silly for renters to sit on the sidelines -- as long as they're saving the difference between their rent and what it would cost to own a home, including mortgage, rates, insurance and maintenance. Hopefully, they'll then have a nice big deposit for when houses become more affordable.
By the way, with a table mortgage -- the most common type -- you do repay principal right from the start. It's a tiny proportion of your early payments, but then grows at an increasing rate until your final payment is almost all principal.
Hang in there, and try to make extra mortgage payments to reduce your "dead" interest payments. The last payment date will come, I promise.
I think you got it wrong in your response to the first letter last week. I don't see that a $1 million retirement fund is out of the ordinary given this woman's circumstances.
On a medium-risk investment at 5 per cent, $1 million will return $50,000 a year before tax. Hardly a massive income. Rates, insurance, maintenance, running a vehicle and everyday household items will easily account for that without luxuries.
I do agree that a smaller sum is better than nothing. I won't make it to $1 million, but it is absolutely what I am going to need.
A: You've overlooked a couple of things.
Don't forget NZ Super. Currently it totals about $23,500 a year before tax for a single person living alone, and $35,500 before tax for a couple. The payments rise each April to stay at 66 per cent of the average wage.
But won't Super be slashed in the years to come? Almost certainly not.
NZ Super cost 4.8 per cent of our gross domestic product before tax last year. The OECD average is 9 per cent. If we change nothing, the cost is expected to rise to 8.4 per cent by 2060, because of the ageing population. While the experts want to get that down, nobody is calling for drastic measures.
A few years ago, Treasury looked at what would happen if Super payments were adjusted each year to match inflation, which rises more slowly than wages. But it rejected that as being too harsh. Instead, it looked at an adjustment half way between inflation and wages -- hardly earth-shattering.
Another option is starting NZ Super at an older age than 65. The National Government recently said it would gradually raise the age to 67 from 2037 to 2040, which would affect people born after June 1972.
A future government could well change that. But some age increase seems likely, given that Australia, the UK, Denmark, Germany and the US are all moving that way.
I don't think it will be a big deal, though. When the Super age rose a whole five years, to 65, between 1992 and 2001, there wasn't much outcry. And given that life expectancies keep rising, anyone who starts Super at 67 after 2040 will probably get at least as many years of payments as current retirees get.
You've allowed for spending only the interest or other returns, not for using up the savings themselves. That way, you would die with $1 million. For most people that's silly.
If, instead, you plan to spend your whole savings, that makes a big difference to your retirement income. See the next Q&A.
My husband and I are like the lady last week who is worrying that she won't have saved $1 million by the time she retires.
We have raised three children who are all well educated and good citizens. We have done our best for them.
We are a couple of years off retirement -- have paid off the mortgage on a house that is probably worth $1.4 million, and we are saving -- and worrying about not having enough. I don't know where we all picked up that $1 million target, but it's made us scared.
Your article has put it all into perspective. It's easy to get trapped into not having fun now because we fear not being able to afford heating in our retirement.
We both have KiwiSaver and I am in my company's super scheme, so we'll have about $200,000. And a house that can be sold to downsize and release equity.
A: There are two good arguments for spending some of your money on fun now, as opposed to in retirement. One is that you might be hit by the proverbial bus tomorrow. But let's not dwell on that. The other is that you want to enjoy a similar lifestyle during your working life and in retirement.
Some people -- who save little or nothing -- will see their standard of living drop in retirement. But people like you could well see it rise if you're depriving yourselves of fun now. That's a pity. You're probably healthier now than you'll be later, and you want to grab chances, as and when they arise, to enjoy life with family and friends.
So where do you stand? I said last week that "retiring with $100,000 or $200,000 and a mortgage-free home puts you in a much stronger position than many." Still, it's not enough for a luxurious retirement.
The Society of Actuaries -- who are experts on money and statistics -- recently came up with four rules of thumb about how far a retirement savings sum will go if you use up most or all of the money. For info on this see tinyurl.com/RulesOfThumbNZ
To keep things simple, we'll look at one of the rules: each year you spend 6 per cent of your starting sum.
If you start at 65 and invest in a conservative fund -- in or out of KiwiSaver -- your money will almost certainly last until your mid 80s. And, depending on future returns, it may last until you're 90 or older, says the society.
If you outlive your savings, you could perhaps sell some assets or take out a reverse mortgage, although many people say that NZ Super is enough at that stage of life.
Applying the rule, someone with $100,000 would spend $6000 a year. With your $200,000 it's $12,000 a year.
Add NZ Super, currently about $31,300 after tax for the two of you, and we're looking at $43,300 a year. And if you free up $300,000 by downsizing your house, add another $18,000. The grand total is $61,300 a year.
A few questions are probably leaping to mind about now:
Will $61,300 after tax be enough?
Most people say they spend less in retirement than when working.
A friend of mine disputes that. "I am in my mid-70s and find that I now have to employ people to do work round the property that I used to do myself when I was younger," he says.
But he has an unusually big property. Many retired people move to smaller sections or apartments, partly to escape maintenance.
And what about the savings on work expenses, such as commuting, lunches, clothes, dry cleaning and bought dinners?
Oddly enough, another big saving is that you'll no longer be saving -- which is currently taking a fair chunk of your income.
On the insurance front, health insurance costs rise fast in retirement. But you no longer need loss of income insurance or life insurance, and some other insurance is cheaper for oldies.
A few years ago I read that only 5.5 per cent of over-65s have income of more than $60,000. That will have risen a little, but still, $61,000-odd puts you among the better off -- certainly with a heated house!
What about inflation?
Good question. Under the 6 per cent rule you'll withdraw the same amount each year, but inflation will gradually decrease its buying power.
But, as noted above, NZ Super currently rises by more than inflation. And it seems unlikely it will rise by less than inflation in future. In any case, spending often decreases as people get older.
What about an inheritance?
Under the 6 per cent rule, if you don't make it past 85, there will probably be some money left over, says the Society of Actuaries. And if returns turn out to be higher than expected, there might still be an inheritance even if you live to 100.
Anyway, the kids can inherit the house. That's not bad. They've already done pretty well by you.
How can you boost your retirement income?
One obvious way is to retire later. Labour force participation for people 65 to 69 has jumped from 11 per cent in 1997 to 45 per cent now -- and it's expected to keep rising.
For every year you keep working, there are two pluses: one more year of saving -- including NZ Super payments -- and one less year of spending.
Many retirees also set up a small business selling something they make or offering a service. Think about what you're good at.
Another option is to free up more when you downsize your home, perhaps by moving to a cheaper area.
Or you can take more risk with your investments, both before and during retirement. I don't mean buying gold. I do mean putting the money you don't expect to spend for 10 years or more in a higher-risk fund that holds mainly shares. It will be more volatile, but long-term returns are likely to be higher.
What about the maths?
Comparing the 6 per cent rule of thumb with the previous correspondent's 5 per cent doesn't seem to make much difference. And yet I said above, that using up all your savings makes a big difference. So what's happening?
The previous correspondent assumed savings earned a 5 per cent return before tax -- or 4.2 per cent after tax. The society assumed 3.5 per cent after tax. Over the years that makes a considerable difference. The society's number is more realistic for most New Zealanders.
More on this topic next week.
Property snapped up for almost double its council valuation.