NZ Herald 29 March 2014

AWhen 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 a business pays no tax it 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.

AYou 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.

AIndeed 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 CEO put it down to determination to hold on to 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.

AAnother 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 really 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, senior manager financial operations 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.