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Articles written by Creating Wealth directors Alison Renfrew, and Richard Renfrew. These articles have been published in the Wellington Newspapers Ltd, Evening Post Newspaper under "Your Money Column". For more articles published refer to Your Money Column - cont'd Also refer to our weekly web money articles Money Articles Rental Property: Investments: Tax Questions: Shares: Retirement Issues: Mortgages Your options when you retire Answer: An attractive option for retired people is to move into a retirement village. They will have a sense of security and will feel part of a community. When a resident becomes older and less able to prepare her own meals, she can choose to upgrade in the village from a townhouse arrangement to a studio unit where meals are included. Ultimately if she becomes quite unable to care for herself she could then move into the actual rest home in the village. It sounds ideal doesn’t it? Unfortunately it is not a perfect scenario. You must be very careful when deciding to buy into a retirement village. Usually you are purchasing the right to live there not the land, bricks and mortar. If the village failed financially you could lose all your life savings. There are now many retirement villages available which are well-managed, attractive and offer friendly and secure living. The larger villages offer help within minutes if you need it. They are purpose designed with no maintenance worries for the residents. The downside is that the weekly costs appear to be prohibitively high. It is important that these costs are fully explained to the person moving into the village. Retirement villages are business enterprises and need to be profitable to the owners. It is in the interests of the owners to make sure that they operate fairly so that more residents will move into them as others move out. The ideal retirement village offers several tiers of service. Firstly, a couple may initially purchase an attractive two bedroomed ‘townhouse’ or apartment in the village. A new one may cost around $200,000 to $250,000. A fee of around $50 to $70 a week will be charged to cover maintenance and use of facilities on the property. Later the couple, or an individual, might chose to downsize to a ‘studio’ unit. These units would have one double bedroom, a small sitting room and a small kitchen. Meals would be provided. They are generally half the cost of the apartments. Money would therefore be freed up to pay for the higher weekly costs which are around $370 for the first person and maybe half for the second person. The weekly outgoings on these units will therefore be around $500 for a couple or for a single person, $370 per week. A single person whose only income is New Zealand Superannuation receives $225 per week after tax. When the weekly costs are $370 per week there is a shortfall of $145 per week. If the costs of staying in the Village increase the shortfall would also increase. Obviously you need to have substantial capital before you move into the Village. If you were able to downsize from an apartment to a studio you could possibly free up capital of $100,000 which would enable you to live in the studio for 13 years, theoretically, but we all have extraordinary expenses and when we get older these can increase with medical costs etc. It would be better in the above scenario to project that funds were available for only 8 years rather than 13. When the money has nearly run out some villages will ‘stockpile’ the shortfalls and recover the money when the resident moves from the studio unit into residential care. Not all rest homes offer this option. It would be terrible for a couple to plan for their retirement, live for 15 years in a retirement village and then run out of money and be forced to move into a council pensioner flat. You need to be careful when buying and have the paper work carefully checked by a lawyer experienced in this area as it is not the same as buying an ordinary house. In retirement you want to be certain that you will not be forced to move from your home, unless you choose to, not because you have to for financial reasons. It is not easy for retired people living in New Zealand. Even if a couple reaches retirement owning a mortgage free home it can be difficult to keep up with rates and maintenance. It is a sad scenario when a retired person, often a woman who has outlived her husband, wants nothing more than to live in her family home which she has been living in for the last 40 years or more, and she is unable to because the rates have become unaffordable. It wasn’t her fault that a house she choose to raise her family in grew substantially in value. Some councils, such as Parematta in Sydney do not charge residents rates after they have lived in the area for twenty years. Our major recommendation for people planning to retire is that you consider your options early. Think about where you want to live when you are in your forties. You will save a lot of money if you don’t have to move again in the future. Some people advise to buy a small property with no stairs. We are acquainted with older people who although arthritic say the stairs are excellent for ensuring they get some exercise everyday, even though it is a little painful. When purchasing a home that you intend to live in when you are retired a bedroom on the kitchen, dining, bathroom level of a house is a good option just in case mobility became difficult. Many people like to move to a warmer climate when they retire so obviously the option of purchasing a family home that can also be your retirement home is not one that will work for everyone. We feel it is a bit of a myth that you will want a smaller place when you are retired. You will still want you family to come and stay won’t you? If you believe you can sell your home and release equity in it to buy a smaller more maintenance free property in the future don’t kid yourself. It often costs more to downsize and buy maintenance free. In conclusion, plan where you are going to live in your retirement early. Save as much as you possibly can. If you hardly miss the money your are saving for your future then you are probably not saving enough. You will have a far greater peace of mind in retirement if you do not have to worry about how to pay the rates, or where the money will come from to paint the house. If you like your family home plan to live in it forever, or upgrade now into your retirement home as soon as you can. If you want to live in a retirement village look very carefully at what you are buying and make sure that you will not run out of money in the future. You must get excellent professional advice before entering into an agreement to buy into a retirement village. There are four types of ownership; license to occupy, freehold (or unit title), cross-lease, registered lifetime lease. License to occupy is the most common form of ownership. You have the right to use the unit for your life, but you do not own any land, or buildings and your name does not appear on the property title. Developers must have a prospectus if they offer this to you. With the second type of ownership, freehold, or unit title, you own your own unit and share a common area. Your name appears on the title and therefore you can use the property for security against a loan. Promoters don’t need a prospectus. With the cross-lease ownership structure you own your own home and a share of the common property, but no particular part. Read the lease carefully, they can be quite restrictive especially regards having a pet. A registered lifetime lease means that you are registered on the title and have the right to live in the property for as long as you are alive, but you don’t own it freehold. We recommend before you buy, get a lawyer to check and explain the paperwork. Make sure that you can pay the regular maintenance and service fees. Ask to talk with existing residents. Move in early so that you can enjoy the facilities while you are both in good health. Check out what happens in a couple of years if you want to move out. What restrictions are there on you selling your unit, does the manager buy it back? Do you get the capital gain or loss on the sale? Buying a new house, Mortgage Options Secondly, it looks great to be without a mortgage in less than four years and you can do it. You will have paid a total of $287,600 to your mortgagor (based on 8.2% interest). If you elected to have a 25-year term to pay off your mortgage you would have paid off $576,700. It is a huge saving. Your net salary is $99,200. To pay a mortgage off in fours years would require that you set aside $1384 a week to do so. You would still have $524 a week to maintain your home and buy the necessities. Many families have to live off less than $500 a week. Most kiwis say there is more to life than scrimping to have a better future. We feel there needs to be a balance. Your mortgage is a lifestyle asset and should not be confused with an investment. Your house provides you with shelter. It does not generate money unless you use the equity in it to leverage into an investment. That is, you can borrow, using the house as collateral, to invest in shares or more property and you will have a tax-deductible loan. Many people do not feel comfortable doing this for fear of losing the house if the investments are not successful. In your case, someone offered to show you how you could pay off your mortgage incredibly fast for only a $2,000 fee. Sometimes the fee is $3,500. These pseudo financial advisors feel that their fee is quite reasonable given that if you follow their advice you could pay $100,000 less in interest on your mortgage. Beware, you can visit a mortgage broker and they will give you very similar advice and will not charge a fee at all. People who charge high fees to explain how to pay off a mortgage in a very short time period tend to appeal to those who have a limited ability in budgeting. Revolving mortgage facilities, can be extremely detrimental to people who are not disciplined with their money. It is incredibly easy to spend money if you have access to instant credit. The banks advertise that they can help you to reduce your mortgage and then promptly invite you to use your savings to purchase a car or have a luxury holiday! Your financial future can go backwards if you do not plan carefully to achieve exactly what you want. It is important to set realistic time frames as well. We recommend you consider your mortgage repayments at the same time that you estimate how much you should have available for emergencies, daily living expenses, holidays, Christmas, car replacement, and your financially independent investment fund. Look at the whole scenario rather than just one aspect of your finances. Some mortgage brokers give advice that only works if you have no other financial obligations. The fact is we all have other financial commitments so it is better to look at your situation holistically even if the time frame is stretched out a little longer to achieve your goals. With the exchange rate down should I be investing off-shore? The effect is that to invest overseas you may experience a 5-10% increase in the US/NZD exchange rate over the next 12 months which will work against your returns. That is, to break even, your overseas funds would need to increase 5-10%. The New Zealand share market is currently floundering with lack of international interest in our market. While there are many factors contributing to the general malaise going through the country, in our opinion it is unfounded. To do well with your investments in the New Zealand share market we recommend an active fund manager. New Zealand equities are at bargain prices now. We buy shoes when they are on sale, but when the share market is on sale the novice investor says, it’s too risky. The answer to your question really relates to your investment time horizon. If it’s less than 12-18 months you would be better off not to be investing off-shore at the moment. We recommend secured debenture/fixed interest type investments with rates between 8-10%. Exchange rates are cyclic and there will always be movement. Its "time in the market not timing the market" that gives the best returns. A diversified portfolio cannot ignore the potentially higher returns that are available with off-shore markets. For equities, do not ignore New Zealand, we would still recommend no more than 15-20% of you portfolio should be in New Zealand equities. For fixed interest investments, these should remain on-shore due to the currency risk. It is always interesting that when interest rates are moving up the fear is that they will never come down and that your mortgage payments are going to get out of hand. With inflation being controlled, it is predicted that long term interest rates will average around 7.5-8.0%. Unless you can get a 1-2 year term around this level we do not recommend going to a fixed term mortgage. Interest rates are likely to have fallen over the next 12 –18 months. Now is the wrong time to be moving to a fixed term mortgage, unless you like the predictability and smoother cash flow of a fixed term mortgage. Around March last year was the best time to have moved to a 2-3 year fixed term mortgage. Is it a good idea to have direct exposure to Technology Stock Answer: If you are using managed funds the fund managers will already have exposure to technology stocks within their portfolios. Therefore it is unnecessary to have direct exposure to this sector. For aggressive investors we do recommend up to 5% of their portfolios have some direct exposure to this sector. This tilts the portfolio slightly to a more aggressive risk/return profile but also gives more direct exposure to this interesting high growth sector. You can get exposure by buying shares directly into this sector or going through a managed fund (unit trust). The technology sector is generally regarded as companies exposed to telecommunications, media, information technology (computer hardware and software companies), bioengineering and medical technology. The general measure of the health of the technology share market is taken as the NASDAQ index which is comprised of around 70% exposure to technology stocks. While technology stocks have been hammered over the last few months what we have seen is some cleaning out of this sector. Some shares were achieving unrealistically high values where companies had listed with an idea and no track record, or even product to market. For investors who want exposure to this sector, but do not have the knowledge or the time we strongly recommend using a fund manager. While returns last year range from 80-100% a long term view for this sector would be 20-25%.
Should I re-arrange my portfolio with 5 years before I retire? You need to be taking less risk with your investments now because you do not have many pay days left to recover from market swings. If we assume inflation will average 2% in your retirement years and that you do re-balance your portfolio to lower risk in retirement then a return of 3%, net of tax and inflation is conservatively realistic. If your investments are worth $372,000 when you are 65, using up all your capital and assuming a life expectancy of 85, we estimate you could have an income, from your investments of $24,300, net of tax per year. You will also have NZ superannuation of $347 per week (married couple rate). Apart from re-balancing your portfolio to take less risk we recommend looking at where you want to live in retirement. Your children have left home, do you still need as large a house? Maybe downgrading to a two bedroom home would release further capital tied up in your house. You may want to live closer to your grandchildren. Do you have a lot of stairs to climb? If either of you were invalided can your house be easily modified for wheel chair access? Answer: There is often a lot of emotional pressure to help your parents when you can see they may not be coping. When you have a large house you may go through a guilty feeling that you should have your mother living with you. Before going ahead with anything, the benefits and disadvantages to your family, and your mother, need to be carefully worked through. You must discuss this with your family first before approaching your mother. While this arrangement can work well with younger children, as they like to have their granny close by, with children of your age we have seen situations where this puts a lot of stress on the family. Often elderly parents want their space and teenagers may not be as quiet as your mother has been used to. It can be unfair to leave an elderly person at home all day alone, while the rest of the family is out at work, or school. Retirement homes can be a better solution, in that elderly people can enjoy living in a safe environment, and enjoy activities with people who have similar life experiences to themselves. From a financial viewpoint there are strong advantages to building a granny flat and having your mother live there. If your mother was to go into a rest home you will see your inheritance disappear at around $300 to $400 per week. As your mother’s health deteriorates you may eventually have to place her in a home where she can have full time care. Every family situation is different but we stress you must not feel emotionally obligated to care for your mother in your home. Queensland Rental Properties Do you have the intention of paying off the mortgage or will you have an interest only loan? It is a better investment if you are looking at interest only finance because the more of your own capital that you invest into real estate the poorer your investment return will be. The downside is that in fifteen years time you will have a tired asset. You will have an old property while attractive new ones will be being built around yours. With low investment returns you can only hope to do well by capital gains. There is high growth in Queensland at the moment but you are considering a long-term investment. What is the growth going to be like in 25 years time? What have you estimated your capital gains to be? We looked at a similar case just last week. The client was on a high income so that he will be taxed at 39 cents in the dollar from April next year. He was attracted to reducing this liability. It is tempting to consider such a purchase because the cost to you is small. We are not excited, however, and do not recommend this sort of investment. A fundamental rule in investing is to buy things that make good business sense. It is not good business sense to purchase a single multi-hundred thousand dollar asset that has an investment return of 4.5% per annum. 4.5% is the sort of yield you would expect when taking into account rental income and then deducting rates, insurance, management fees, vacancies, and maintenance. We have assumed the rental income would be around $250 per week. Queensland property investments are too tax dependent. No prudent investor would invest based on tax benefits alone. Given the costs of tying up a significant amount of money, greater than two hundred thousand dollars, you would want to be investing in something that made good business sense. We appreciate that the money is borrowed and you are not using your own savings but you are still liable for the repayments. If, for some reason, your property is not tenanted your monthly commitment will be around $1,600 in debt servicing. If you don’t get the expected rental return, or if there is a downturn on property in Queensland, over the next 25 years (a reasonable expectation) your tax attractive investment could place you in serious jeopardy. Why don’t you raise a loan and purchase several company debentures at 10-11%? The interest will be higher than the return from a residential property investment in Queensland. You do not need to worry about tenants destroying your residence. You do not need to pay 7.5% of your investment return into management fees. Your money will not be tied up in one large asset. Better still though, we recommend you invest in a variety of Australian shares (because they continue to outperform New Zealand shares). You can raise a loan where the capital is guaranteed so that even if the share market collapsed your capital would be protected. All the gains are yours. By buying a variety of shares you could be investing in banks, industries, resources and energy companies. You will have far more diversification. These sorts of investments have yielded returns greater than 50% over the last few years due to the power of 100% gearing. If you want to borrow money to invest you will be far better off to invest in the Australian share market by raising a loan that has a guarantee on your capital, rather than investing in just one residential property in Australia which has no guarantees, no diversification, and poor investment returns. You will still have the tax advantages but the risks will be far smaller. Finally, ask yourself why when Australia has a population that is five times greater than New Zealand’s do sellers of these properties come to New Zealand to encourage New Zealanders to invest. The best investments are not advertised, they do not need to be. The book, The Warren Buffett Way, by Robert Hagstrom Jr. mentions that Descartes said "It is not enough to have good intelligence, the principle thing is to apply it well." Apartments as Rental Investment We have built the first two town houses on the first section. They cost $470,000 to build and we sold one for them for $350,000 and are renting the other one for $400 a week. We have now started to build the next two town houses on the next property. Do you agree this is the best thing to be doing with my money? You spent 33% of your inheritance on motor vehicles, generally regarded as depreciating assets, and wonder if you have made a good investment! Those purchases were indulgences. We are unaware of your overall financial position, however, we approve of people indulging in such large depreciating assets only when all their other financial goals are on track. If you have estimated that you are well on track for your financial independence, then enjoy the purchase the of your vehicles. In other words, if you have sufficient income from your investments that you have an independent income which provides enough savings for you to purchase these cars you have our approval to have bought them. Most of the time people we meet who have bought expensive cars have high debts and few investment assets. Read the book The Millionaire Next Door by Drs Thomas Stanley and William Danko. This book describes the typical characteristics of millionaires. The authors are Americans but we feel the same applies to New Zealand millionaires. If you exclude those who have inherited wealth, most millionaires do not drive very expensive cars, nor do they live in very expensive houses. They have become millionaires by saving money, investing prudently, and not spending on luxury items. With regard to your property development you appear to have made some fortunate purchases. You must have bought in a desirable area and you have done very well to turn a $470,000 development cost into $700,000 of property. Congratulations! Obviously you have leveraged your investment, you borrowed money, and this will make your investment return even more attractive. We recommend you sell the other property which you are presently leasing. A rental income of $400 a week, after maintenance, rates, vacancies, etc. would have an investment yield of around 4.75%. This is an extremely poor investment return. You could sell the town house and earn more money in fixed interest. You have high risk associated with your property. Tenants could damage it, you risk falling property values etc. For this reason you should be getting an investment return of 5% more than you would in a bank account. Your return should therefore be around 10% to justify holding on to it. Obviously it would be impossible to rent your property out for $800 a week so you should sell it. Again we do not know about your other investments but your letter demonstrates that you have a significant amount of money tied up in residential property. We recommend that you invest the proceeds from at least one of the properties into international shares. Inland Revenue will, of course, regard you as a property developer and you will be liable for capital gains tax. Make sure you are working with a competent accountant with experience in this area. Your accountant could save you thousands of dollars in tax. In consultation with your accountant, lawyer and financial advisor we hope you have formed the correct structure for the property development and ownership, a trading trust, family trust or company. Another way to consider if your investment has been successful is to consider the following: You have purchased 3 properties for a total value of $300,000. You must have borrowed money, at say 12%, to build two town houses which have a total value of $700,000. You appear to have turned your $300,000 into $1,050,000. Your friends will be congratulating you for your business acumen. Now, take off the building costs of $470,000 and you have $580,000. Your interest repayments on the $470,000 you have borrowed at 12% would be $169,000. Take that from $580,000 and you are left with $411,000. You also have capital gains tax to pay. If you hold on to the two other properties worth a total of $200,000, your tax will be assessed on $211,000. Profits are calculated using historical costs. The longer you own the property the greater the capital gain is likely to be and the more tax you will have to pay when you sell. There is no time limit, ie: waiting for ten years, to selling. If you had invested your $300,000 as aggressively as you have but into international shares and futures funds you would have averaged 10% per annum, after tax, over the last 3 years. You would have $399,300, tax paid, sitting in your bank account. You would not have had the stress that property developers go through, project management, liability, etc. You would not have had to pay a lawyer to structure your investment to protect you from the risks of subcontractors failing etc. For these reasons, we think you would have been better not to have developed the properties. By the way if you had invested the entire $450,000 your investment would now be worth $598,950 (10% return). At this time you could be enjoying an independent income, after tax, of around $36,000 a year. That is a 6% income stream on your money. Capital growth, to keep your investment in pace with inflation, would be in addition to that income stream. Saving for Retirement Budgets tend not to work in our modern world. The old method our grandparents used putting money in separate jam jars really did work. The modern way is to budget by setting up automatic payments from your main account into sub accounts, one for holidays, personal expenses, food and clothing. Pay bills by automatic payment and where you can pay monthly instead of annually it is worth doing this to smooth out cash flows, even if it costs you slightly more. The saying "pay yourself first" is most important. Basically if you take out 10% of your income and put this towards a savings plan then your lifestyle will probably adjust. Or alarm bells will start ringing in terms of overdrafts. Remember if you don’t see it you won’t spend it. The problem with our society is money is too easy to get; EFTPOS machines and credit cards . Some ideas on saving money are:
While budgets tend not to work, it is a fascinating exercise to take a note book and write down every purchase you make over the next month. I am sure you will be surprised and can find ways to save without cramping your lifestyle too much. What you do save make sure it is giving the best investment returns. Rental PropertyYou have answered letters recently and commented that property is not a good investment. Last year I bought a property in Lower Hutt for $155,000 and 17 months later I have sold it for $175,000. That seems like a good investment to me! Answer: You are right. You purchased well and you have had an excellent return. Even after legal fees and real estate agents fees you have obviously made an excellent capital gain. Well done. The key to successful property investing is to buy well in the first place. A good purchase price is where most of the capital gains are made. We encourage people to invest in property when they buy at good prices and where the investment return will ensure that the investment itself is worthwhile. Our comments in previous columns have been that some people buy property at inflated prices and have poor rental returns. They justify their poor investments by claiming they are benefiting from negative gearing, that is they can offset their investment losses against their taxable income. An investment has to be an investment in the first place. The benefits of negative gearing should be secondary. Always follow a fundamental rule when making investment decisions which is: "buy things that make good business sense". Share ClubI manage a small unit-based share club in the New Zealand high technology sector. The intention is to provide a long term savings scheme with a buy and hold approach. The purpose is to maintain the unit holder's normal investment status, being exempt from capital gains tax. What does the club need to do to maintain exemption from capital gains tax? Answer: Capital gains taxes are not imposed in New Zealand. However profits from the sale of property and shares may be classified as assessable income in certain circumstances, such as when the business of the taxpayer comprises dealing in property or shares. This is a very ‘grey’ area as far as the IRD are concerned. The IRD have not come out with a definite minimum number of transactions. Based on recent court cases if you conduct seven or more share transactions in a year, you may be classified as dealing in shares, and therefore liable to pay tax on any capital gain. As your stated goal for your share club is to "buy and hold", in our opinion you could claim to be exempt from paying tax on any capital gain. To promote this concept you must get a written reply by way of asking the IRD for a "letter of determination" that you will be exempt from paying tax on any capital growth. While you have drawn up an investment statement answering the key questions required under Schedule 3D of the Securities Regulations 1983, you need to be cautious. You are holding yourself out as a club, in that you are not personally being rewarded from your activities, other than capital growth in your own investments in the fund. Under Section 3 of the Securities Act if you offer an investment to members of the public then you need to register a prospectus. The act does allow an exemption if the members of the public are relatives or close business associates of the issuer, habitual investors or someone who has been selected other than as a member of the public. If an offer is made to ten habitual investors and one member of the public, it is considered an offer to the public for the purposes of the Act. The act basically deems a member of the public does not possess the knowledge to be able to differentiate a good investment and a habitual investor should. We recommend you confirm your specific situation with the Securities commission. There is another New Zealand based company that invests in Technology stock, HCM Global Technology fund by HCM Global Funds Ltd. This is an aggressive fund using Henderson Group based in the UK and K&S Global Inc and HCM Global Ltd to manage the futures and options exposure. The HCM Technology Fund invests in world technology funds such as computer hardware, software and bio-engineering companies. In terms of your ‘club’ concept of pooling direct shares of New Zealand high technology stocks, and publicly listed venture capital companies, as far as we are aware, this is unique. Tenant ProblemsMy tenant gave written notice that he would move out at a certain date, he had not paid the rent for 4 weeks. We arranged for a new tenant to move in 2 days after the set date. He had not moved out. Over the next 3 days excuses were made for not moving out. Again another assurance was made that he would move out by a set date. One week later, still having not paid any rent now for 5 weeks he was still in the flat and my new tenants were not able to move in. I contacted the Police and they say it’s a civil matter not criminal. Even after we reported one week later the tenant was drunk, unconscious, and had urinated and damaged the place, the Police reported it’s a civil matter not criminal. What are my rights as a landlord? Answer: Inevitably if you rent properties to people, you do not know, there is a possibility that you may rent to a ‘rotten apple’. Your downfall was not having enough time to inspect the property before arranging for the new tenants to come in. This was hardly your fault though because you had every reason to believe that the property would be vacant, especially as you had this statement in writing. The Police are powerless to act in civil matters such as yours. They are very good at solving murders though! You need to apply for an emergency hearing via the Tenancy Tribunal. The normal time for a tenancy hearing is usually around two weeks. In your situation you should be able to get an emergency hearing within two to three days. Given your evidence as outlined in your letter there will be no question that you are the innocent party. The Police will be able to assist you to evict the tenant immediately after the hearing. You will only be able to apply for eviction at that emergency hearing. You will have to apply for another hearing with the tribunal to claim for costs and lost rental income. The time frame will be about two weeks. Make sure you are able to contact your tenant at his new address. It is up to you to know the contact details. If the tenant disappears no matter what the Tribunal orders he pays to you there is little point if you cannot issue a summons to him. Once again the police will not help you with this ‘civil’ matter. If you try to remove the tenant yourself, or his possessions and any of his items are lost, or damaged you will be liable. It is better, therefore, that you follow the legal procedure even though it is frustrating for you. The past doesn’t equal the future. Just because you have had an unpleasant experience with a ‘rotten apple’ doesn’t mean that your next tenant will be as bad. There is no point in selling your apartment based on the information you have provided. Generally if you are renting low quality, low rental apartments you may be attracting people who are less reliable, or able to pay the rent. What is the yield on your apartment? When you calculate your yield include costs such as lost rental income, cleaning costs etc. To calculate the yield we use the weekly rent, times 52, times eighty percent (banks use 70%) divided by the market value. The 20% allows for rates, insurance and 3 weeks of no rental income. If you are not earning a yield of 7% or higher you should not consider your property to be an investment. Rental properties need to compensate you for the risks you are taking, both financially and emotionally. The yield is particularly important today now that property values are on average increasing by only 2% above the inflation rate. Without capital gains, you could own a property for a number of years, suffer the stresses that landlords do, and in six to eight years give up being a landlord having made no progress. If you sell a property above your purchase price you will need to repay any depreciation claims made. We recommend you read "Rich Dad’s Guide to Investing" by Robert Kiyosaki. In this book he talks about the cash on cash return for rental properties. He says that whatever cash you put into a property, you should get a return on it. Any rental property should ultimately give you some monthly return. Do not consider properties that you have to ‘prop up’ by adding to the mortgage repayments. These sorts of ‘investments’ are very poor and can lead to high levels of anguish. Question: We have been trying different avenues as to ways we can get some money behind us. We have a freehold house worth $120,000, both of us are on GIR pension, but have nothing else to come and go on. We have had 8 children, 2 in Australia whom we haven’t seen for 6 years, we would dearly love to go aver and see them and the grandchildren. But it is hopeless for us to try and save enough on our pension. What ways are there that we can apply for $10,000 on our house. Answer: You have little room to move here in that the value of your house is relatively low so downgrading into a smaller home is not really an option. Banks would be reluctant to give you a mortgage and you would not have the spare money for the mortgage repayments or a personal loan. You could take out a reverse equity mortgage. Essentially a company gives you regular payments until the equity in your home is gone. On the value of your house the income would be low and you would end up not owning your property. A more favourable option is to approach your children and get them to buy a share of your house. If the loan documents are drawn up correctly this can protect your children’s inheritance eg against Social Welfare claw backs if you both end up in a rest home later in life. Tax Havens and Rental PropertyA few years ago while working in the UK I opened a term investment in the Guernsey Islands. This is a tax haven and I believe I do not have to declare this income, is this correct? Answer: This situation is not too uncommon, where a New Zealand resident may have deposited money in funds in a "Tax Haven", such as the Guernsey Islands, in the belief that the New Zealand IRD would not be able to assess the income. This is really quite a complex issue and your individual situation should be reviewed with an accountant experienced in this area. The Income Tax Amendment Act (No. 2) 1993 applies to all Foreign Investment Funds (FIF) interests held by New Zealand Residents on or after 1 April 1993 and FIF interests acquired after 2 July 1992. Its aim is to ensure that all New Zealand residents pay tax on their world-wide incomes, without dilution, arising from favoured tax treatments available in other countries. Our advice is to simplify your affairs. If you hold less than $20,000 (original cost), in total in funds which come under the FIF regime, you avoid having to estimate your FIF income for New Zealand tax purposes. Where funds do distribute or pay an income then you should declare this on your tax return. Any tax paid in ‘Grey List’ countries (this includes Australia, Canada, Germany, Japan, UK, US) is credited against your total tax liability. It’s best to seek advice. The penalties are not worth the risk. The penalties on the tax shortfall are 20% for lack of reasonable care, or unacceptable interpretation, 40% for gross carelessness, 100% for abusive tax position, 150% for tax evasion. Then there is use of money interest at 2% per month. Tax evasion can also carry imprisonment for up to 5 years, and/or a fine of up to $50,000. Answer: There are two parts to the answer to your question. They depend on whether you want to off-set any tax losses against your income, or whether you want to protect your assets against possible creditor attack. Our general recommendation is that you own your rental properties in a ‘holding’ company which is also a LAQC company, Loss Attributing Qualifying Company. Initially most rental investments make a loss, when the interest payments and depreciation costs are taken into account. With a LAQC company, as the shareholder, you can off-set the losses against your personal income. When your rental properties are making a profit, and you do not want to purchase any more, then you can change the ownership of your company to your family trust. If your rentals are held in a family trust and they are making a loss you can only carry this loss forward to future tax years. There is no personal tax off-set that you can do. With the company structure, when you decide that asset protection is more important, or that the rentals are in a profit situation, the transfer to the family trust only involves changing the company shareholder ownership. The properties are not actually sold so there is no depreciation claw-back, or land transfer costs required. If your income is over $60,000 you can use the company or your family trust to accumulate your savings and pay tax at 33%, not 39% which would be the case if these rental properties were held in your own name. When making a decision with regard whether to have a rental property we recommend:
The highest returns are usually where you can buy the worst property in the best area and put your time in to do it up. This does not suit everyone. You tend to make the most profit at the time of purchase. That is, negotiating hard and buying below market price. If you do improve the property, thereby increasing the market value, always re-calculate the yield. You may find it more profitable to sell the property. Share IndicesWith share markets going up and down recently various references are made in the Newspapers and Television to the following. Would you please explain what these are; NASDAQ, Dow Jones, S&P500 and NZSE40 Indexes. Answer: The NASDAQ and Dow Jones indices have been widely quoted with the recent activity and selling off of technology stocks on the US share market. The NASDAQ Stock Market began operating in 1971 with 250 companies. It has since evolved to a fully-fledged electronic stock market with over 5,000 companies listed from around the world. The NASDAQ is an acronym for National Association of Securities Dealers Automated system. More new companies are listed on the NASDAQ than all the other US stock markets and hence it has become an indicator of the health of technology stocks. The largest listed company on the Nasdaq is Microsoft. The Dow Jones Industrial average (Dow Jones Index) is the most quoted index. It represents 30 large, "blue chip" corporations and has been computed since 1896. The composition of the Dow Jones Industrial average is changed every so often to reflect changes in the economy. Currently the companies making up the Dow Jones index are; Alcoa, Amer. Express, Boeing, Citigroup, Caterpillar, Du Pont, Disney, Eastman Kodak, GE, GM, Home Depot, Honeywell, HP, IBM, Intel, Johnson & Johnson, JP Morgan, Coca-Cola, McDonald’s, 3M, Philip Morris, Merck, Microsoft, Proctor & Gamble, SBC Comm., United Tech, Wal-Mart, Exxon. Microsoft and Intel were only added in the last review in 1999. The Dow Jones is not particularly representative of the state of the American economy. The Standard & Poor’s Composite 500, commonly referred to as S&P 500, is more broadly based and is a ‘market-value weighted index’. As such it more closely reflects the US economy. In New Zealand the main public market index is the NZSE40 which covers 40 of the largest and most liquid stocks listed and quoted, weighted by number of securities on issue. Constituents of the NZSE40 are reviewed quarterly. The NZSE40 Index is based on a value of 1000 as at 1 July 1986 and includes all New Zealand listed and quoted ordinary shares and those securities capable of converting into ordinary shares. Each security is weighted by its capitalisation. There are two forms of the Index; NZSE40 Gross and NZSE40 Capital. The Capital Index is not adjusted for dividends, thus reflecting the rise in share price when a security is quoted before dividend and the fall when it is quoted ex dividend. The Capital Index measures the capital value of the securities ignoring payments to shareholders. The Gross Index is adjusted for dividends and therefore does not fall when shares are quoted ex dividend, as the Gross Index calculates an adjusted price based on the drop in the company’s assets, which is also the theoretical pre-tax payment to shareholders. The Gross Index measures the value to the investor of investing in the market and in effect assumes that dividends are re-invested. One of the major problems with the NZSE40 and the New Zealand share market is that it is highly weighted towards a few companies; Telecom 25%, Carter Holt 11%, Fletcher Challenge Paper 4%, Lion Nathan 4%. Other commonly quoted indexes are: All Ords (Australia), FTSE100 (UK), Nikkei 225 (Japan), Hang Seng (Hong Kong), Euro Top 100 (Europe). Share market indexes can be used as a tool to measure what is going on with share markets. They do not reflect what is happening with an investors diversified portfolio. That is, a portfolio diversified across all asset classes; cash, fixed interest, property, equities, specialties. Actively trading unit trust fund managers will often outperform the index especially at times of major market movements. An example of this was the recent large changes in the NZSE40 Index and the small movement in many New Zealand unit trust funds. How to avoid the higher tax rateMy salary is $87,500 I understand that the new Labour Government is likely to increase my tax rate. Do you have any ideas how I can get around paying more tax? Answer: There are several possibilities for minimising your tax liability. From 1 April next year you will probably have to pay an extra $1,650 tax. That is such a minimal difference that Dr Cullen thinks that the majority of people around your income level will do nothing to try to reduce their liability. If you believe that your income will increase over the years consider forming a company or a trading trust if you are self employed. If you are an employee and are unable to establish either of the above perhaps you could negotiate a different pay structure. At the moment you are probably contributing at least 20% of your income towards your ‘financial independence fund’. Your financial advisor would have encouraged you to and if you are not, now is the time to reconsider this advice. 20% of your salary is $17,500. Next year it will cost you a further $1,050 in extra tax payments to save the same 20% of your income for your future. If you request your employer to pay you a salary of only $70,000 and contribute $17,500 to a super fund you will effectively be earning the same income. It is possible that Inland Revenue will claim that you are attempting to avoid paying tax. For the sake of $1,050 it hardly seems worth pursuing but Inland Revenue have a different way of thinking. The case of CIR v Duke of Westminster (1936) was given a judgment that every person is able to arrange his or her affairs in such a way so as to attract the least amount of tax. By rearranging your remuneration structure it seems reasonable that you are merely mitigating, or lessening your taxes just as the Duke of Westminster did. The safest option is to accept your increased tax liability but when you negotiate an increase in your salary ask for the increase to be paid into an approved superannuation fund. This goes against the trend in recent years where employers have wound up their own superannuation funds, car schemes and are paying the extra benefits by way of an increase in income. By the way a downside to contributing to a superannuation fund is that these funds generally cannot be transferred into a trust. In the future it may be more important to you to protect your assets rather save some tax. Phillip Macalister addresses these options in Good Returns. The web site address is: www.goodreturns.co.nz We recommend if you are considering rearranging your income to pay less tax that you discuss this with your accountant. For additional articles published please refer to this link: financial calculators retirement insurance investments OM-IP family trusts leveraged investments financial planning |
Disclosure Statement available on request and free of charge, phone 04 471 0662, or email alison@lyfords.co.nz |
