Money: Shares best option to build nest egg

By Mary Holm

Money Matters



Q. I have some doubts about long-term saving for retirement. Seems like everyone will get rich except me.

We are told to save for our retirement because there will not be enough young people around to fund our retirement out of taxes. But how do we save?

If we take the best long-term option and buy shares, we will have the same problem - not enough young people around to buy our shares, so they will be worthless.

Suppose at 25 I aim to retire at 70. If I put a one-off saving of $1000 in a unit trust that grosses 12 per cent, that money would be worth $164,000 in 45 years.

But tax at 33 per cent reduces the return to 8 per cent, and my money is worth $32,000. Then manager's fees reduce the return to 6.5 per cent and my amount to $17,000.

So of my $164,000, 81 per cent has gone to the IRD and 9 per cent to the manager, leaving me with a measly 10 per cent. That's a bit greedy isn't it?


A. Quickly! Make more babies if you still can. And get all your friends to do the same.

Seriously, you make some excellent points - even if you over-dramatise the situation.

First, let us look at your fear that there will not be enough young people to buy our shares when we are older.

One reason the US sharemarket has done so well in recent years is said to be that the Baby Boomers - born in the mid-40s to mid-60s - are reaching their peak investment years, and buying up fast.

(The same thing is not happening in New Zealand, perhaps because other factors are working against it.)

As the Boomers retire, and die, some of their shares will be sold. And, as you say, there will be fewer young buyers.

This, some experts say, is expected to dampen share prices. But there are a few "buts."

* Not everyone sells all or even most of their shares, or units in a share fund, in retirement.

* The trends will be gradual. Someone born in 1965 probably will not retire until around 2030, and may well hold shares until 2050 or beyond.

* Population trends vary from country to country. If you invest in an international fund, not all share prices will be affected as much or at the same time.

* Many other factors affect share prices. Recently, big boosts in productivity, largely driven by technological developments, have helped to push up world share prices. Who knows what factors will be at work in the future?

Turning to your numbers, you have calculated the totals correctly.

When you say, though, that Inland Revenue gets 81 per cent of your money and the fund manager 9 per cent, that assumes those two put every year's tax or fees into an investment earning 12 per cent, which rolls up over the 45 years with no deductions from it. Of course that does not happen.

Nevertheless, while the IRD and fund manager do not roll up the money, you would have. Without taxes or fees, you would have ended up with piles more.

Another issue: Your choice of time period and return makes a big difference to your results.

If you had used 20 years instead of 45, the tax take would have wound up depriving you of 58 per cent of the money instead of 81 per cent.

And if your return had been 6 per cent instead of 12 per cent, taxes would have deprived you of 62 per cent. With a combination of 6 per cent and 20 years, you would have missed out on 46 per cent.

Still, regardless of what numbers we slot in, there is a clear message: The level of taxes and fees can hugely affect long-term investment results - Michael Cullen (Treasurer and Minister of Finance) and fund managers please note.

Where does all this leave us on your first question: How do we save?

You answer it yourself when you say shares are the best long-term option.

You seem to have overlooked that, if you invest directly in shares or through an index fund, you usually do not pay tax on capital gains. And capital gains are a major part of share returns, particularly outside New Zealand and Australia.

(On New Zealand shares, you do not pay tax on dividends either, because of imputation. But you could argue that is because the companies have already paid the tax.)

There are no manager fees on direct share investment, and low fees on index funds.

The total effect of tax and fees will not be nearly as bad as in your example.

As for population trends, they are certainly not going to make shares worthless.

Even if world share prices do not continue to grow as fast as they have, you will still undoubtedly be better off in retirement with share holdings than without.


Q. I'm writing about your article on revolving credit mortgages (January 29). Presumably if one's mortgage interest is tax deductible for some reason (residential investment) then one would need to be careful with a revolving mortgage, because the investment (and therefore tax deductible) portion may become mixed in with personal expenses.

Presumably the IRD could well claim that whenever the loan increased, this was due to personal expenses, and the per cent of the interest which was tax deductible would decrease accordingly.

This process repeated over numerous small transactions could result in a very disadvantageous situation. Am I right?


A. Yes - although "very disadvantageous" is putting it rather too strongly.

With a revolving credit mortgage, for those who did not read the earlier column, the loan is like an overdraft.

You put all your income into the overdrawn account, so it is credited against the mortgage balance until you spend the money. That means you pay interest on a lower balance.

On a non-investment mortgage -such as one on your own home - it is the equivalent of getting the mortgage interest rate, tax-free, on your income, for as long as the money is in the account. That is a pretty good short-term return.

On an investment mortgage, with tax deductible interest, it is the equivalent of earning the mortgage interest rate after tax. Not quite so good, but still well worth getting.

The cleanest and simplest way to use one of these mortgages for a rental property would be to use the account only for that investment.

Rental income would go into it, and you would pay rates, insurance, maintenance and other investment expenses out of it.

All the mortgage interest you pay would then be deductible.

If, though, you used the same account for other personal income and spending, strictly speaking you should work out what portion of the mortgage is used for the rental property, and deduct only that portion of the interest.

One way to do this would be to keep track of all the money going in and out. But that sounds like a book-keeping nightmare.

A tax accountant tells me that, in his long experience, Inland Revenue does not usually expect every last dollar to be noted down in this sort of situation.

There is no guarantee, though, that you will not be the one who gets audited on this very issue.

If you want to rest easy at night, you might be best to use the mortgage account only for rental income and expenses.

Another reader wrote that she has a revolving credit mortgage "which allows us to redraw, but only up to the amortisation line. This gives the benefits of the revolving mortgage, but still has a finish date."

This is a variation on the theme. The maximum amount you can borrow decreases steadily, reaching zero after 10 or 20 years or whatever the term of the loan is.

It means that you cannot borrow any extra unless the total you have put into the account, minus what you have taken out, is more than what the repayments would be on a normal mortgage.

That limits out-of-control spending. And, as the reader says, it gives you a finish date. A great feature for many.


Q. The letter from the couple in their 50s who thought they were well set up for retirement, and then had the double disaster of the woman being made redundant and the man having heart trouble and probably never being able to work again (January 15), highlights the need for some form of disability insurance to underpin any retirement plan.

A simple income protection insurance contract could have saved this couple from this gloomy situation. It surprises me that this form of insurance is not better publicised.

I took out a policy for myself last year and was amazed how reasonable the monthly cost can be.

If I was in the unfortunate position of being too ill to ever work again I would receive 75 per cent of my present income until I reached 65, and my benefit would be index-linked to keep up with inflation.

The cost is less than I pay for my house and contents insurance, and apparently it is tax deductible.

I am sure that there are plenty of readers out there who, like the couple who wrote to you, think they are well set up when in fact their biggest asset (their future income) is unprotected.


A. You are right. Many people do not realise how important their earning power is until too late. They might have life insurance they no longer need, but no income protection insurance, which they do need.

Self-employed people are more likely than others to be insured against loss of income, often with a policy that pays a portion of their usual income after four weeks off work.

But employed people can also get coverage. They should find out how long their employer would pay them if they became disabled, and get coverage for the period beyond that.

A policy that kicks in three or six months after you stop work is much cheaper than one that starts after four or eight weeks.

And the premiums vary according to your occupation. If you work at a desk, you will pay less than a builder. A helicopter pilot or bulldozer driver may not be able to get coverage at all.

You can choose to get up to 75 per cent of your income if disabled. If you choose a lower amount, the premiums will be cheaper.

As far as taxes are concerned, the premiums on some common types of coverage are deductible. And, if you make a claim, the payments you receive are taxable.


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