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Use windfall to pay off the mortgage
By Mary Holm
5:30 AM Saturday Aug 24, 2013 ✩Save
I'd appreciate some quick advice about what to do with a $4500 "windfall".
My house mortgage is down to $10,000 and the interest is $23 a fortnight. Should I put the windfall on my mortgage or add it to my savings (at 4 per cent)?
I am 64 and in full-time employment. I plan to retire in about 18 months.
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Mary Holm :
Get rid of that mortgage, not just using the $4500 but also your savings - assuming you have enough savings. Speed up the glorious Mortgage Free Day - at which point you can dance on the beach and splurge for a month, but then be a good girl and put your former mortgage payments into your savings.
Why do it that way around? Let's say your mortgage interest rate is 6 per cent. When you pay it down, you improve your wealth in the same way as if you had an investment earning 6 per cent after fees and taxes. Your savings are earning only 4 per cent - and that's probably before tax. So they can't compete.
It's good to have some savings for emergencies, even if you have a mortgage. But it's not financially smart to have much money earning 4 per cent while also paying a higher interest rate on a loan.
Oh, and I can't resist asking my "When I'm 64 Question": Are you in KiwiSaver? If not, join before you turn 65 and are no longer eligible.
KiwiSaver is a particularly good deal for people in their 60s. And everyone gets at least five years of KiwiSaver incentives, so you'll get them until you're 69.
You'll receive the $1000 kick-start and, while you're working, employer contributions and the tax credit. After you retire, I suggest you keep contributing $1043 a year - perhaps as $87 a month - and you'll get the $521 maximum tax credit each year.
The downside is that you tie up the money, but it's only for five years from your joining date. People close to retirement don't usually mind that. They can spend other savings in the meantime.
Why is KiwiSaver so good for older members? It's about the returns on your contributions - more specifically what happens to each year's contributions.
Let's look first at 20-year-old Jack. The money he puts into KiwiSaver this year is boosted by government and employer contributions. So in its first year in KiwiSaver, that money earns a fantastic return. However, Jack's 2013 contributions then sit in his account for decades, earning whatever his fund earns - which we might call an "ordinary" return.
Next year, Jack's 2014 contributions will get the big boost. But then that money will also earn just ordinary returns for decades. And so on. For Jack, a lot of money earns ordinary returns for a lot of years, watering down his total returns.
Meanwhile, Jill joins KiwiSaver over 60. Her contributions also get the first-year boost, but they then earn ordinary returns for just a few years.
I'm not saying KiwiSaver isn't a good deal for Jack. The incentives can mean he will end up with twice as much - or more - than if he had saved the same amount elsewhere. And anyone who saves over a long period benefits from powerful compounding.
But Jill does even better. Even if she has to dip into savings to make the contributions after retirement, it's well worth it.
By Mary Holm
5:30 AM Saturday Aug 24, 2013 ✩Save
I'd appreciate some quick advice about what to do with a $4500 "windfall".
My house mortgage is down to $10,000 and the interest is $23 a fortnight. Should I put the windfall on my mortgage or add it to my savings (at 4 per cent)?
I am 64 and in full-time employment. I plan to retire in about 18 months.
------------------------
Mary Holm :
Get rid of that mortgage, not just using the $4500 but also your savings - assuming you have enough savings. Speed up the glorious Mortgage Free Day - at which point you can dance on the beach and splurge for a month, but then be a good girl and put your former mortgage payments into your savings.
Why do it that way around? Let's say your mortgage interest rate is 6 per cent. When you pay it down, you improve your wealth in the same way as if you had an investment earning 6 per cent after fees and taxes. Your savings are earning only 4 per cent - and that's probably before tax. So they can't compete.
It's good to have some savings for emergencies, even if you have a mortgage. But it's not financially smart to have much money earning 4 per cent while also paying a higher interest rate on a loan.
Oh, and I can't resist asking my "When I'm 64 Question": Are you in KiwiSaver? If not, join before you turn 65 and are no longer eligible.
KiwiSaver is a particularly good deal for people in their 60s. And everyone gets at least five years of KiwiSaver incentives, so you'll get them until you're 69.
You'll receive the $1000 kick-start and, while you're working, employer contributions and the tax credit. After you retire, I suggest you keep contributing $1043 a year - perhaps as $87 a month - and you'll get the $521 maximum tax credit each year.
The downside is that you tie up the money, but it's only for five years from your joining date. People close to retirement don't usually mind that. They can spend other savings in the meantime.
Why is KiwiSaver so good for older members? It's about the returns on your contributions - more specifically what happens to each year's contributions.
Let's look first at 20-year-old Jack. The money he puts into KiwiSaver this year is boosted by government and employer contributions. So in its first year in KiwiSaver, that money earns a fantastic return. However, Jack's 2013 contributions then sit in his account for decades, earning whatever his fund earns - which we might call an "ordinary" return.
Next year, Jack's 2014 contributions will get the big boost. But then that money will also earn just ordinary returns for decades. And so on. For Jack, a lot of money earns ordinary returns for a lot of years, watering down his total returns.
Meanwhile, Jill joins KiwiSaver over 60. Her contributions also get the first-year boost, but they then earn ordinary returns for just a few years.
I'm not saying KiwiSaver isn't a good deal for Jack. The incentives can mean he will end up with twice as much - or more - than if he had saved the same amount elsewhere. And anyone who saves over a long period benefits from powerful compounding.
But Jill does even better. Even if she has to dip into savings to make the contributions after retirement, it's well worth it.
