30 September 2018

KiwiSaver Explained

KiwiSaver is a New Zealand investment vehicle to help regular people easily save towards their retirement. It exists alongside the Government Pension (Superannuation) that every citizen is entitled to, and having some support for that possibly fragile benefit is a very good idea indeed. If you're relying on Government Super come your 65th birthday, unless you're you're nearly there, I think you're going to be woefully disappointed.

Tax Efficient Saving

If you consume podcasts, books and blog posts from the general Financial Independence community, you'll no doubt hear about IRAs, Roth IRAs, Pension funds, 401ks, etc. If it all sounds complicated - that's because it is.

There's some good news here. New Zealand has no comparable investment vehicles, so the situation is much simpler. We also don't yet have a Capital Gains tax on the gains made from 'long-term' held share-based investments. Even as a non-betting man however, I'd put money on the fact that this will change.

There's some other bad news too. New Zealand has no "tax efficient", or pre-tax way of investing. There is no way to redirect any of your earnings into a savings pot before the government has taken their Income Tax percentage off the top.

A Word on KiwiSaver

When I moved here five years ago, my expectation was that KiwiSaver allowed exactly that pre-tax opportunity. You'd pay your 3%, 4% or 8% directly from your salary into your KiwiSaver and as a thank you for potentially easing the burden on the state in your old age, they'd give you that contribution before income tax.

Nope.

Your contributions are calculated before tax - e.g. if you contribute 4%, that would be 4% of your gross salary, not 4% of the remainder after you've paid mandatory PAYE income tax and ACC contributions. However, the government does contribute a "Tax Credit" of 50c in each dollar, up to a maximum of $521.43. Once you've contributed $1,042.86 there are no further tax benefits available by paying in more. As long as you're not self-employed there is a compelling additional reason however.

Employer Contribution

If you've signed up for and pay into your KiwiSaver, your employer is obligated to pay in a minimum of 3%. In some cases they may choose to match the amount that you put in.

The employer contribution is also taxed after the 3% is calculated, so their contribution will be less than yours, even if you both pay the same percentage. Weird? Read on…

Reading Your Pay Slip

Which when you look at your pay slip, it can look pretty confusing.

Employee contributions Employer contributions (Example figures)

If you're both paying at (for example) 4%, then why is the number different?

The Employee contribution is calculated on your pre-tax gross wage amount. For example, if you earn $50k a year, then your contribution at 4% would be $2k annually. Then you pay PAYE income tax and ACC contributions on that gross wage amount, and then the KiwiSaver contribution is moved to your KiwiSaver account.

$50k tax breakdown (https://www.paye.net.nz/calculator.html)

The Employer contribution is calculated at your pre-tax wage amount also. Then the Employer Superannuation Contribution Tax (ESCT) is removed from their contribution, before it is paid into your KiwiSaver account. ESCT is roughly the same tax banding as PAYE income tax.

If you want to understand ESTC, check out the government's explanation video.

For The Self Employed

KiwiSaver is a bit of a dud if you're self employed. It seems the only benefit is the $521.43 tax credit, which is still free money, just not very much in the scheme of things.

As far as I can tell, there is no rebate or tax credit available to a business for their employee KiwiSaver contributions. It's basically an additional 3%, 4% or 8% on top of the employee's gross pay, depending on at what level the employer chooses to match.

Is KiwiSaver Worth It?

Your KiwiSaver is most likely a regular investment fund. It has the huge advantage of your employer throwing in some extra money and the government gives you a $500 tax credit as a nice bonus. Of course, it has the huge disadvantage that you can only access the money under very limited circumstances - it's designed to only really be available when you hit 65. Although it can be used to help purchase a first home or in a case of extreme financial hardship, this is really about helping Kiwis in their retirement.

As it is a regular investment fund, then you will be charged PIR tax¹ on any dividends the fund receives, but don't worry about this as the KiwiSaver provider will handle it all for you.

Withdrawing from the fund is currently tax free. This is huge for us in New Zealand, but probably won't still be the case when I'd like to retire in 15 years.

In short, insomuch as your employer matches your contributions, then KiwiSaver is worth it. If they'll match 4%, then contribute 4% yourself. If your employer will go as high as 8%, and if you can afford it, then pay 8% yourself. It may come with strings attached, but it's free money.

It has the advantage of being withdrawn from your pay cheque before you ever see it, which can make the savings process easier. However, if you're on this FI path with me, then you've probably set up automated payments of your own. Personally I would not make payments that exceeded my employer contributions, it's just tying up money behind restrictions. Instead, take any spare money and stick it in your own low-cost ETF investment fund.

Who wants to wait until 65 to retire anyway?

I'm planning on going into much more detail on tax on investment funds in a soon-to-be-written post. That will cover PIE, PIR, FIF and Capital Gains taxes.