NZ Herald 1 November 2008

ARelax. Things are much better than you think.

Firstly, the National Party plans you write about have nothing to do with KiwiSaver. Secondly, being in KiwiSaver is almost certainly the best way to get into your first home. And thirdly, old age is by anyone’s measure at least three decades away for you. Many of us would like to think it’s much more!

National has said that if it wins the election it would aim to invest 40 per cent of the New Zealand Superannuation Fund’s money locally. That fund, sometimes called the Cullen Fund, is a pool of government money to help cover Baby Boomers’ future NZ Super payments.

It’s quite separate from KiwiSaver. While the government contributes to KiwiSaver, everyone’s investments are in privately run funds, and we each choose what we invest in.

I’m not happy with National’s plans for the Cullen Fund for several reasons, chief among them the importance of the investments being diversified around the world.

But that’s another story. Let’s get back to you. While you can take a contributions holiday from KiwiSaver after just a year, I strongly suggest you don’t. It could make all the difference to whether you end up owning a home.

After three years in the scheme, you can take out not only your own contributions but also employer contributions and earnings on all your KiwiSaver money, to put into your first home. You have to leave in the government kick-start and tax credits — but that’s money you wouldn’t have had anyway, outside KiwiSaver.

Also, as long as you have been contributing 4 per cent of your pay, your household income is less than $100,000 and you buy a cheaper home, you can get a KiwiSaver first home subsidy. This is $3000 if you have been contributing for three years, rising to $5000 for five years or more.

With any luck, the timing will work well for you. In three to five years, house prices seem likely to be lower than now, possibly quite a lot lower. Don’t give up on the home ownership dream.

AThere’s no doubt that, if National gets to make its proposed changes to KiwiSaver, mortgage diversion will be less attractive to many — especially older people and those on lower pay.

If you have been in KiwiSaver for more than a year, you can divert up to half your contributions — but not any money from employers or the government — towards your mortgage.

Mortgage diversion makes no sense for the self-employed or other non-employees. If they have a mortgage, they should simply contribute up to $1043 a year — $20 a week — to get the maximum KiwiSaver tax credit, and put the rest towards their mortgage.

But, under the current rules, diversion can work well for many employees, who have to contribute at least 4 per cent of their pay. They still get the same employer contribution. Their government tax credit — which matches the amount of their own contribution left in KiwiSaver after diversion, up to $1043 — depends on their income, as follows:

• On more than $52,150, they get the full $1043 tax credit.
• On $26,075 to $52,150, if they divert half their contribution, they will leave less than $1043 in KiwiSaver. Mortgage diversion will therefore reduce their tax credit — a little for the higher earners; more for the lower earners.

Still, even Susie on $30,000 will probably be better off using mortgage diversion than not.

Without diversion, she would put 4 per cent of her pay, $1200, into KiwiSaver and receive the $1043 credit. With diversion, she would divert $600 and leave $600 in KiwiSaver. Her tax credit would also be $600, which is $443 smaller.

However, this will probably be more than offset by the fact that her diverted money is likely to get a higher effective return than if she left it in KiwiSaver.

If she repays a 9 per cent mortgage, that improves her wealth in the same way as an investment that brings in a 9 per cent return, after fees and taxes. Chances are that her average return in KiwiSaver will be lower than that.

• On less than $26,075, the loss of tax credit is a bigger deal.

Let’s look at Johnny, who earns $20,000. Without diversion, he would contribute 4 per cent, or $800, and receive a matching tax credit. With diversion, he would divert $400, leave $400 in KiwiSaver and get a $400 tax credit — only half as big.

Still, he like Susie needs to weigh up repaying his mortgage versus leaving the money in KiwiSaver.

How does it work out for him? Two factors affect this. The first is the difference between the effective return on repaying the mortgage and the return on KiwiSaver. The riskier Johnny’s KiwiSaver fund is, the more likely the difference will be smaller over the years.

The second factor is how many more years he will be in KiwiSaver. The younger he is, the more years he will benefit from the higher effective return of mortgage repayment.

So — should Johnny use mortgage diversion? Crunching the numbers gives different answers depending on which mortgage rates and returns are used. Here are the best guidelines I can come up with:

If you earn less than $26,075, and you are:

• Under 35, use mortgage diversion.
• 35 to 55, use mortgage diversion if you are in a conservative KiwiSaver fund, not if you are in a riskier fund that holds mostly shares and/or property.
• Over 55, don’t use mortgage diversion.

Still with me? Sorry this is rather complicated. I didn’t design KiwiSaver.

Now, along comes National, with its plans to reduce the minimum employee contribution to 2 per cent, and to keep the minimum employer contribution at 2 per cent, from next April.

If National wins the election, employees with mortgages should reduce their KiwiSaver contributions next April to 2 per cent of pay, and put any further savings into their mortgages.

The big question is whether they should then use mortgage diversion, leaving 1 per cent in KiwiSaver and diverting the other 1 per cent.

To get the answer, we double the cutoff numbers above. For employees using mortgage diversion:

• On more than $104,300, you get the full $1043 tax credit. Go with diversion.
• On $52,150 to $104,300, mortgage diversion will reduce your tax credit, but it may still make you better off.
• On less than $52,150, if you are under 35, you might want to use mortgage diversion. If you are 35 to 55, use it only if you are in a conservative KiwiSaver fund. If you are over 55, don’t use mortgage diversion.

That’s all fine, but there’s another issue here. Under National, would mortgage diversion be worth the trouble of setting it up?

Let’s say you earn $80,000. Your 1 per cent diversion would be $800, and your tax credit would drop from $1043 to $800, a loss of $243.

At a 9 per cent mortgage rate, the effective return on your diverted $800 would be $72 a year. If you didn’t use diversion and earned a return of 5 per cent in your KiwiSaver fund, the return on that money would be $40 a year.

It would take more than seven years for the higher return from diversion to make up for the reduced tax credit. After that, diversion would be a plus. But unless you were doing it for several decades, there wouldn’t be that many dollars in it.

For those on lower incomes, the loss of tax credit is bigger and there are even fewer dollars at stake. Personally, I wouldn’t bother with mortgage diversion under National unless I was young or on high pay.