NZ Herald 19 October 2013

AGosh, you’ve had a tough run.

Your story illustrates some of the downsides of running your own business. There are lessons for others, such as not relying too heavily on any one customer, and not putting your family home on the line.

But that’s no help to you.

And after holding your letter for a couple of weeks while I thought about it, I’m afraid I haven’t come up with any brilliant ideas.

My only suggestion might make you angry, but I’ll try anyway. It’s to get free budgeting advice from the NZ Federation of Family Budgeting Services, whose website is www.familybudgeting.org.nz. I suspect you’ll respond that you already know how to budget, but they might come up with ideas you haven’t thought of.

The best solution, though, would be to come up with a new source of income. Other readers might have some thoughts. Anyone?

AThere’s irony here. Peter Neilson is chief executive of the Financial Services Council, whose members include many KiwiSaver providers. I’m sure he doesn’t want to discourage you or your acquaintances from joining KiwiSaver.

But let’s start with your question.

The tax rate on KiwiSaver earnings — as in the percentage of income that goes to Inland Revenue each year — is a lot less than 50 per cent.

Almost all KiwiSaver funds are portfolio investment entities, a.k.a. PIES. And the income on PIES is taxed at lower rates than income on other investments like bank term deposits. For example, the top PIE tax rate is 28 per cent, whereas on other income it’s 33 per cent.

So tax is not a good reason to stay out of KiwiSaver.

However, at a Financial Services Council conference this past week, Neilson said the “effective” tax rate on KiwiSaver can be higher than 50 per cent.

What he was referring to is the effect of paying tax on your long-term savings total. In some scenarios, if you paid 28 per cent tax on your KiwiSaver earnings every year for 40 or 50 years, you would end up with less than half the total savings you would have if you paid zero tax.

It’s the result of compounding. A similar thing happens with paying fees on an investment. The annual fee might be 1 per cent of your savings total. But if you pay that fee every year over many years, it ends up reducing your savings total by much more than 1 per cent.

It’s important to note here that:

• Other PIE investments are affected in exactly the same way. And non-PIE investments like bank deposits are hit even harder by tax.
• If you invest in a riskier KiwiSaver fund that holds largely shares, the tax rate and effective tax rate are considerably lower because of dividend imputation and tax breaks on capital gains.

The fact is, though, that tax on KiwiSaver is higher than on similar retirement savings in Australia, the UK and elsewhere, said Neilson. He added that it’s also higher than on many rental property investments — especially highly mortgaged, short-term investments.

That’s not really a fair comparison. KiwiSaver is an entirely different type of investment, in almost all cases a lot less risky than such a property investment. But still.

Neilson went on to say the government should reduce the PIE tax rates on retirement savings. It could make up for the loss in revenue by reducing the KiwiSaver government incentives.

“If we removed the $1000 up front and the annual $521 tax credit, the Government could use the money to cut the PIE tax rates on retirement savings from the average 17.5 per cent down to an average of 6.4 per cent,” said Neilson.

“Probably what is more likely to win support, is to keep the $1000 sign-on incentive, but abolish the $521 annual tax credit, which would be enough to bring the 17.5 per cent PIE tax rate down to 8 per cent.”

It may be a good idea. In someone’s early years in KiwiSaver, the $521 tax credit is a big boost to their account each year. But once their balance is more than, say, $100,000, the tax credit doesn’t make much difference percentagewise, whereas a lower tax rate on the considerable annual earnings would be most welcome.

Where does all this leave you, our correspondent? In KiwiSaver, I hope. Tax is one consideration. But another is the government incentives (or the tax reductions that Neilson would like to trade for them). They make KiwiSaver really hard to beat, even when compared with rental property. And if you’re an employee, you get a further bonus in the form of employer contributions. It’s a pity to miss out.

AIt took me a few moments to work out what you’re getting at here. But I think I’ve got it, and it’s a good point.

Last week I wrote that it’s often wise to split your mortgage so that part is at a floating rate, part is at a fixed rate for one or two years, and part is at a fixed rate for five years.

You can pay off the floating portion without penalty if you get a windfall, and you have some certainty about payments with the fixed portion. And as interest rates change, you’ll be happy with at least part of your total loan.

I assume you’re thinking of doing a split like that, and then concentrating your repayments on whichever portion of the loan is charging the highest interest. That’s always a good tactic, which can be extended to include credit cards or any other debt. Attack the most expensive loans first.

I doubt if all lenders would let you pay interest only on the lower-interest portions. But it can’t hurt to ask. Even if they won’t allow that, and you have to repay principal as well as interest on all portions, you should always put any extra payments towards the highest-interest loan.

ABecause I hoped it would be helpful.

It’s a bit like when I insist that uni students put a greeting on their emails to me, even though many young people apparently don’t bother when emailing one another. I tell the students that if they don’t start with “Dear” or “Hi” or — if they must — “Hey”, they’ll alienate the oldies when they go out into the work force.

Similarly, people who use bad grammar make a poor impression on many of us old fogies, and perhaps even some young fogies. Does that matter? It might if they want an opportunity or a job.

At least some people appreciate a bit of help with their grammar. Read on.

AFor me it wasn’t a mate but my mother. And I must say there were times when I was talking ten to the dozen, telling Mum about some exciting new project, and I wasn’t thrilled when her response was, “Different from, not different to”. But it’s stood me in good stead.

AThanks. And also to others who wrote in similar vein. I can’t resist including just one more letter.

AAnd I think you are wonderful for writing such an encouraging letter.

Now back to my knitting — another thing Mum taught me.