NZ Herald 27 September 2008

ANo — to the tune of many thousands of dollars at retirement. What you are overlooking are the effects of KwiSaver government and employer contributions.

But let’s start at the beginning. Before KiwiSaver, the best use of your savings would generally be to pay extra off your mortgage.

If your mortgage interest rate was 10 per cent, repaying it faster than necessary improved your wealth as much as an investment that pays a 10 per cent return, after fees and taxes, and with no risk. No investment was that good.

But along came KiwiSaver. If you join and contribute $160 a month or $1920 a year, the government will contribute the maximum tax credit of $1,043 a year. What’s more, your employer will contribute at least 1 per cent of your pay, or $480 a year.

The total going into your account is $3,443 — close to doubling your own contribution. And by the time the employer contribution reaches 4 per cent of pay, from April 2011, the total will be $4,883 — more than 2.5 times your contribution.

That’s powerful stuff. It means your retirement savings will be more than 2.5 times what you would have saved in a similar account outside KiwiSaver.

Calculations show that you are highly likely to end up better off at retirement than if you had put 4 per cent of your pay into extra mortgage repayments.

This is particularly true if you are within 20 or 25 years of retirement and you invest in a riskier KiwiSaver fund, with higher average returns.

In some market conditions, younger people in lower risk funds may be better off contributing to KiwiSaver for just a year and then taking a contributions holiday and putting the money into mortgage repayment. I would hope, though, that as New Zealanders become more familiar with KiwiSaver, long-term investors will move to higher risk funds anyway.

In any case, this all becomes academic once we add mortgage diversion to the mix. Almost all KiwiSaver employees with mortgages would be foolish not to use diversion.

With mortgage diversion, you put in only half the money, but you still get the KiwiSaver incentives. Employer contributions are unchanged, and — if you earn more than $52,150 a year — the tax credit is also unchanged.

If you earn less than that and divert half your contributions, the tax credit is smaller. That’s because you’ll leave less than $1043 in your account, and the tax credit matches your contribution up to $1,043.

Even so, calculations show that every mortgaged employee should benefit from using mortgage diversion unless they earn less than $26,075 and are either:

• aged 35 to 55 and in a fairly conservative KiwiSaver fund — but not if they are in a riskier fund.
• over 55, regardless of their fund.

In your case, you would divert $80 a month to mortgage repayment. The other $80 a month or $960 a year would stay in KiwiSaver. The government tax credit would match that, and your employer would still put in $480 a year until April 2009, rising gradually to $1920 a year from April 2011 on.

By 2011, the total going into your account would be $3840 a year — four times your contribution, which quadruples your retirement savings. Wow!

The maths go like this, assuming you start mortgage diversion now:

If you took a contributions holiday — or never joined KiwiSaver — and put the full $160 a month into extra mortgage payments on a 10 per cent mortgage, that would improve your wealth by about $32,000 over 10 years or $197,300 over 25 years.

On the other hand, contributing to KiwiSaver, with mortgage diversion, you would pay $80 a month off the mortgage. That would improve your wealth by $16,000 over 10 years or $98,700 over 25 years.

Your other $80 a month would go into KiwiSaver, to which we add the government and employer contributions. In a fairly conservative KiwiSaver fund, with average annual returns of 4 per cent after fees and taxes, your account would grow to $39,700 in ten years or $141,100 in 25 years.

In total, then, over ten years in KiwiSaver with diversion your wealth would grow by $55,700 — compared with $32,000 out of KiwiSaver.

Over 25 years, your wealth in KiwiSaver with diversion would grow by $239,800 — compared with $197,300 out of KiwiSaver.

The KiwiSaver totals should be even higher if you invest in a riskier KiwiSaver fund. The numbers are pretty compelling.

Consider, too, that on a contributions holiday you might not have the discipline to put 4 per cent of your pay into mortgage repayment.

I strongly recommend you continue your KiwiSaver contributions and use mortgage diversion, knowing that you can always go on a contributions holiday if you get in a financial bind. But try to resist that. You’ll be glad at retirement.

By the way, mortgage diversion doesn’t make sense for the self-employed or other non-employees with mortgages. They do best by simply contributing $20 a week, or $1,043 a year, to KiwiSaver and then putting any further saving into mortgage repayment.

AAs explained above, mortgage diversion certainly works well for those who take advantage of it. And in these worrying times, it’s good to see people reducing their vulnerability by paying off debt. But it sounds as if you are more concerned about the economy as a whole.

Clearly diverted money is not staying in KiwiSaver funds, which typically invest in non-property assets, such as cash, bonds and shares — although some are also in commercial property.

Hopefully, though, as diversion helps people to get rid of their mortgages faster, at least some will then turn to other saving, rather than buying more expensive homes. And after some years in KiwiSaver, they may appreciate the advantages of non-property investments and boost their savings in those.

In any case, we’re not talking big numbers. Even a KiwiSaver earning $100,000 will typically be diverting only $2,000 a year. While it’s a great thing to do with that $2,000, it won’t make a huge hole in most mortgages.

Another way of looking at it: Without mortgage diversion, some people might not join KiwiSaver. Chances are, then, that less of their savings would end up in non-property assets.

Note, too, that mortgage diversion applies only to your own home, so it doesn’t encourage investment in rental property.

On your second point, I agree that it wouldn’t be good for the government to try to stop house prices from falling — even if it could.

Quite apart from the question of whether governments should intervene in markets — a hot topic in the United States at the moment — I reckon most New Zealanders gain, or at least don’t lose, from falling house prices.

As you say, the clear winners are those who don’t yet own a home. And while many homeowners seem upset that house prices are down, arguably they should be indifferent, or even pleased.

How come? The changing trend should reduce the “wealth effect”, which happens when house prices soar and people think, “I’m now a half millionaire. Why shouldn’t I increase my mortgage and buy a new car?”

The fact is that most people are not really better off when house prices rise. We always need accommodation, so its value doesn’t much matter — until we die.

Borrowing against a rising house value to buy things that lose value just leaves the borrower with a debt to repay and lower total wealth. Falling house prices should put an end to this silliness.

It’s different, of course, if you increase your mortgage to fund an investment that might grow in value — such as a business or property. But this works only when the investment brings in a higher return than the mortgage interest paid — which, as many property investors are now realizing, is not guaranteed.

That brings us to the losers when house prices fall. They include:

• Those who have invested in property assuming its value will always rise.
• Anyone forced to downsize their home — perhaps because they could no longer make mortgage payments.

Assuming all house prices fall by 10 per cent, if you sell a formerly $1 million house for $900,000 and then buy a formerly $500,000 house for $450,000, you have suffered a net loss of $50,000. What’s more, higher priced houses tend to fall by a larger percentage in downturns.

I doubt, though, that people in these two situations make up a large portion of the population. I would be surprised — and disappointed — to see any political party proposing moves to stop house prices from falling.