- Why older people get a better deal from KiwiSaver, but younger people should nevertheless still join.
- Do interest-only mortgages qualify for mortgage diversion?
QAs a chartered accountant/financial analyst I have done some analysis and came to the conclusion that the older you are the better the deal with KiwiSaver.
Because savings are locked in till 65 (or probably older by the time we get there) and you can opt out later via contributions “holidays”, I believe KiwiSaver is best analysed as a series of separate annual opportunities to invest 4 per cent of your pay in a long-term deposit until retirement.
Let’s say you earn $52,150, so that 4 per cent of your pay is $2,086. In KiwiSaver, after April 2011 you get a return of 150 per cent interest in the first year. That’s the employer’s tax-free contribution of 100 per cent when they equal your $2,086 contribution, and the government contribution of $1,043, which is 50 per cent.
After that, you get an average investment portfolio return for the remaining years of perhaps 6.5 per cent after tax and fees.
A young person earning $52,150 with 40 years to retirement gets one year of 150 per cent and then 6.5 per cent for the remaining 39 years.
If you put that in a spreadsheet you will find that that year’s investment only will grow to about $65,000 in 40 years.
This sounds great, but if they were to put their $2,086 in an investment earning 9 per cent after tax (without any of the first year benefits) it will also grow to about $65,000 in 40 years.
And the obvious place for a young person to find an investment offering more than 9 per cent after tax return is their mortgage.
However, for a person who is, say, 10 years from retirement, the KiwiSaver return is much better. They would need to find an investment paying more than 16 per cent a year after tax to beat that over only 10 years.
My conclusion is that the effective return offered by KiwiSaver increases each year as you approach retirement. And you should join KiwiSaver only when the effective lifetime return for this year’s option to invest exceeds the interest rate you are currently paying on your debts, or can obtain from other equal risk investments.
For anyone over the age of 50, it will be a “no-brainer”, as the effective return increases so dramatically near the end it could outdo any other typical investments. But for young people the conclusion is not that clear.
I would be interested in your opinion of my analysis.
AIt’s fine — as far as it goes. My calculations differ slightly from yours, but that’s probably because of different assumptions about when the contributions arrive. Basically, our conclusions are the same. KiwiSaver is really attractive for older people, not quite so good for the young.
But does that mean younger people shouldn’t join? Some counter arguments:
- You mention the possibility of non-KiwiSavers going into other equal risk investments. But debt repayment is the only “investment” that can beat KiwiSaver once we take risk into account. Any other investment expected to pay a higher return than KiwiSaver must be considerably riskier, because the KiwiSaver incentives give it such a boost. That means that your argument applies only to people who have a mortgage or other long-term debt.
- You consider someone who has a mortgage for 40 years before they reach NZ Super age. These days most people don’t take on a mortgage until they are perhaps 35 or 30 years from retirement, and then it often runs for less than 35 years. That weakens your case.
- Your analysis also depends on there being a fairly big gap between KiwiSaver returns and mortgage rates. If that gap narrows — which experts say is likely as the current big difference is unusual — KiwiSaver becomes more attractive.
Nevertheless, your argument may still hold for young people with mortgages when the mortgage/investment return gap is fairly big. There is, though, one factor you haven’t allowed for that makes a big difference — mortgage diversion.
Under the KiwiSaver legislation, once you have been in the scheme for a year, you are allowed to divert up to half your contributions to pay off the mortgage on your home. Your provider and mortgage lender must agree to this, but most will.
The New Zealand Bankers Association announced this week that because of difficulties with the mortgage diversion rules, banks won’t accept applications for mortgage diversion until August. This means those who joined KiwiSaver in July 2007 will have to wait 13 months or so to take part — but that probably won’t be a big deal for many people.
Once mortgage diversion is under way, the person in your example earning $52,150 could divert half of their $2,086 KiwiSaver contribution — $1,043 — into faster repayment of their 9 per cent mortgage. Over 40 years — if the mortgage did run that long — that reduction in mortgage debt would increase their wealth by about $32,500.
Meanwhile, their other $1,043 would stay in the KiwiSaver account, along with the employer’s $2,086 and the government’s $1,043, totalling $4,172. Over 40 years that would grow to about $52,000.
The total of the two, $84,500, far exceeds the $65,000 in your example.
Conclusion: If you are an employee with a mortgage at whatever age, it’s almost always better to join KiwiSaver and use mortgage diversion than to concentrate on repaying your mortgage. Don’t, though, put more than 4 per cent of your pay into KiwiSaver. Any further savings are best put into repaying your mortgage.
Number crunching shows that this conclusion applies to people on all incomes, except some people who earn less than $26,075. While they will be better off in KiwiSaver than repaying their mortgage, it’s not so clear whether they should use mortgage diversion. That depends on their age and appetite for risk.
A rough guide for employees earning less than $26,075: Over 55s should skip mortgage diversion. Those aged 35 to 55 should use diversion if they are fairly conservative KiwiSaver investors. Those under 35 should use diversion in any case.
Mainly because of mortgage diversion, then, I don’t buy your argument. But I’ll concede three points:
- The case for KiwiSaver is not quite as strong in the short term if your employer is putting in only the compulsory employer contributions, which are less than 4 per cent of pay until April 2011. However, this is offset at least partly by the $1,000 first-year kick-start. And each April, as employer contributions rise, the case gets stronger.
- The big drawback with KiwiSaver is that the money is locked up, generally until retirement age. If you use the money to repay a mortgage instead, it’s somewhat easier to get access to that money later if you need it.
- People with credit card, hire purchase or other higher-interest debt that they don’t expect to repay in a few months arguably should get rid of that before joining KiwiSaver.
There are, though, some circumstances in which joining KiwiSaver is better in the long run even than repaying 20-plus per cent credit card debt — particularly for people 55 or older. But psychologically most people would probably prefer to get rid of the debt first.
A good idea for high-interest debtors is to join KiwiSaver and contribute 4 per cent of your pay for a year. That gets you the $1,000 kick-start plus the other incentives and, importantly, makes you set aside some money.
After a year, take a contributions holiday and put all the money that you had been contributing to KiwiSaver — plus as much else as you can manage — into debt repayment. Once your debts are gone, start contributing to KiwiSaver again. Throughout all this, please try to develop the habit of saving before you spend!
Some final points:
- Whatever your age, if you haven’t joined KiwiSaver and you haven’t yet bought your first home, there are some especially good reasons to join. Firstly, you may be eligible for the first home subsidy. You have to contribute about 4 per cent of your pay to KiwiSaver for three years to get $3,000, ranging up to five years to get $5,000 — or twice as much for a couple. You have to buy a cheap house, and your household income has to be not too high. The cutoff was $100,000 a year (for one or two people), but that is being reviewed.
Secondly, anyone on any income can use some of their KiwiSaver money to buy their first home. After three years in KiwiSaver you can take out your own contributions, your employer’s contributions plus returns earned on all the money in the account.
- Our correspondent assumed a KiwiSaver return of 6.5 per cent after fees and taxes. Despite current high interest rates, I wouldn’t expect average returns that high over the years unless you are in a risky fund — holding all or mostly shares and/or property. If you’re more conservative, your return might average more like 5 per cent.
QI heard that you can only divert KiwiSaver payments into a mortgage if it is paying off principal. Is this true? Can you divert to a mortgage that is interest only?
AInland Revenue confirms that you can divert to repay an interest-only mortgage or an interest-and-principal mortgage. And it can be at a fixed or floating interest rate.
Note, though, that it can’t be a revolving credit mortgage. That is presumably because money diverted into a revolving credit mortgage could then be readily taken out and spent. While the government is prepared to have employee KiwiSavers paying 2 per cent into the scheme and effectively another 2 per cent off their mortgage, it’s not prepared to see that second 2 per cent frittered away.
Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.