Strategic use of KiwiSaver can help first-time home buyers catch a break or else build retirement savings faster

Strategic use of KiwiSaver can help first-time home buyers catch a break or else build retirement savings faster

By Amanda Morrall

KiwiSaver proponents will tell you the scheme bodes well for just about everyone regardless of age, but when it comes to retirement planning youth is a distinct advantage. 

The earlier you start contributing to your savings, the more time you have to grow your money. It sounds a cheap sales ploy the likes of which you hear from banks trying to lure your business, but long-term mathematical modeling lend this well-worn mantra of the investment community some credence.

The graph below shows what a stark difference varying rates of return can make over long time frames. For the first 10 years, the differences are marginal and yet going forward nuances between 3%, 5%, and 8% annual rates of return transform into great divides. Although tax, investment fees and inflation haven't been taken into account here, this crude example nevertheless underscores the importance of fund selection.

A 25-year-old employee earning NZ$45,000 a year invested in a conservative fund that could reasonably expect to deliver a 3% annual return could end up with NZ$428,933 at age 65. Whereas someone invested in a more growth-oriented fund that might return 8% per year, will end up with more than three times that amount. Naturally, there are many unknown variables that could alter that equation but in general terms it shows the potency of compounding interest.

 

Most under 30s are more familiar with the crucifying financial effects of compound interest on credit cards, hire purchase and mortgages. High interest-bearing debt left to languish on a minimum repayment basis is a killer and as such constitutes one of the single biggest impediments to wealth creation for this age group.

Just as the intoxicating effects of consumerism can temporarily blind one to the true cost of borrowing, an awareness of how it can supercharge your long-term savings can be a real motivator to invest smartly.

With the majority of  18 to 24 years-old in the workforce already enrolled in KiwiSaver, under 30s appear to have taken note. And yet most of them remain parked in default funds. These are the kind of funds you end up in automatically if you do not specify a particular preference. That's not a bad thing necessarily as default funds have, ironically, produced the best returns over the three and a half years since KiwiSaver was introduced.

The reason default funds did so well, relative to more grow oriented funds, is because of their composition. Conservative funds, which is what default funds really are, are mostly made up of cash and bonds, what's known in the industry as fixed-interest. When stock markets nose-dived during the financial crisis of 2008-2009, growth funds (more heavily weighted in equities) took a beating while more conservative cash-oriented funds were mostly spared.

There are some good reasons to remain in a conservative fund given continuing economic uncertainty and yet on a long-term basis KiwiSavers with time on their side may do themselves a disservice by staying in a default fund. The rationale is that they could end up missing out on the higher long-term returns that share markets have historically been known to deliver.

Given the diversity of funds in the market (there's more than 200) and the number of competing providers (more than 30) it can be a daunting job choosing a fund. And KiwiSaver

AMP's KiwiSaver scheme manager David Wallace suggests taking it slow and keeping it simple at first to avoid confusion or getting put off the whole idea of retirement savings.

"I think a lot of people are still getting used to the concept of KiwiSaver and that's fine. It's just allowing people to make one decision at a time as they feel comfortable as opposed to making them all at once,'' said Wallace, suggesting that as account balances grew peoples' interest in KiwiSaver would naturally grow.

For those looking to grow their knowledge base, available KiwiSaver resources include the providers themselves (find out more about your provider here),  interest.co.nz's comprehensive KiwiSaver's section, Inland Revenue's website, the Retirement Commission's website (sorted.org.nz)

Can you afford to be in KiwiSaver?

There are conflicting views on whether KiwiSaver makes sense for everyone and the national savings scheme is not without its share of critics.  (See our interview with Bruce Sheppard).

Also, as an investment vehicle, KiwiSaver entails an inherent element of risk. (For more on the risk question see Diana Clement's opinion piece).

Institution of Financial Advisers President Nigel Tate said for those unable to meet their daily living needs and expenses, it was probably not a good idea. His advise was to consolidate one's debt, if that was an issue, focus on a proper budget (for help see New Zealand Federation of Family Budgeting Services)) and put in place some financial structures that would support the eventual adoption of a savings plan.

Wallace said while that might work for some people, the advantage of staying with KiwiSaver was that it would be a means of forced savings.

"A lot of people continue to put off savings while they continue to amass debt. It comes down to personal behaviours,'' he said.

For those 20-30 years olds committed to the scheme, Wallace said it was a good idea to differentiate between whether KiwiSaver was going to be a long-term savings strategy or a way to save for the purchase of a first-time home. Knowing the answer to that question would help to narrow down the choice of fund.

"For those focusing on saving for their first house, I think the decision is likely to be a more conservative type fund, either cash or conservative. For those long-term savers, it comes down to their personal view on how willing their are to accept short-term volatility.''

Under the national plan, KiwiSavers who are invested for three years are able to withdraw the accumulated savings from personal and employer contributions and use them toward the purchase of a first-time home. Additionally, first-time home buyers with a gross income of less than NZ$100,000 may potentially qualify for a Housing New Zealand Corporation KiwiSaver subsidy on a deposit for the purchase of a home.

The longer you are invested in KiwiSaver, the bigger the deposit subsidy. For example, if you met the income and asset test, after a period of five years in KiwiSaver you could get NZ$5,000 towards a deposit on your first home.

If keeping up with KiwiSaver payments, on top of a mortgage, proved to be too difficult, Wallace said it made sense to take a contribution holiday. Those who were able to keep up a NZ$20 a week payment to their account would still receive the NZ$1,042 annual tax credit from government.

"Lost savings" beckon in Oz

Under legislation that will be finalised this year, New Zealanders who have spent time working in Australia contributing to a compulsory savings plan there, will be able to repatriate their savings and roll them into a KiwiSaver account here. Similarly, Australians who have spent time working in New Zealand will be able to migrate work-related superannuations schemes.

Regardless of whether you decide to put banked Australian savings into KiwiSaver, it could pay just to find out how much you have sitting there. There's close to NZ$16 billion in abandoned retirement savings funds waiting to be reclaimed. It's referred to as the "lost savings.''

Although consolidating one's retirement savings in New Zealand could simplify the management of your investments, some say there is no tax advantage to bringing them home. For more see ("Is it worth bringing funds over the ditch). When you turn 60, you can start to draw down on those funds on an as needs basis and they remain tax free. Prior to that point, they are taxed at a flat rate of 15% as opposed to the income dependent staggered PIR (Prescribed Investment Rate)  we have in New Zealand. (For more on PIRs, click here.)

For someone new to the investment sphere, it is a lot to digest. Starting with the basics and working up toward more sophisticated issues is a strategy that will serve you well, says Institute of Financial Advisers President Nigel Tate. (For an overview of some of the basics, see KiwiSaver 101 introduction.

 

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

26 Comments

Good info. As someone who fits into this category, this is what I've been explaining to my friends for the past 3 years. I've stayed in a conservative fund as Kiwisaver isn't a retirement scheme for me, just a first-home deposit (and subsidy) scheme. After buying my first home, I plan to take a (permanent?) repayments holiday exactly as suggested.

Hope you've got an alternative retirement scheme then!  Old age is not as far away as it seems to you now, and even if NZSuper is still available when you get there, it's very unlikely to be generous

I certainly do have another plan. Whether or not I stay on a 'holiday' depends on what changes are made to Kiwisaver over the years..

Beware Sqaure of the hooks in kiwisaver. The first home scheme has many including the type of area and value of home you may purchase. These may not be where you want to live. You also can only take out as deposit a portion of the funds and these rules will change.

Re taking a holiday these ‘IRD guidelines’ will also change at the whim of the IRD. Be very aware. Once you are in kiwisaver there is no way out and over your earning lifetime especially as your earnings improve and the kiwisaver returns and fees get even worse, you will regret it.

Better to self manage your savings and ignore the $1000 kickstart bribe and $1043pa that will be worth didly squat in 40 years.

I am aware of the possible pitfalls, except for the "You also can only take out as deposit a portion of the funds" part. Where is that information coming from?

More attractive than the $1043pa from the Government is the 2% from my employer. If I wasn't in Kiwisaver, I'd earn 2% less, simple as that.

I think you can use all of your and your employers contribution to any first home.  It is only if you want the extra $5000 subsidy that conditions apply to how much you earn and how much you spend. Correct?

You MAY be able to withdraw Your and the Employer contributions only. http://www.kiwisaver.govt.nz/already/get-money/early/first-home/

The up to $5000 subsidy has significant hooks to make it a long shot.

http://www.kiwisaver.govt.nz/new/benefits/home-sub/ks-first-sub.html

Be very aware of these hooks and future changes of policy by IRD or leglislation by Govt.

When negotiating a job request a Total Package. Should you belong to kiwisaver the employer will deduct 2% from the wage/salary component of this. Else they won’t.

Also beware that you have little control of kiwisaver fees and that these fees will continue even during a contributions holiday eroding your savings. Be very careful before accepting the $1000 bribe.

I see your point, and those are the reasons I held off joining. However eventually kiwisaver will become compulsory, once a certain percentag eof people have joined. They you will probably lose some of those incentives like the free $1000 kickstart.

 

Really kiwisaver benefits babyboomers who are due to retire soon the most, over anyone else, as their kickstarts and contributions will not be erroded by inflation, and they can get out of it.

I think the gov contributions and kickstarts need to rise with inflation. As soon as they raise GST, it erodes the value of those contributuons.

Interesting to see on that graph how much extra money you end up with at 8% investment return compared to what you end up with at 3%. This is where I think Kiwisaver can be bad for those who are in their 20's - after 45 years you would probably end up better off with that money 'invested' in paying down the mortgage (effectively a tax free 7% compounding return) compared to getting a 100% non-compounding return from your employer (assuming they don't dock your real salary to compensate), a 50% non-compounding return from the government (depending on how much you earn), and lets say a 3% compounding return from your provider after fees and tax (if you're lucky). From memory I worked it out and after 35 years 7% compounding worked out better than 150% non-compounding + 3% compounding. And of course you get to spend it how you want when you want.

Jimbo, wouldnt the employer and your returns compound over time also?

KS beats a mortgage as  (so long as the employer doesnt drop your pay) a $50k wage earner gets 200%+ return if they put in 2%

You may not agree with it in principle or like the fact that it is paid by the tax payer, but currently this is exactly what a $50k earner putting 2% away gets, 200%+ on that money.

a bit better than a 4% gross bank deposit.

Yes all of the returns compound at the rate that the provider makes (my guess about 3% after fees, I am sure the provider would have you believe otherwise). But the difference between compounding at 3% compared to 7% is massive over 35 years.

After about 30 years in Kiwisaver, the investment returns during each year far outweigh the employer and government bribes - so if you are getting 7% investment return after tax, you are making much more in those last few years than at say 3%. And that is assuming that the employer and government bribes still exist by then!

This article is misleading bordering on delusional. There is no way you can find a fund returning 8% after inflation, tax, and fees for 40 years! Try 2%, even then that's assuming a stable economy and stable world situation. 2% is the figure that the government website, sorted.org, uses. The effect of compounding interest is then not quite so exciting.

Saving 5% of $45,000 for 40 years at 2% after tax, fees, and inflation leaves you with a lump sum of $138K. Your 2% interest will now give you $2760 a year to live off. Or, you could eat into your capital. sorted.org assumes that you plan to erode your capital to zero in 18 years (the present life expectancy at 65) with no allowance for "unforeseen events" like living more than the average lifespan or experiencing ill health.

Sorry if you are disillusioned by the story Robert:).  I did point out that we did not factor in fees, tax and inflation and it was a crude example. The aim was to point out that over a longer time frame,  the type of fund you are invested in can make a big difference to your accumulated savings. Fidelity Life's Options Kiwi Fund for example has delivered annual average returns of 11.59%  (that's before tax and after management fees) over three years. The average default fund delivered just over 4% per annum in the same time. It's doubtful whether Fidelity can keep it up but it does go to show 8% isn't not entirely delusional. I'll put the question to their CEO when he's here tomorrow. Stay tuned....

Cheers,

 

"Strategic use of KiwiSaver can help first-time home buyers catch a break or else build retirement savings faster".

And nowhere in the article is "risk" even mentioned.

Why is there no balance?

You might want to read the link in the story to my interview with  Bruce Sheppard. I think it will provide the kind of balance you suggest is lacking. Diana Clement offers a reasonable opinion on the risk question.  I've put up a link to her column just now. Thanks for pointing out that all investment related stories should be stamped with invest-at-your-own-risk warning each and every time.

Cheers,

Thank you.

As well as your invest-at-your-own-risk warning, I think all investment related stories should also each and every time remind your audience that return and risk are usually a tradeoff.

One person I don't EVER want to see in future interviews here about  'KS'  Amanda is Mary Holm.

NEVER!

Kiwisafer - is like saving money for an "Ice- skating tour on Lake Taupo.

Instead of a KS 'focus' on "buying your first home", wouldn't it be MORE prudent to have a KS incentive account focused on "starting your first business" ? 

Why continue to prop up a fully corrupted property market for thuck sake using taxpayer funds?

Where's the magic word of  "productivity" in KS?

Mmm.... let me get this straight.

So you make more money if you invest in a scheme with a higher rate of return?? Man, I wish I did economics at high school, because that just blows my mind.

As implied in the story - the problem is what provider can guarantee 8% return?. Is South Canterbury Finance going to be launching a KS scheme?? As we all should know - higher rate = higher risk - over a long period the risks equate to losses, and the rates average out.

I'm at the wrong end of the 20-30 age bracket. I intend to be earning over $100,000 when/if I buy my first home. So basically that money would be locked away until I am decrepit and old. My parents aren't even at retirement age yet - think how old your parents are!

If someone offered me the choice of $100,000 tomorrow, or $1,000,000 when I turn 65 - there's no question. There's no point saving to get my descendents a good inheritance!

Hi Amanda, I would agree that 8% may be possible over 3 years, but please tell me how to get that over 40 years! The investment advisor's mantra "go for higher risk investments over the longer term" has seen many Americans' and others' retirement portfolios shredded and is not a useful guide to retirement saving.

On this date 40 years ago the Dow Jones stood at 878, today it is 12,268. Inflation has turned US$1 into US$5.60 today. An inflation-adjusted return of 2.3% per annum over 40 years. Dividends (not included in the Dow) will have added a percent or two in the early years, but since the 1990s most large US companies have stopped paying dividends.

In New Zealand, the NZSE 40 stood at 405 in July 1973 (couldn't find any other data except its launch at 100 in 1957 and 3968 in 1987), and the present NZX50 is at 3390. (The two indices matched at switchover.) An increase of 8.4x. Except inflation was 11.2x in the same interval. A return of -0.8%/year over 38 years. Since 2003 the index has included dividends but these would be eroded by tax. (ie the index assumes that pre-tax dividends are reinvested, but it would be illegal to not pay tax on your dividends).

 

 

Couldnt agree more Robert. Which is why the mantra trotted out by Mary Holm annoys me so much. Simply handing money over to a fund manager over a 40 year period like this is a recipe for dire returns. This mantra about drip feeding into the market is demonstrable nonsense.

I might add that in my view next 40 years of equity investing will include far, far more hair raising episodes than the last 40 (to put it mildly).

 

Wel said R and A. Especially A's comment about the future; extrapolating from recent history is a dangerous exercise.

The big problem in our family is that the 20somethings just refuse to save unless forced to. And I don't altogether blame them.

The NZX and NZ corporate governance need a major overhaul. Partial sale of SOEs will help, but until we clear all the old school fat cats off boards, and tighten up the regulatory environment, the sensible Kiwi will stay away from the whole thing. 1987 was an expensive lesson for most families.

I still have some shares but it is not really worth the time and effort, just provides another topic at the pub.

Thanks Robert. You've raised some good points that add to the debate and challenge industry norms. I was interested to hear that 80% of senior managers at Fidelity Life have their money parked in that fund I mentioned above that has delivered 11.59% returns over three years. But I expect they are much closer to retirement than those who have 40 uncertain years to go before giving up working life. "The times they are a changing" -- probably faster than anyone can properly prepare for financially and otherwise. Cheers

The wife and I have nearly $35K saved up since start of Kiwisaver

It was good in the early days with the 8% (4% + 4%)

We are in a growth fund and the last 6 month report said I got a 8% return which aint too bad

I think it is a good idea for 20-30 yr olds to get into kiwisaver if you can afford it, otherwise just pay off the mortgage 1st

Regards