Should you Withdraw the Maximum Amount from your KiwiSaver for your First Home?

by Alpha

We have a sky-high house price in New Zealand at the moment, especially if you are looking to buy in major cities such as Auckland, Wellington, and Christchurch. To get your first home, you will need all the help you can get. Here comes the KiwiSaver.

KiwiSaver First-home Withdrawal

A KiwiSaver member can withdraw most of their fund from KiwiSaver to pay for your first home. Here is the condition

You must have been a KiwiSaver member for three or more years.
You can ONLY withdraw money to purchase your first home – not an investment property.
A couple can both use their KiwiSaver withdrawal on the same property as long as it is their first home.
KiwiSaver members can withdraw most of their fund out but must leave a minimum balance of $1000 in your account.

Joe and Jill buying their First Home

Joe and Jill are a young married couple. They want to get into their first home. They’ve $65,000 cash saved up for their first home. They want to buy a $435k house in Wellington.

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The $435k Dream House for Joe and Jill

To buy that house, they will need to come up with a 20% deposit. For a $435k house, they will need $435,000 x 20% = $87,000. The cash they have are not enough for a 20% deposit, but luckily, they are both in KiwiSaver. Here is their KiwiSaver balance.

Joe joined KiwiSaver 2 years ago with the balance of $7,000.
Jill joined KiwiSaver 10 years ago with the balance of $48,000.

Since Joe only in KiwiSaver for 2 years, he cannot withdraw his KiwiSaver balance. However, they will have enough with just Jill’s KiwiSaver.

Jill withdraw $47,000 from her KiwiSaver and left $1,000 balance in her fund. They use that money and combine with their cash, they managed to buy their first home with a mortgage.

Don’t put everything in KiwiSaver

Will and Grace also want to buy a house for $400,000. They are both in KiwiSaver for 4 years, and they were contributing 8% to KiwiSaver. They had $85,000 total in KiwiSaver and kept $10,000 in their bank. If they want to get into a $400K house with a 20% deposit, they will need $80,000. They can withdraw up to $83,000 from their KiwiSaver account.

They managed to get a $400K house from an auction (Yay!) and the real estate agent ask them for a 10% deposit on that day. Will thinks ‘No problems, I’ve got that money in my KiwiSaver.’ However, the fund in KiwiSaver can ONLY use for settlement and cannot withdraw before that. The winner of the auction is required to pay a deposit on the same day, usually at 10% of the price. So now Will and Grace need to come up with a $40,000 cheque in a short time.

Withdraw Maximum or Just Enough

I’ve got a couple readers asked about KiwiSaver First Home withdraw. One of the questions is,

Should you withdraw just enough for home deposit or withdraw maximum from your KiwiSaver?

There are good reasons for both sides of the argument. If you withdraw just enough on the KiwiSaver, more money will stay in KiwiSaver, and it will provide a better return in the future. For a 10-20 years terms, the money sitting in KiwiSaver should be averaging 6-7% return after tax and fees. Compare that to the interest of your mortgage at 4-6%, it seems better to leave the money in KiwiSaver and invest it.

On the other hand, if you withdraw all the maximum amount from KiwiSaver, you can put whatever you have as your downpayment and reduce the size of your mortgage. You can also keep same mortgage amount and have more cash on hand for emergency or home improvement.

Back let’s go back to our example of Joe and Jill and see how those two options work out. Here are the basic info and some assumption for our analysis.

House Price: $435,000
20% Deposit: $87,000
Cash on Hand: $65,000
Emergency Fund Ideal Level: $10,000
Jill’s KiwiSaver Fund Balance: $48,000
Jill’s KiwiSaver Monthly Contribution (include employer and MTC): $277.17
KiwiSaver Fund Long Term return (after tax and fees): 7%/year
Home Loan Interest rate average: 5.5%/year

Options 1 – Withdraw just enough

They will keep $10,000 cash on hand as an emergency fund and put $55K toward the deposit. They also withdraw $32,000 from Jill’s KiwiSaver fund to make up the 20% deposit. Here is their financial breakdown

Mortgage: $348,000 (30 years term)
Minimum Mortgage payment: $1,975.91/month
Cash on hand: $10,000
Jill’s KiwiSaver Fund Balance: $16,000

Options 2 – Withdraw maximum

They will keep $10,000 cash on hand as an emergency fund. They put their remaining cash ($55k) plus withdraw the maximum amount ($47k) from KiwiSaver toward to their downpayment ($102k). The mortgage amount will reduce to $333k, but they will pay it off as a $348k mortgage.

Mortgage: $333,000 (30 years term)
Minimum Mortgage payment: $1,890.74/month
Actual Mortgage payment: $1,975.91/month
Cash on hand: $10,000
Jill’s KiwiSaver Fund Balance: $1,000

30 Years down the road

In option 1, Joe and Jill will pay off their mortgage in 30 years while Jill’s KiwiSaver growth from $16,000. Here is the breakdown:

At the end of the 30 years, they will fully own their house, and Jill’s KiwiSaver’s balance is $468k.

In option 2, Joe and Jill will pay extra on their mortgage every month, and they will pay it off in 27 years. Once the mortgage is gone, they pay extra into the KiwiSaver.

At the end of 30 years, they fully own their house, and Jill’s KiwiSaver’s balance is $425k.

Not a clear cut answer

Based on the numbers, option 1 will have a better financial position compared to option 2. We already know that from the beginning because we set the after-tax return on KiwiSaver at 7% and mortgage interest at 5%. KiwiSaver and investing will always come out on top when you compare the number this way.

However, after I understand about risk and being a first home owner for couple years, I will prefer to reduce the mortgage (option 2).

First, there is always risk associated with investment because you’ll never know whats gonna happen. The long-term average return will be 7%, but that is based on past performance. We should keep in mind that past performance is no guarantee of future results. For all that we know, our investment maybe heading 10 years of negative returns. Also, the mortgage interest rate is not guaranteed as well. Past data shows the interest rate is at the historic low so there is real possibility it will go up. On the other hand, the return from paying off your mortgage is guaranteed and tax-free.

There is the risk in investment. Also there is the risk in life. Being a first-time homeowner with a mortgage, it will put you in a position that you’ve never been (for most people anyway) – you are DEEPLY in debt.

Before you purchase your first home, you may be someone with not much asset and a little or no debt. Once you’ve bought the house with the mortgage, you are now partly own a big asset (the lender still own the most), had a mortgage 5-15 times of your annual income, don’t have a lot of cash on hand and a big part for your income went to mortgage repayment. Financially you are in a vulnerable situation. If something happens with your life like job loss, sickness, accident or something you’ll need to fix on the house, you may be short of cash. You should avoid being in this situation by having a smaller mortgage (pay more on deposit) or have more cash on hand.

Some personal experience here. Wife and I found out we are having our first baby just 1 week after we won a house in an auction. All of our budget plans are out of the windows. We were down to one income for couple month as a new house owner. Luckily, we did one thing right on our mortgage was putting over 20% down payment on our house while the bank was advertising 5% deposit. With a bigger down payment, come with a small mortgage and a smaller minimum payment. We were managed to get through that period with careful planning and frugal living. I can’t imagine what sort of pressure we will be in if we just put down 5% deposit and borrow 95% on the house.

Based on those reasons, I personally prefer getting the maximum amount out of KiwiSaver and put it toward mortgage or keep it on hands for at least 1 year.

It’s better to withdraw Maximum

Your situation and risk appetite may be different than mine, and you may prefer to keep the money in KiwiSaver for your retirement. However, I will still recommend you withdraw the maximum amount no matter what choice you’ve made.

The reason is you can only withdraw from KiwiSaver once, but you can always put your money back in later. By having more cash when you move into a new house, it will help you to deal with any unexpected situations.

Let’s go back to our example of Jill. Jill’s KiwiSaver balance is $48K, and the maximum amount she can withdraw is $47K. She may decide to put down 20% deposit, just withdraw $32K and keep $16K in KiwiSaver for retirement (option 1).

I would suggest she still withdraw $47K out and put $40k from their cash for their 20% deposit. Now they will have $25K cash on hand and $1,000 in Jill’s KiwiSaver. She will hold on to that cash for 6-12 months to make sure their house is in order, and there is no major repair required. If everything’s fine and Jill still prefers to invest with KiwiSaver, she can put it back into her KiwiSaver after 12 months as KiwiSaver allows members to make manual contribution anytime.

How can You decide

There is a simple way to help you decide to keep the money in KiwiSaver for retirement or help reduce your mortgage.

Imagine you fully own your house today with no mortgage at all. Will you borrow $X on your house to invest in KiwiSaver for your retirement and won’t get it out until you are 67? (X is the difference between withdrawing everything and just enough. In Jill’s case, that will be $15,000.)

What I did was reserve the situation and let you look at the question from the other side. Mathematically, invest your available cash in KiwiSaver and not paying off your mortgage is the same as borrowing on your house to invest in KiwiSaver. Once I frame the question this way, you will feel the security of owning your house and the risk of investing.

Other Support from KiwiSaver

Apart from First Home Withdrawal, KiwiSaver member may be qualified for KiwiSaver HomeStart grant. Check out the information on Housing New Zealand site or contact your KiwiSaver provider.

I will continue to write more about mortgage in the coming days. There is a mortgage set up that allows the homeowner to reduce their mortgage amount while having access to cash if they need to. So stay tuned for my blog post on the Best Mortgage structure for most homeowners in New Zealand.

October 26, 2017 Investing, KiwiSaver Bonus Bond, Children, Kids 4 Comments

The Best Way to Invest for Your Children in New Zealand – Other Options

by Alpha

This is the part 3 of my investing for kids series. We’ve talked about what you need to prepare and what is my fund recommendation. Now in part 3, we will look at some other investment options for kids.

Term Deposit with Bank

One of the most popular investment options of kids is savings and term deposit in Bank. It is simple, easy to understand, easy to set up and very safe investment. However, since most of the kid’s investment a for the long term, I think bank deposit is just too safe for that time frame. I believe kids can take up more risk than a term deposit. The average return on term deposit was around 4-5% and now is around 3-4%. The long-term return of stock market is about 6-7%.

Here is an analysis comparing the return on term deposit and stock investment for 14 years (March 2003 to Aug 2017). I used historical retail term deposit return from RBNZ and compare to NZX50 index return. I ignored dividend in NZX50 for the ease of calculation. In reality, NZX return will be higher if we included dividend reinvest. Monthly contribution is $50. Tax rate at 10.5%.

As you can see, the after-tax return on stock and much better than term deposit in a long run. The share took a dip during GFC in 08-09, and the performance is actually lower than the term deposit. However, it quickly recovers and suppresses bank deposit. In the end, stock overperformed by 57%.

Investment Fund with Bank

Here is a quote from a reader.

“Thanks for the recommendation on your blog. However, I’m concerned the safety of those investment companies. How do I know if they will take my money a run away? Is there any investment with a reliable provider, like a bank?”

Well, a lot of people concerned about those investment service providers is running a Ponzi scam. I’ve done some research on that area, and I am personally are satisfy with the result before I recommend them. We will look into how safe is your investment in another blog post.

Most of the retail bank in New Zealand offers investment product for kids. However, the fees they are charging are much higher compared to my recommendations. Most of the management fee is average at around 1%-2%. They also have a higher initial investment requirement, higher lump sum investment amount. They will charge a to put money into their investment and charge another fee when you want to take your money out. Some of them have performance fee as well. All of those are just too high for my preference.

However, if I have to pick one, I will recommend ASB investment fund. ASB Investment funds management fee is at the low end amongst retail banks. They mostly invested in low-cost passive index fund from BlackRock, and that’s why they can offer a lower fee. Please make sure you understand their fees structure before you join.

Invest in Adult’s Name

Invest in Adults name is a simple and easy solution. The good thing is you will not be limited by the age restriction from many investment services, and you are free to invest in anything. However, as I pointed out early, the investment return will be taxed at your own PIR rate, so that is not tax efficient.

Here is an example of the same investment with the different tax rate.

SmartShares

When you sign up for SmartShares contribution plan, there is an option for you to sign your kids up for some SmartShares. However, SmartShares is a listed-PIE fund, and all investors got taxed at 28% regardless your PIR rate. So SmartShares will be tax ineffective for your kids.

However, if you already using an accountant, you can get them to claim those tax back.

Ruth from thehappysaver.com wrote two excellent blog posts on putting her kid on SmartShares. Check it out.

SmartShare for Kids part 1 and part 2

Buy Share on Share market

Another common way to invest for children. The Mum/Dad buy shares in some company under their kid’s name. It is great especially if you are already familiar with stock trading. You can also buy SmartShares ETF directly on the stock market which makes it a great options.

However, there is a cost everything you buy or sell on the stock market, so that is not good for regular or small amount investing. Also, you are supposed to pay tax on your dividend received. So there is some added work to do.

KiwiSaver

KiwiSaver used to be top investment choice for your children as they used to be $1000 kick-start and member tax credit for kids. However, our government had taken those benefit away, and the only benefit for kids join KiwiSaver is they will have lots of choices to participate with no limitation. For example, if you want your kids to join the investment fund from Simplicity but they won’t accept under 18 years old, you can get your kids to join their KiwiSaver.

However, the significant disadvantage of KiwiSaver for kids is the limitation on how and when they can use that money. Currently, They can only get the money out to buy their first home, or they turn 65. So it limited how your kids can use that money. They can’t use that for study, can’t use that for OE or start their own business.

If you already started KiwiSaver for your kids, you should keep your money there and let it grow. You don’t have to put more money in until they turn 18 years old.

If you haven’t started, invest your money outside KiwiSaver. Only get them to join once they turn 18.

Bonus Bond

Another favorite gift for kids. Bonus Bonds were first introduced by the Government in 1970 as a way of encouraging New Zealanders to save more. However, people need to understand this.

Bonus Bond is NOT an investment. Bonus bond is merely a placeholder for a lottery.

Bonus Bond pays no interest or dividend. It is highly unlikely your kids will get that million dollar price from them. So if you have the money, you will be better off to keep it in the bank where you can earn interest.

If your kids got them as a gift, you should accept it and understand your kids have a placeholder for a lottery. If your kids have over $100 in bonus bond, you should cash out down to $100 and try your luck.

Conclusion

A term deposit is a safe investment, but the return is too low.
Investment product with big banks are subjective safer for some people but comes with a higher cost and more limitation.
Invest in Adult’s Name is simple and straightforward. Also, it will have a lot more options available. However, you will pay more tax then you suppose to.
Buy shares on share market is not ideal for regular or small sum investing due to the cost of trade on each transaction.
KiwiSaver will have more investment options for kids. However, it limits how they can use that money.
Bouns Bond is NOT an investment. It’s merely a placeholder for a lottery. Don’t put more than $100 in there.

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September 29, 2017 Investing, KiwiSaver Annuity, Lifetime Income, Retirement, Simplicity 1 Comment

Simplicity Guaranteed Income fund, What’s that and How it Works?

by Alpha

Simplicity, the non-profit and low-cost KiwiSaver provider introduced a new fund last week called “Guaranteed income fund.” Guaranteed income investment products had been around for years in other overseas markets, but it’s very new to New Zealand. So in this blog post we will look at what is guaranteed income fund, how does it work, the pros, the cons and do you need it.

What are Guaranteed income fund and annuity

The guaranteed income fund is basically an annuity. They provide a stable and secure source of retirement income. You will need to surrender a sum of money in exchange for a stream of income that’s guaranteed for life. The annuity has been around for a very long time in the overseas market. Usually, annuity service is offered by an insurance company because there is a guaranteed element in this product. New Zealand just had our first annuity service from LifeTime Income Ltd not long ago.

How does it work?

Simplicity now partners with Lifetime Income Ltd and provide a guaranteed income fund that offers 5% guaranteed return at age 65 for the rest of your life. The minimum amount is $50,000, the annual cost is $30, fund management cost is 0.31%, and insurance cost is 1.3% of your protected income base. Protected income base is your initial investment if you start receiving cash payment immediately. If you decided to delay receiving the cash payment, your protected income base would be either your initial investment amount or the current fund value, whichever is higher. We will explain that later.

You can think of it as you borrow some money to another person. That individual will keep paying you interest at 5% for the rest of your life.

Here is an example of how it works. Assume you are now 65. You decided to put $50,000 into Simplicity Guaranteed income fund and start receiving the cash income immediately. Every year, you will receive 5% of that $50,000, which is $2,500. It will payout fortnightly at $2,500 / 26 = $96.15 for the rest of your life. The $50,000 are still with Simplicity as an investment. That money will continue increase or reduce according to how the investment market performs, tax and fee charges. The cash you receive will also come from that fund as well.

Here is a simplified calculation

Your capital + gain or loss from investment – tax – annual fee ($30) – management cost (0.31%) – Insurance cost (1.3% of initial value) – cash payout (5% of initial capital) = end balance

Apply that to our $50,000 example with 6.5% return, Taxed under FDR rule with PIR at 17.5%, here is the performance for the first year.

Initial Capital $50,000 + Investment return $3,250 – Tax $465.94 – Annual fee $30 – management cost $163.63 – insurance cost $650 – cash payout $2,500 = End year balance $49,440.43

Here is the performance for next 25 years with the same return at 6.5%

Here is the graph of your fund value over the years.

What if my fund runs out?

As you can see with 6.5% return, your fund value will keep going down, and you will run out of money some day. If your investment fund is exhausted, there will be no money to draw from. At this point, the insurance policy will take over and pay out that guaranteed amount ($2,500/year) for the rest of your life. That’s why there are a 1.3% insurance charges on the fund.

Now I will use the same example but lower the return on investment to 2.5%.

Your investment fund exhausted age 82. You can only draw $1,495 from your fund at that year. The insurance company will pick up the tap and continue to pay the guaranteed income for the rest of your life.

Here is a closer look at guaranteed income. Insurance policy kicks in at age 82 and continue.

Can I delay and get more Cash Payout?

The 5% is the minimum income guarantee. It goes by 0.1% each year that you defer taking out the guaranteed income. When you start getting the income at 65, the guaranteed rate is 5%; if you start getting it at 70, the guaranteed rate is 5.5%. It tops at age 90 with 7%. The money in the fund will increase or decrease with the investment return but there is no cash withdraw.

Here is an example when you join at 65 but only start to get income at 70 and get 5.5% guaranteed income.

What if the receiver pass away?

If the receiver passes away, whatever left in the account will be passed on to their estate. Now, let’s go back to our 2.5% return example.

If the receiver passes away at age 77, there are still $16.962 capital in the account. That amount will pass onto receiver’s beneficiary. On the other hand, if the receiver passes away at age 86, there will be no money left in the fund. So there will be no money to receiver’s beneficiary, and the insurance payment will stop.

What so good about Guaranteed income fund

Imagine you are now retired and you only living on superannuation plus your saving. Every time you spend money on the power bill, water and food, your retirement saving go down a little bit. Do you worry you may outlive your retirement savings and have to live on superannuation alone? This is a real concern for many retirees and it reduces their spending in retirement years.

Below is the typical situation for New Zealand retiree. Their retirement is partly funded by superannuation and their own savings/income to reach their ideal standard of living.

Since we don’t know how long we are going to live, some retirees worry they may outlive theirs. So they reduce their spending and stand and hope the saving will least long enough. The living standard reduced as a result.

Since guaranteed income fund and annuity provide a steady stream of income for life, it is a powerful tool for retirees. You can surrender part of your retirement saving and exchange for a guaranteed income for life. Add that on to superannuation from the government, you will have a bigger part of fixed income every fortnight. So it will help to bridge the gap between your living expenses and superannuation. Also, It will reduce the concern if you will out the saving. The most significant benefit its gives you the certainty that you can always fall back to Superannuation + guaranteed income level.

What are the Limitation & Risk

There is always a catch with investment and insurance products. There are certain restrictions and risk regarding guaranteed income fund.

KiwiSaver Only – currently this fund is only open to the KiwiSaver member. If you are not eligible for KiwiSaver or you already left KiwiSaver, you can’t join the fund. Also, you’ll have to be 65 to start receiving a cash payment. Alternatively, you can get the annuity from Lifetime Income with a higher cost.

Fixed amount – It is great that you will have an income for the rest of your life. However, that amount is set for life as well. So inflation will be your biggest problem. With inflation, the same amount of money will have less buying power. In the early 2000s, the price of petrol was well below $1. I can fill my tank for $30-$40. Now, I can only fill 60% of the same tank with $40. Here is a table of the real value for $2500 after 2% inflation. 10 years in at age 75, that $2500 will worth about $2000 today, it lost about 20% of its value.

Since the cost of living and superannuation are rising along with inflation, you will have to fund more of your living expenses out of your retirement savings. Just like the graph below.

However, people tend to spend less as they age. Although the cost of living increased, the cost for an ideal living standard will decrease and it softens the effect on inflation.

Cost: This fund is very similar to Simplicity balanced fund and they have the same admin fee and management cost. However, guaranteed income fund have an insurance policy attached to it and it cost 1.3% of your initial fund amount. No matter how your fund performs, it will charge the same amount of insurance fee.

Insurer risk: Since this fund has an insurance policy, there is always the risk of insurance company collapse. The insurer is Lifetime income limited, which is not a big insurance company like AIG.

Access to fund: You will need to surrender a large sum of cash to the investment provided to start your income guaranteed fund. There are limitations on how you can withdraw your fund from the plan. First, your fund may not have enough money due to the fees and investment return. If there are fund to pull out from, you can either withdraw up to 20% of your fund and take a pay cut by the same percentage you took out. The other options are completely empty your fund. The good thing is Simplicity will not charge a fee on that.

Do I need it?

I think it’s great that there is one more option for New Zealand retirees with Guaranteed Income fund. It will reduce the concern of retirees outlive their savings and provide a fallback for them if they have to scale back their spending.

Make sure you understand Guaranteed Income fund is just one of the many options for retirees and you should not put all of your eggs in one basket. I will include them as part of the retirement plan along with term deposit, investment fund or property and superannuation.

The key point is you should not put all of your money into Guaranteed Income fund and annuity. One way to work out how much guaranteed income you’ll need is to decide how much income you wish to be guaranteed along with superannuation income.

For example, a married couple will get $1200.60 each fortnight. They also worked out their ideal living standard will cost them $2350 each fortnight including nice food, shopping, dining out, travel and avocado on toast every Sunday. On the other hand, we can cover their basic expenses (power, water, communication, petrol and basic food) for $1500 each fortnight.

If the couple wants to the guaranteed income cover their ideal living standard, the guaranteed income needs to be $2500 – $1200 = $1300 each fortnight. To get that amount of guaranteed income, the couple will have $1300 x 26 / 5% = $676k in the fund. That is not a small amount for most people.

How about we just need to cover the basic. The guaranteed income will be $1500 – $2500 = $300 each fortnight and the fund value will be $300 x 26 / 5% = $156k. This amount is not too big and seems reasonable to average retirees. It will cover the basic for the couple at their early stage of retirement. They will be happy to know if anything happens that cost all of their life-saving, they will still have enough to cover the basic living with superannuation and guaranteed income. They can even increase the fund value to hedge against inflation.

Conclusion

Simplicity offer Guaranteed Income fund for the KiwiSaver member.
The investment fund is similar to Balanced fund with $30/year admin fund, 0.31% fund management fee and 1.3% insurance cost based on the initial fund value.
Investors will receive 5% of the initial fund value as cash payment every year from 65 for the rest of their life.
The cash payment is drawn from your investment fund. If the investment fund runs out, an insurance policy will kick in and provide the cash payment.
This is a great option (in combine with superannuation) for retirees to set a safety income line.
Do not over commit. This fund should be part of your retirement plan along with superannuation, term deposit, and other investment.

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August 4, 2017 Investing, KiwiSaver Fees, Simplicity, Superlife Leave a comment

How to Check Your Investment Fund and KiwiSaver Fund’s Admin Fee

by Alpha

A reader asked me about their Superlife fund charges. She notices something funny on her transaction list: Instead of charging $1/month on admin fee, she got charged $1/day.

After checking my transaction, I believe those charges are incorrect and she contacted Superlife. Superlife immediately said the charges were wrong and reversed them straight away.

This is a good reminder for all investors to a take look at their transaction once in a while. I am all for ‘set and forget’ method to invest but we should look at those charges maybe once or twice a year. Not only to Superlife but all of your investments including your KiwiSaver.

I have account with Superlife and KiwiSaver with Simplicity, here is how to check those transactions

Superlife

Go to superlife.co.nz and click on “Log in”

Click “Transaction history” on the left

Select ‘last 12 months’ on period, select ‘All’ on Funds, select ‘Administration Fees’ on Transaction types.

They should charge $1/month. (The $2.75 charges was before the admin fee price drop)

Simplicity KiwiSaver

Go to Simplicity.kiwi and Log in.

Click ‘My transaction’ on the menu.

There will be a list of transactions and Simplicity should charge $2.5/month on member fee.

If you are with a different fund or service and don’t know how to check transactions, call the service provider and ask them.

If there is anything out of the ordinary, you should contact the fund manager and get them to correct that as soon as possible.

July 6, 2017 Debt, Investing, KiwiSaver, Mortgage, Personal Finance Basic New Zealand, Personal Ffinance 6 Comments

Top 3 Investment Options in New Zealand

by Alpha

I spent a lot of time on my blog talking about ETF and index fund investing in New Zealand. I believe they are great options and an import investment vehicle to help me achieve financial freedom.

However, there are three investment options are objectively better than ETF and Index fund with low entry requirement, low risk and high (sometimes guarantee) return. They are the low hanging fruit of personal finance that everyone should do it. Those three investments options are pay off consumer debt, join KiwiSaver and reduce the mortgage. I will go through each one of them and talk about they risk and return.

No.1 Pay off Consumer Debt

You want to kill those consumer bills ASAP!

Credit card debt, car loan, payday loan, personal loan, hire purchase, P2P loan… All of those are consumer debt. Debts that are owed as a result of purchasing goods or services that are consumable and do not appreciate in value. Those debts usually have high-interest rate and exorbitant admin fee. If you are paying interest on depreciating assets, they are dragging back you financially. You won’t go forward if most of your income goes to those stupid bills. You need to get rid of them ASAP!

Paying off debt is Investing

This concept may not be obvious to everyone but PAYING OFF DEBT IS INVESTING. For me, debt and investing are just two sides of the same coin. One side (investing) is to increase your wealth (with a given level of risk). Like you buy NZ Top 50 ETF from SmartShares, if the share price increase and they pay out a dividend, your wealth increased. On the other hand, the shares price may drop, and your wealth will decrease. So there is a risk of losing money with investing.

The other side of the coin (debt) will reduce your wealth. If you have $1000 credit card debt with 20% interest, your interest expense for the first month will $16.67. So your wealth reduced by -$16.67. Unlike investing, the debt will guarantee to reduce your wealth and drag you back financially. Therefore, reduce your debt will move you forward financially, guaranteed.

Whats the return and risk?

I will use a simplified sample to present the financial effect of paying off debt.

Assume you have $1000 in cash and $1000 credit card debt with 20% interest. If you keep the $1000 in cash and don’t pay it off credit card debt, in one year, you will be $1000 x (1 + 20%) = $1200 in debt. Financially you moved backwards by $200.

Now, you invest the $1000 cash in a 12 months term deposit with 3.25%. You still keep your $1000 credit card debt and not paying that off. In one year, your earn $1000 x 3.25% = $32.5 in interest from your term deposit. Take away $9.75 as tax; you will have $1022.75 in cash. On the other hand, your credit card debt still cost you $200 in interest. So financially, you moved backwards by $177.25.

Instead of invest that $1000 into a term deposit, you use that $1000 to pay off your credit card debt. Since the credit card debt is gone, it won’t occur interest. In one year, you will be in the same financial position.

Look at all three scenarios, pay off credit card debt resulted in the best financial position. As you putting that $1000 cash to pay off your credit card debt, you are in fact getting 20% return on those $1000. Unlike other investment, those returns are Tax-free and guaranteed. If you need to get 20% after-tax return on investment, the pre-tax return will need to be 27.77%. That is an excellent return on investment. I am not saying you can’t get 27.77% return out there, but I am sure there is no investment (except KiwiSaver) can guarantee a 27.77% with no risk.

If we look that those high-interest-rate consumer debts, paying them off will be a great return for your money. Also, paying off consumer debt will reduce your financial risk and stress. You will be in a much better position when you negotiated mortgage term and resulted in better deals. That why paying off consumer debt is one of the top three investment options.

What about Student Loan?

The student loan in New Zealand is interest-free as long as you are staying in the country. The payment only occurs when you have income. So you should just pay it off as you’ve got income. I would not be paying them off early unless you plan to leave the country for a long time.

No. 2 – Join KiwiSaver

KiwiSaver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement. It’s designed to be hassle-free, so it’s easy to maintain a regular savings pattern. Once you join KiwiSaver, at least 3% of your income will invest into a KiwiSaver fund. You can only access those fund until you use it to buy your first home or turn 65. What makes KiwiSaver to be a top investment option is because of employer contribution and member tax credit.

Employer match

If you’re over 18 and is a member of KiwiSaver, when you make your KiwiSaver contribution, your employer also has to put money in. By law, the employer required to contribute at least 3% of your income. The employee can choose to contribute either 3%, 4% or 8% but employer only requires to match at 3%. Some employer may decide to match 4% or 8%.

It may seem you will be making 100% return on investment on your 3% contribution. However, IRD will take out tax from you employer contribution, so the actual return on your contribution is about 67%-89.5%. (You can find out why here) It’s still an unbeatable risk-free guaranteed return.

Member Tax Credit

KiwiSaver Member Tax Credit is to help you save on your KiwiSaver. The government will make an annual contribution to your KiwiSaver fund (a.k.a Free money). The amount is $0.5 on every dollar up to $521.43. You will have to be 18 or above to receive the tax credit. This is a way of government help you save for your retirement and encourage you to join the plan. It cap at $521.43 so it will benefit for the most full-time employee but not favour mid to high-income earner.

Return on Employee

If you are over 18, fully employed, annual income at $55,000 before and contribute at 3%. Your minimum return on your contribution will be like this.

Your annual contribution (3%): $1650

Employer contribution after tax: $1361.25

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1650 + 1361.25 + 521.43 – 1650) / 1650 = 114%

Return on Self-Employed

If you are self-employed, you won’t get the employer match, but you are still entitled to member tax credit as long as you make a minimum manual contribution for $1042.86

Your manual contribution: $1042.86

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1042.86+ 521.43 – 1042.86)/ 1042.86 = 50%

Those are only your base return; you are likely to make investment return on your KiwiSaver Fund as well. Here is a couples data on a KiwiSaver fund with different income level. The KiwiSaver fund cost and return data are based on SuperLife 80.

No. 3 – Reduce your Mortgage

Mortgage payment can easily be the biggest expenses on most homeowners’ budget. Average first home buyer will spend $1500/month on the mortgage, and it will cost more if you have a mortgage in a major city. Imagine what you can do with that money if you don’t have a mortgage payment.

Return on Reducing Mortgage

Paying off have the same effect on paying off consumer debt. It will give you a tax-free and guaranteed return. The return is not as high as those consumer debts because the interest rate on the mortgage is lower at 4% – 6%. The equivalent pre-tax return is around 8.3%.

Reduce your Mortgage or Invest elsewhere

Some people may think 7-8% is not a very good return, and you can achieve that with other investment options without taking a lot of risks, like the share market. However, I still think paying off the mortgage on your own home is a better option because you are paying off an asset that will provide you with a place to live, offset the cost of renting in the future and the house will increase in value (in the long term for most cases).

If you can’t decide to reduce mortgage or invest elsewhere, ask yourself a simple question:

If you fully owned your house today, will you borrow $500k on your mortgage-free house to invest in share market? Or you will use your income to invest in the stock market every month?

If you say you won’t borrow on your mortgage-free home (like me), then you should focus on reducing that mortgage now. I basically asked the same questions but put it in a different perspective. If you have the money to reduce the mortgage, but you put it into the share market, you are basically borrowing on your house to share market.

Saving Big on interest expense

Since the mortgage size is usually over $200K (over $500k in Auckland) and the payment terms are 20-30 years. You end up paying A LOT on interest expenses. Check out the chart below.

For a 30 years term mortgage at 5% interest rate, you will end up paying 93% extra for interest payment. So what will happen if we increase our payment and shorten the mortgage by ten years?

When we shorten the mortgage term by ten years (-33%), our monthly payment increased by 23%, total interest paid decreased by 37.3%! Only 36.9% of your payment went to interest.

Reducing mortgage may not give you a high percentage return, but due to the size of the mortgage, the saving you are likely to make is in the hundreds of thousands. I will have a series of blog posts in the coming month to show you how to be smart on your mortgage with different setup and tips.

Conclusion

The top 3 investment options in New Zealand are paying off consumer debt, join KiwiSaver and reducing your mortgage.
Paying off consumer debt is investing. The returns are in the range of 15% – 35%. You will be in a better financial position once you pay off your debt.
A KiwiSaver member can enjoy instant return from minimum 50% – 110% due to member tax credit and employer match. However, that money is locked-in until you purchase your first home or turn 65.
Paying off return about 7% – 8% on your dollar, not as high compared to other. However, due to the size of the mortgage and interest paid, you are likely to be saving hundreds of thousand of the dollar

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

June 2, 2017 KiwiSaver KiwiSaver, New Zealand, Personal Ffinance, Tax 4 Comments

Why your KiwiSaver Employer Contribution are Less than Yours while Both Paying 3%

by Alpha

By New Zealand law, the employer required to contribute to their employee’s KiwiSaver account or complying fund at 3% of their gross salary or wage if the employee joined Kiwisaver. However, when you look into your KiwiSaver contribution transaction record as an employee, you may notice the employer contribution amount are less than your employee contribution.

Here is an example, assume your weekly income before tax is $1200, $62400/year.

Without KiwiSaver, your take home pay will be $1200 – 225.77 (PAYE) – 16.68 (ACC) = $957.55.

If you join KiwiSaver and contribute 3%, your take home pay will be $1200 – 225.77 (PAYE) – 16.68 (ACC) – 36 (KiwiSaver) = 921.55 On your KiwiSaver statement, your contribution will be $36. However, your employer contribution will be $25.2, not $36. Why?

The reason is the employer contribution are taxed under Employer superannuation contribution tax (ESCT). Your employer payout extra 3% of your income to KiwiSaver but part of that went to IRD as tax.

You may think why both employer and employee are paying 3%, how come the cash hit my KiwiSaver fund is different? (That was me two days ago)

Let’s break it down in detail. The 3% contribution is calculated based on your income before tax. In our example, the weekly 3% KiwiSaver contribution will be $1200 x 3% = $36. So both employee and employer will pay $36 each into the KiwiSaver Fund.

Here is the tricky part, on employee contribution, it was calculate based on pre-tax income and take out on after-tax income. So the $36 will take out after they deduct PAYE and ACC and that $36 will reach your KiwiSaver fund without IRD take out any more tax.

On the other hand, employer contribution will be taxed under ESCT. So 30% of $36 = $10.80 will go to IRD, and the cash hit your KiwiSaver fund will be 36 – 10.8 = $25.2

Therefore, I was wrong by saying you will have 100% return on your employer contribution. It’s more like 67%-89.5% return. It’s still an unbeatable risk-free guaranteed return and one of the best investment in New Zealand.

Check out IRD website on ESCT for more information.

P.S. Thanks to gligorkot for pointing that out on a previous blog post.

May 17, 2017 FIRE - Financial Independence Retire Early, KiwiSaver, Personal Finance Advanced Financial, Financial Independence, FIRE, Investing, KiwiSaver, New Zealand, Personal Ffinance, retire early 8 Comments

Do you need KiwiSaver if you plan to retire early?

by Alpha

(This post contains the concept of Financial Independence & Retire Early (FIRE), and terms like 4% withdrawal rate that may sound confusing. If you like to know more, jump to the end of this blog post for more information.)

When we approaching June in New Zealand, you can see lots of personal finance articles tell everyone to put in some money into their KiwiSaver and get the free money. I want to focus on a group of people who is working toward financial independence and wants to retire early. They may think since they are planning to retire way ahead of 65, KiwiSaver is irrelevant to them. They could be in KiwiSaver, but not sure if they should include KiwiSaver as part of their financial independence plan.

Return on your KiwiSaver contribution

If you wish to live off your saving and investment, you ought to find the best return on investment out there. For KiwiSaver, your employer has to match your 3% contribution, and some employer may go higher. That’s 100% return on investment! (Correction: Actually is not 100% return because the employer needs to pay tax on their contribution. So the ROI is 100% – Tax, from 10.5%-33% less. Still a great return)

The government also provide KiwiSaver member tax credit for the first $1042.86 contribution from you each year (not counting your employer contribution). The Government will pay 50 cents for every dollar of member contribution annually up to a maximum payment of $521.43. That’s 50% return on your first $1042.

If your wife/husband/partner is not working and you are working full time, you should consider contributing $1042 into their account as well. Those credits are risk-free and guaranteed. It is hard to find such return on the market with basically no-risk.

Locked until 65

Some people think the big problem of KiwiSaver is you cannot access the fund until you turn 65 or to buy your first home. For the people who are planning an early retirement, they like to put every dollar into their investment so the investment can generate enough income to support their living expenses. They don’t count on KiwiSaver and NZ superannuation to retire. However, you should still put money into your KiwiSaver.

One simple question: Do you plan to live beyond 65? If yes, then you should contribute to your KiwiSaver because it’s your money! You will spend on your investment before 65, and you will still spend on your investment after 65. The KiwiSaver fund is just one of your investment funds, and you don’t draw on that fund before 65, it will still help you to achieve your financial independence.

Include KiwiSaver fund into your early retirement number

Look at the graph below. We assume you need 1 million portfolios to retire early, $300k in KiwiSaver and $700k in a normal investment fund. Your annual withdrawal rate 4%.

You just need to stack up your investment and put KiwiSaver at the bottom and only draw the fund at the top. You keep drawing your non-KiwiSaver investment fund before you turn 65 and let your KiwiSaver Fund untouched. Yes, your non-Kiwisaver fund may get smaller and smaller (depends on your withdrawal rate) because you are drawing $40K (4% of 1 million) on a 700k investment fund. However, your KiwiSaver fund will keep growing. When you reach 65, you can draw from both funds.

Therefore, you should keep contributing to your KiwiSaver and include KiwiSaver as part of your early retirement plan.

Don’t over contribute into KiwiSaver

The key is you should not put too much into your KiwiSaver. You don’t want your non-KiwiSaver fund run out of money before you reach 65. Although it’s unlikely but possible.

Let’s assume you are 40 years old and have 1 million investment portfolio. You plan to draw 4% on your investment every year for living expenses. The expected return on investment is 6%. However, for some unknown reason, 70% of your investment are in KiwiSaver, and only 30% of your investment are in non-KiwiSaver Fund. You can only draw from your non-KiwiSaver fund before you turn 65.

By age 48, your total portfolio growth to 1.24 million but your non-KiwiSaver fund ran out. Most of your money are locked in KiwiSaver, and you are 17 years away to access them. You need to go back to work.

To avoid that, you just simply contribute up to wherever your employer will match and enough to get the member tax credit every year. Put all extra cash into your non-KiwiSaver investment, including paying off mortgage, shares, bond, property, etc.

Now, if we reverse that situation and put 30% investment in KiwiSaver, 70% in non-KiwiSaver. That non-KiwiSaver fund will least 30 years. Here is the how the fund works.

How long will you non-KiwiSaver fund least?

I actually worked out the formula on how many years your non-KiwiSaver fund will least base on percentage of your portfolio in KiwiSaver. The graph was based on 4% withdraw rate.

X is the percentage of your KiwiSaver and Y is the number of years will your non-KiwiSaver fund last.

If your Kiwisaver is about 18% of your total investment and you are 28, do you need to worry? Using that formula y = -24.61(0.18) + 0.3429, y =42.5. Your Non-Kiwisaver fund will least 42.5 years, by the time your non-KiwiSaver fund runs out, you are already 70 years old.

If you plan to retire at age 38, you will have to draw on your non-KiwiSaver fund for 27 years. Using that formula 27 = -24.61 In(x) + 0.3429, x = 33.85%. So your KiwiSaver needs to be less than 33.85% of your total investment portfolio.

That formula only works with 4% withdraw rate. You can work out how long will your non-KiwiSaver fund least with your own figure. Check out this google sheets. Make a copy and play around.

Conclusion

KiwiSaver is a great investment with a high return on investment due to employer match and government tax credit. It is one of the best investment in New Zealand.
You should contribute toward your KiwiSaver to achieve Finacial independence and include your KiwiSaver amount into your equation.
Do not over contribute into your KiwiSaver.
If you are employed, you should contribute up to your employer match and no more.
If you are self- employed, just put in $1042.86 to get your $521.43 tax credit every year.
All extra cash goes into non-KiwiSaver investment.
If you are not retiring extremely early (in your 20s) and your KiwiSaver is below 20% of your total investment portfolio, you will be alright.

About FIRE

If you want to know more about Financial Independence & Retire Early, I will cover that in the future. Meanwhile, Check out the link below.

What is Financial Independence & Retire Early (FIRE)

The Shockingly Simple Math Behind Early Retirement

The 4% Rule: The Easy Answer to “How Much Do I Need for Retirement?”

Kiwi Mustachians – New Zealand FIRE community (Facebook Group)

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

March 17, 2017 Investing, KiwiSaver Defensive Fund, Financial, Growth Fund, Investing, Investment Mentality, KiwiSaver, New Zealand, Superlife Leave a comment

Will you switch KiwiSaver plan during a market correction?

by Alpha

as [I wrote this back in 5th Oct 2016]

I’ve got into a discussion with a colleague about changing KiwiSaver plan. He is in his 30s and he decided to switch his growth plan to a defensive scheme. His reasoning was that he thinks there is a market correction coming in late 2016 or the first half of 2017, so by switching to the defensive scheme, he can avoid a drop in his investment. He will switch back to growth once we are out of the correction.

I do agree there is a market correction coming and a defensive scheme will do better in a down market compared to a growth plan.

Let’s use Superlife income (defensive scheme) and Superlife60 (growth) as an example.

During the 2008 GFC, most markets were down by A LOT. SuperLife income returned about 6% to 8% during 2008-2009 and SuperLife60 was returning -8% to -14% at the same time. So if you start your Kiwisaver in 07 in SuperLife 60 (returning 4.8%), then switch to SuperLife Income at 08, 09 (6% and 8%), and finally switch back to SuperLife 60 at 2010 (15%). You would have returned on average 8.45% p.a. while SuperLife 60 was returning -0.55% in those four years.

By looking at the math, it’s all great, but the main question is HOW DO YOU KNOW WHEN TO SWITCH? We are trying to time the market. The return looks great when we do it retrospectively, but in reality, it takes lots of time, resource and knowledge to time the market and people who are experts in that area still don’t get it right. If we switch too early, we may miss out on the last bit of gain. On the other hand, if we change too late, we will take the hit of the initial crash.

I am personally not sure about this. I was trying to time the market back in 2014, and I was wrong. The conventional wisdom was to ignore the ups and downs of the market and keep your investment in a growth fund. You will ride it out eventually. However, somewhere in my mind I still think I can get a better return by switching. Not to a defensive scheme but a balanced scheme to smooth it out.

[Now, back to March 2017]

I ended up keeping the growth fund and it turned out great. The return on those months is far better than the defensive fund. The main reason was due to the poor performance of income asset in the last quarter of 2016.

However, this post is not about growth fund doing better than the defensive fund during that time period. In fact, I’d still be happy if the defensive fund did better because the performance for my KiwiSaver in a single quarter only has a tiny impact on the lifetime of my fund. The lesson I learned was to stick to right fund for me, just sit back and let it grow.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.