The drawbacks of KiwiSaver

The vast majority of middle to high-income earners should not be using KiwiSaver as their main retirement savings vehicle.

I recently wrote about why you are probably investing too much in KiwiSaver and received plenty of feedback.

There were many good questions and some confusion about whether everybody should have a second retirement fund, separate from KiwiSaver.

The answer to that burning question is yes, for most people. For those who are young or on lower incomes, KiwiSaver will initially be a one-stop shop and fulfils a basic need. Beyond this, better solutions exist for people with a bit more money.

For the avoidance of doubt – I’m talking to a very large group of people. If you are investing more than 3 per cent of your salary into KiwiSaver, you should be questioning why.

The crux of the argument is that New Zealand has a particularly odd retirement scheme by international standards. Once you’ve invested enough to collect the annual government donation and your employer’s contribution (usually 3 per cent of your wages is matched by your boss) continuing to invest additional savings only has disadvantages.

The two main drawbacks are compelling

Lack of diversification

KiwiSaver forces you to invest with one manager for decades of your life. Even if you switch managers, the whole lot goes to a single firm. There’s no polite way of putting this – it’s incredibly bad practice. In terms of portfolio construction, you will never find a professional who suggests this.

The lock-up

Some people like the idea of not being able to touch their savings, but never stop to think of the consequences later on. Lifestyle choices are removed. If you find you can retire early, or get a new car a few years before quitting work, sorry sunshine, your money is locked up.

KiwiSaver is a poor cousin internationally

In other countries, people are prepared to use the government scheme as they’re offered big tax advantages, multi-manager platforms and early retirement options. In the UK, your gross salary is invested. That means the tax normally paid on your wages is invested in your pension and you get decades of gains on this. The pension pot is taxed as you withdraw from it, but the benefits of gross-rollup are huge. In addition, you can take 25 per cent of the fund tax-free and you’re allowed to start withdrawals from age 55 if you want to retire early.

KiwiSaver is extremely poor by comparison. Our contributions are from net wages (after tax), they are taxed within the fund and the padlock is in place until age 65 with no early retirement options for those who save well. We are not taxed on withdrawals at retirement, but describing this as “tax-free” is marketing talk, not a technical truth. It’s taxed at entry and all the way through. There is simply nothing left that attracts tax.

Your KiwiSaver questions answered

1. I’m going to double my KiwiSaver contribution from 3.5 per cent to 7 per cent. I also have $5000 in cash for emergencies. Can you suggest a fund for me to invest in?

Firstly, don’t invest the $5000 in a fund. This is far too small and only enough to cover a couple of home appliances going wrong. Set up an automatic payment with another fund manager for your additional savings. It could be a bank, or a specialist manager like Devon, Booster, Fisher Funds or Simplicity. Ask about fees and check the minimum monthly investment. You could split your payments between two or three managers. It’s probably wise to stick to the same risk profile as your KiwiSaver.

2. I’m self-employed so I keep quite a substantial amount of money in cash in case I don’t get work. I noticed you said people should look at investing this, but not in KiwiSaver as it’s locked up.

Traditional advice is to use a blanket rule of three to six months’ wages in cash for emergencies but it’s far too generic to apply to everyone and large sums are now earning no return. Take a look at what you’ve accessed in the last five years. A certain amount will have to stay in cash if you regularly dip into it, but there is bound to be a part you’ve never touched. Managed funds are all liquid and you can make a withdrawal within a week or two. They can also fall in value, so it needs to be a rarely needed safety net.

3. I have some retirement funds with one manager and KiwiSaver with a different manager. The first manager thinks I should combine it and put it all with them. What should I do?

Of course they do. Leave it where it is and consider if you should be splitting things up even more. Check the minimum lump sum requirements of other managers.

4. I invest the minimum in KiwiSaver and have the rest of my savings of $160,000 with one other manager. Should I split it out further?

Yes further splitting would be advisable, but it can get hard to manage yourself. This is an example where a financial adviser could design a well spread portfolio and prepare some modelling on predicted retirement values and inflation adjusted income levels.

5. I’ve read that I should get personalised financial advice to invest in KiwiSaver, but the bank won’t give me a face-to-face appointment and I can’t go to a private one as they are too expensive. They gave me an information pack and told me to decide.

The truth is advisers charge an hourly rate like accountants or cost between 0.5 to 1 per cent of your portfolio value each year. This is fair. They generally see people with lump sums of $300,000-plus, high or double incomes or young professionals with substantial career growth ahead. If your only savings are into KiwiSaver, branch staff can give you generic information and they’re very good at setting everything up. They’ll explain the risk levels and it’s your decision on how comfortable you are. It’s common to use your bank and select a balanced fund if you are OK with medium risk.

Janine Starks is the author of www.moneytips.nz and can be contacted at moneytips.nz@gmail.com. She is a financial commentator with expertise in banking, personal finance and funds management. Opinions are a personal view and general in nature. They are not a recommendation for any individual to buy or sell a financial product. Readers should always seek specific independent financial advice appropriate to their own circumstances.