KiwiSaver blunder: What thousands paying the wrong tax rate says about society

People paying the wrong tax rate are generally those earning low incomes. Photo / Getty Images

Hundreds of thousands of Kiwis found to be paying the wrong tax rate on their KiwiSaver earnings highlights the poor state of financial literacy in this country, says an industry leader.

Sam Stubbs, founder and managing director of KiwiSaver provider Simplicity, said there is a clear point of difference between those with a deep understanding and active interest in money matters and those who don't.

It's a sad reality within society, he said, particularly given the country's appalling rates of depression and mental health issues - many stemming from money woes.

Last year the Government's Mental Health and Addiction inquiry found one-in-five New Zealanders experienced mental illness or significant mental distress in their lifetime, costing the economy $12 billion a year.

"People talk about mental health and depression being a problem in New Zealand - the number one cause of mental health problems is money problems and yet we don't teach these things in school," said Stubbs.

"One of the best fences at the top of the cliff in terms of preventing depression and mental health issues is getting people to understand and get on top of their money problems."

Inland Revenue Department (IRD) spent more than $1 billion on a new automated and digitised tax system introduced in April which detected 450,000 people paying the incorrect prescribed investor rate (PIR).

New Zealanders have to choose their own prescribed investor rates on managed funds such as KiwiSaver.

A spokesperson for IRD said the tax department did not incorrectly tax people, rather people had supplied their investment providers with the wrong PIR.

IRD does not yet have a figure on how much money would be retrieved following the incorrect tax rates applied in the last financial year.

Stubbs said there were two reasons why so many Kiwis were paying the wrong tax rate: either they did not know or they decided to pay lower tax knowing that they would be asked for the tax at the end of the year. The latter, less common, he said.

Sam Stubbs, managing director of KiwiSaver provider Simplicity. Photo / Doug Sherring

"The people who are least likely to know their PIR rate are those in default funds and those people who have pretty low balances or don't pay a lot of attention to their money, finances and savings.

"I think there will be relatively few examples of high balance members getting it wrong."

Commission for Financial Capability personal finance expert Tom Hartmann said KiwiSaver was set up to be the responsibility of the members to correct their tax rates.

"Unfortunately members are being defaulted into KiwiSaver and they have to opt out, if they don't engage they don't really have an opportunity to correct their tax rate and it seems really unfair in that not doing that they end up paying much higher tax rates and are not able to claw that back at all," Hartmann said, adding that the 450,000 figure of those not paying the incorrect prescribed investor rates was "way higher" than he had anticipated.

Hartmann said the people paying the wrong tax rate were generally those earning low incomes, below $48,000.

"Part of it is education, part of it is how the system opts you into KiwiSaver - it's up to you to get your settings right.

"People need to be switched on to what is happening with their KiwiSaver."

Stubbs believes many Kiwis would have been paying the wrong tax on managed funds for years, decades even, depending on when they first signed up to the fund.

The irony in the situation is many New Zealanders were advantaged by being in KiwiSaver by the tax system compared to any other form of savings because the rate of tax in KiwiSaver is lower than in other investments, Stubbs said.

PIR for residents is based on income from the last two years. The prescribed guideline rates are 10.5 per cent for those earning an income between 0 and $14,000, 17.5 per cent for those between $14,001 to $48,000 and 28 per cent for those earning more than $48,001.

"When KiwiSaver was set up it was originally designed to provide a small tax incentive to save ... one of the reason KiwiSaver is likely to do better than another investment is because you will pay less tax over time," Stubbs said.

He believes the new system will permanently stamp out incorrect tax rates - not only because the system can now detect it but because unexpected letters will encourage people to find out what rate is applicable to them.

He sees the situation as a one-off event and the fault largely of the individual as opposed to the provider.

Inland Revenue has spent more than $1 billion on the new tax system. Photo / Janna Dixon

He said it was shocking that many Kiwis did not know their tax rate but also "indicative" of how simple and easy New Zealand's tax system was.

"In a funny way this is actually an endorsement of how simple our tax system is. This is one of very few times where a person would have to know what tax rate applies to them, most people on a salary don't have to worry about that."

An unintended benefit of the situation meant people would now be aware that there is a tax advantage in KiwiSaver even if there is a top rate applicable, he said.

Rebates owed to Government could be significant in that it helps the department recoup the cost of upgrading the system, Stubbs said.