Are you paying too much KiwiSaver tax? - Diana Clement

Is your KiwiSaver leaking tax? It might be time to have a look under the bonnet and see what's going on. Photo / 123RF

OPINION

Is your KiwiSaver leaking tax? Kiwi investors have been trained to worry endlessly about how much they’re paying in KiwiSaver fees.

However, one Kiwisaver provider argues that tax is another fee and that most people are paying too much, impacting their returns.

Savers pay tax at their own personal Prescribed Investor Rate [PIR] on their KiwiSaver. However many KiwiSaver providers have third-party international investments under the bonnet, which pay another layer of tax that few investors know about or see, says Kernel KiwiSaver’s founder Dean Anderson.

How it works is KiwiSaver providers often invest some of their savers’ money in third party funds to ensure they have a wide range of investments in different markets. However, if those funds are domiciled [based] offshore, they’re paying tax to overseas governments that can’t be clawed back as credits and is lost.

“It’s quite simple. As long as the local [KiwiSaver or other] fund here owns Nestle in Europe [for example], that’s fine,” says Anderson. “But if the local [KiwiSaver or other managed] fund owns a fund in Australia that then owns Nestle It has an extra step and you can’t get the tax back. That’s where the leakage comes in.”

In that scenario, KiwiSaver providers end up paying tax here on income that has already been taxed overseas. That double taxation can drain 0.25 per cent to 0.9 per cent of returns, says Anderson. “So quite a large impact on returns. All of those little fractions add up.” The numbers aren’t that different from some KiwiSaver management fees.

A cynic would say that Kernel, which owns the underlying investments in its funds, has a barrow to push. But for the record I approached Anderson on the subject, not vice versa. A line about “tax leakage” in a Kernel newsletter had caught my eye. The idea of additional layers of tax and fees in KiwiSaver sub funds has always bothered me and the word “leakage” was a pithy way to put it.

Tax is an increasingly big question for investors thanks to rising personal and trust tax rates, says Anderson. It’s not just KiwiSaver.

Thanks to the top personal tax rate being raised to 39 per cent in 2022, clients were looking to move some of their other investments to Pie funds. The top tax rate for a Pie fund such as KiwiSaver is 28 per cent, which was significantly less than 39 per cent for tap rate taxpayers on non-Pie investments.

Clients are becoming more interested in the total cost of investing, says Anderson. Tax is part of the “everything else” over and above management fees that investors should think about, he says. “Treat it in the same way [you do] management fees. Tax is just another fee you should also look at and ultimately try to minimise.”

I spoke with Simplicity KiwiSaver founder Sam Stubbs. In April last year the KiwiSaver provider switched from holding Vanguard funds for overseas exposure to remove the tax leakage.

“It ends up making our members, somewhere in the range of 30 to 70 basis points extra a year in terms of returns,” says Stubbs. The move was a reluctant one because Vanguard wouldn’t provide Simplicity with locally domiciled funds to invest in. “Unfortunately it’s the curse of the small market. New Zealand is too small a market for them. So we made our own [international] funds and outsourced them to DWS to manage.”

Just as with fees, layers of extra tax don’t always translate into a poor return. Sometimes high-fee funds have better returns than low-fee funds. Likewise a KiwiSaver fund paying higher tax under the bonnet, isn’t necessarily the one with the poorest return. It’s all part of the mix, however, says Katrina Scorrar, senior tax associate at Johnston Associates.

Neither Kernel, nor Simplicity had the highest annual return over five years in their respective KiwiSaver categories when I compared returns from FundSource and Morningstar.

Having the highest return, lowest fees or tax isn’t necessarily the most important factor for everyone. Personally I try to choose funds that are more likely to be ethical, and less likely to greenwash. Readers can compare KiwiSaver funds on grounds such as these at MindfulMoney.net.

Scorrar says the tax leakage issue is one that people need to bear in mind as they do fees or returns. “It’s another piece to the puzzle of how much you’re actually going to get back from your investment. Because of all the other factors that you have involved, it is hard to isolate tax by itself.”