Perhaps its just a demonstration of evolutionary theory in practice, but I find it fascinating that it can be the unexpected benefits of some new innovations that end up adding greatest value. The medical profession seems full of examples. One relatively recent case was the discovery of Viagra (Sildenafil). Although originally developed to treat hypertension (high blood pressure) it was during clinical trials that an interesting unexpected benefit was discovered.
It was that unexpected benefit that caused Viagra to be one of the fastest selling prescription medicines in history.
So, what does this have to do with financial advice?
Well, back in the early 2000s, when the Government was looking to encourage New Zealanders to save for their retirement, they sought advice from the accountancy profession and the funds management industry to find out what features any new scheme (which came to be known as KiwiSaver) would need if it was to be successful. The feedback they received was extensive and included some high-profile matters, such as the inclusion of a universal annual tax credit, which now forms part of KiwiSaver.
Contained in that industry feedback was a subtler, but perhaps more significant observation. The industry noted that the tax laws at that time worked against investing in managed funds and superannuation schemes as you often paid more tax than you would if you owned shares personally. Clearly this was a significant handicap for any new savings scheme.
To help address this imbalance the Portfolio Investment Entity (PIE) regime was created; a new regime of taxing investors in managed funds and superannuation schemes.
One of the key objectives of the new approach was to encourage savings by reducing tax barriers to collective investment (''levelling the playing field'' so to speak).
The essential point here is that the advantages of the new PIE regime were not limited to just KiwiSaver schemes alone: advantages of the PIE regime were conferred to all collective investments that qualified.
The PIE regime is quite complex, but for the sake of this column the main advantages can be summarised as follows:
- The maximum rate of tax that you pay is capped at 28%. Compared to the highest income tax rate of 33%, this represents an attractive discount.
- The capital gains on New Zealand shares and/or shares in most large Australian listed companies are not taxed, even when the shares are traded frequently.
- The need for many investors to file tax returns was removed, providing a saving in both compliance time and cost.
On first reading these tax concessions might not seem particularly impressive, however their cumulative benefit can be significant. For example, a 5% reduction in the tax paid on your retirement savings each year will soon add up over the lifetime of your KiwiSaver investment.
But the PIE rules also provide what may be unexpected benefits for some investors. For example, lets say you get a pay rise from $40,000 a year to $60,000. While this will move your top income tax rate from 17.5% to 30%, you can choose to use the 17.5% PIE tax rate for another two years.
Why, you ask? Because your PIE tax rate is based on your taxable income in either of the last two income years. So, for those two years, instead of paying 30% tax on returns from your savings, you could limit your tax rate to 17.5% by investing in a PIE.
The PIE regime has now been in place for more than 10 years.
My observation is that it has not only ''levelled the playing field'' between collective and direct investment, but in some cases has also provided unexpected benefits for investors in collective investments.
-Peter Ashworth is a principal of New Zealand Funds Management Ltd, and an authorised financial adviser, based in Dunedin. The opinions expressed in this column are his own and not necessarily that of his employer.
