Portfolio Investment Entities

The introduction of the PIE regime was a response to the over-taxation of managed funds, which was a major barrier for investors, when considering the whole range of investment options. In the past, funds would pay tax at the company rate (it was then 33 cents in the dollar) and those on a lower rate (say 19.5 per cent) could not claim back the difference. In effect, investors were taxed 33 per cent regardless of what other income they had.

So, the PIE regime was born – and a good thing for investors too. The playing field was tilted away from managed-funds investors but now it has been levelled (in fact, tilted in favour of managed funds in many cases).

Managed funds may now apply to become PIEs (nearly all have) and when they have been registered as PIEs they will deduct tax from each investor’s returns and distribute the income with no more tax for the investor to pay. However, the investor has to tell the managed fund what his or her tax rate is for PIE purposes. This is called the Prescribed Investor Rate (PIR) and it is different from your ordinary tax rate. PIRs are calculated by adding together the ordinary taxable income that some has (e.g. from wages, salary, NZ Super etc.) to the income that they  derive from PIEs. This table shows you what your PIR will be at various income levels.

Note from the table that you cannot pay more than 28 per cent tax if you invest in a managed fund which is PIE. This is especially useful for high-income earners who are on the top rate of tax (33 per cent). If these same people made investments in something that was not a PIE (e.g. if they were direct investors in shares, bonds, bank deposits or property syndicates) their investment income would be added to the income they earn from their salaries and this would be taxed at 33 per cen. By investing in a managed fund is a PIE, their investment is taxed at no more than 28 per cent.

No investment should ever be made solely for tax purposes. However, once a particular type of investment is chosen, you should certainly look for the most tax-efficient means of making the investment and PIEs often fit that bill. For example, if you decide to invest in commercial property; you could choose to invest in a small property syndicate in which case income from the syndicate would be taxed at your own rate. However, if you decide to invest via a managed fund that was a PIE(e.g. Kiwi Income Property Trust o MAP NZ Office Trust) you could be taxed at your PIR which could be lower.

One area where this can be important is for those making term deposits and holding cash with their banks. Banks have established ‘cash PIEs’ – managed funds that invest in term deposits and the like and these have been able to get PIE status. These ‘cash PIEs’ are more tax efficient than ordinary term deposits and savings accounts with much the same risk – except that some of these PIEs may not carry the government guarantee. You should check before investing.

Income Protection

What is your most important asset? Your house? Your car? No, it is your ability to earn an income, in fact your financial success depends upon it. A 40 year old earning $40,000 a year (and increasing at an annual rate of seven percent per year) would earn $2.5 million by the time they retire. Although most people insure their house and car against loss very few protect themselves against an inability to work and the resulting loss of income. One can only assume the reason for this is that most people do not expect to lose their ability to work.

Statistics show that more than two out of every five people suffer illness or injury for longer than 6 months during their working life and one in every one hundred people is likely to suffer a major disability each year. Without adequate protection a prolonged absence of income could have a devastating effect on a family’s standard of living. It could result in a serious depletion of their retirement savings.

Have you ever considered what would happen if you lost your ability to earn? Who would pay your bills and continue your savings plan?

Income Protection is designed to protect a family’s income position and restore the income should the earner lose their ability to work or any length of time through illness or accident.

Self employed people accustomed to a high standard of living in particular need this form of cover. They are often in stress related occupations and in many cases have high commitments on mortgages as well as high standard of living to maintain.

Planning your Superannuation

The logical way to plan your super is in two steps:

1. Work out how much you will need in retirement.
2. Work out how much you need to save to get that amount.

As with any long-term plans, there are many variables and plenty of scope for things not to work out as planned. The Office of the Retirement  Commissioner has produced material to help with these calculations. This information is free, so why not use it?

How much will you need in retirement?

There’s not always an easy answer to this one. There are many unknowns, about which you need to make educated guesses, such as:

• The age at which you will stop working (many people can and wish to continue working beyond age 65).
• The age you will live to.
• The lifestyle you will want. It may be cheaper to live in retirement but you may want to continue some expensive habits.
• Your health-care needs.
• The amount of government assistance.
• Investment rates of return while you are in retirement.
• The rate of inflation between now and retirement.
• The degree to which you will be comfortable spending your capital – if you spend everything there will be no inheritance for your children.
• Whether you will use the equity in your house to live on.

If you can calculate how much you will want each month to live, there are financial tables to work out the amount of capital required to give that amount. There is plenty of scope for those calculations to be inaccurate, but it is still an exercise worth doing. As a benchmark, it is generally thought that most people need about 70 per cent of the income they require before retirement.

How much should you save?

Once you have calculated the capital sum you need to produce a reasonable income, it is relatively easy to work out how much you must save. There are two main variables:

1. The time you have before you are likely to retire

Remember this plan may change: some people decide to retire sooner; some have retirement forced on them by ill-health or redundancy; others decide to work longer.

2. The returns you have before you are likely to retire

This is harder to predict, but over time a good diversified portfolio should earn 5 per cent after tax and fees.

If you know these two things, and the capital sum you require, it’s relatively easy to calculate the amount you must save weekly. A financial planner can make this calculation or you can use the Retirement Commissioner’s website www.sorted.org.nz. If you can’t afford to save the amount you have calculated, don’t despair. Save what you can within your budget and lifestyle. As time goes by you will probably be able to save more: your salary may rise, you may pay off the mortgage your partner/spouse may go back to work etc. Even a little saved now helps – it provides a base and will grow as the returns compound over the years.

Start early

Most people should pay off their mortgage before they start to save. However, as soon as you can, start saving and investing. Time makes all the difference:

The more time you have, the more you can tuck away. If you start at age 45, you have 240 months to make regular payments into a fund before reaching 65; if you start at age 35, you have 360 months.

The more you have, the better compound interest will work for you.

• Age 45 years, saving $200 per month (6 per cent) at 65 years: $92,800
• Age 35 years saving $200 per month (6 per cent) at 65 years: $201,900

The difference is obvious. Start saving as soon as you can!

Taken from: Financial Secrets, Martin Hawes, April 2002

KiwiSaver as a DHB employee

As you are aware Kiwisaver can be part or all of your DHB subsidy. The absolute majority of doctors who I deal with in Kiwisaver are in it on a splitting basis with superannuation.

Contribution levels

These are fixed at either 3%, 4% or 8% of your gross income. No other figure is possible. If you wish to save additional monies super offers flexibility here in that you can save any amount. Note that if you are only in Kiwisaver and wish to pick up the 6% gross DHB subsidy you need to save 8% as 6% is not an option.

Access

Standard features for access for both super and Kiwisaver include death, permanent disablement and financial hardship.

Funds can be accessed from Kiwisaver other than these in two circumstances:

• If you haven’t purchased your first home once you have been a member for 3 years and made 3 years contributions you can withdraw both your and the employer contributions towards your deposit.
• Once you reach the age of eligibility for NZ Super (currently 65) your funds are available. Of course the government decides on this age which needs to increase over time due to the demographics.

Government benefits

Currently when you enrol in Kiwisaver the government deposits a one off lump sum of $1,000. In addition if you contribute at least $1,042/yr the government will add a tax credit annually of $521. This means at a 3% contribution rate you need to be earning a minimum of $34,733 gross per year. If you have additional self employment income and are not set up for PAYE, you can invest the $1,042 annually and pick up the tax credit. Note The Kiwisaver tax credit year runs from 1 July to 30 June each year. In the first year of membership you will only receive a proportionate amount of tax credit based on what time of the year your $1,042 investment was made. This is not an issue in subsequent years.

Changing providers

It is easy to change providers. All you need to do is complete an application for the new scheme and the rest is taken care of.

Opt out process

Should you not wish to join Kiwisaver you need to opt out within the first 8 weeks of joining a new employer (note you cannot opt out in the first two weeks, however deductions over this time will be refunded).  Opting out needs to be exercised each time you start with a new employer. Of course if you join Kiwisaver it will follow you around (like a loyal dog) employers without the need to re join.

Contribution holiday

If you wish to stop contributing to Kiwisaver for a period of time (up to five years at a time) you can, once you have contributed for a year.  Should you wish or need to, contribution holidays can be rolled over every 5 years. The process for a contribution holiday is to complete a contribution holiday form (KS6 obtained from www.kiwisaver.govt.nz ) and send it to the IRD. Once they have replied and confirmed this, forward their confirmation to your payroll.

The future

One thing (and this would be my biggest criticism of Kiwisaver) you can be guaranteed about Kiwisaver is that it will be constantly changing. The reason for this is that the government make the rules. Since it was created in 2007 there have been numerous changes (without going into the details).  You will no doubt be aware that if Labour is the government after the September election there will be further changes (compulsion, increase in contribution rates, ability for the Reserve Bank to increase contribution rates as a monetary policy tool and finally a likely increase in the retirement age (which I agree with).

Conclusion

Kiwisaver is here for good. It can be a useful part of your retirement savings mix. The key is to understand its nuiances so it can work to your best advantage.

How does currency affect my investments

Investors who have monies invested offshore have an additional risk which is currency. Currency can magnify gains or losses on the assets themselves. Sometimes the movement of the currency ends up being more important than the performance of the asset. It is possible to eliminate currency risk by taking out a currency hedge. This is a financial instrument that guarantees that an investor can change foreign money for a certain rate in the future. The problem is that the cost of such hedges can be quite expensive and difficult to manage for private investors.

While currencies can be quite volatile over the short term the long term trends of currencies is more open to fundamental analysis. Two key drivers of a countries currency are interest rates and GDP growth. If both of these are increasing there will be a greater demand for that countries currency and conversley if these are failing the currency will soften. At present NZ’s dollar is strong against other currencies due to our solid economy and relatively high interest rates. While our dollar is likely to remain high over the next 12 months pressure is building for further declines after that.

For your information currency hedging is used across your AMP Super and Kiwisaver funds. This has the effect of smoothing returns.

How do I determine my risk profile?

Lots of doctors I meet have no or little understanding of investment which is not surprising given your focus and time is spent in obtaining your qualifications, treating patients and keeping up with your education.  I would encourage you to make it your business to learn about investments. The main aspects of determining your risk profile centre around the following:

1. Your time horizon
2. Your investment experience/knowledge
3. Your job security
4. Your comfort level with market volatility

1. Time Horizon

If you have a long time horizon which typically you do for retirement savings (assuming you start in either your 20’s 30’s or 40’s) you can choose riskier (and also higher returning) investments such as shares and property. The reason for this is that even though share and property markets experience losses from time to time they always recover and move higher over time. If you have shorter time horizons such as 1-3 years you need to opt for safer investments such as cash and bonds. These investments experience low volatility however also no (cash) and low growth (bonds).

2. Your investment experience/knowledge

It would be fair to say that if you have had experience in owning shares or managed funds for example that have suffered historical losses you are more likely to be comfortable owning these in the future. Also knowledge of investment markets can prepare you for losses or give you insight as to when you may sell or switch to cash.

3. Job security

You are pretty fortunate that you have excellent job security. This means that you can take more risk with your investments than people whose job security is not that great such as some senior management roles in listed companies.

4. Your comfort level with market volatility

Some people are naturally conservative and are risk adverse which means they should only be opting for low risk investments such as conservative, cash or bond funds. If you are more of a risk taker and prepared to accept volatility, on the premise that your longer term gains will be greater you need to be including a reasonable percentage of shares and property in your portfolios. As long as you stay invested when markets lose ground you will be rewarded as they always recover (even though it can be a fairly long wait at times).

How to be smart about your money

Buy smart with our high dollar

Regardless of where the dollar goes in the future, New Zealanders should understand their currency is an opportunity to be taken advantage of.  The dollar’s strength is a double-edged sword.  It provides cheap imported goods and makes our cost of living cheaper.  It also puts pressure on interest rates to remain low.

For investors, the high dollar creates conflict.  If, like me, you have kept a proportion of your super fund in international investments for the past decade you will implicitly understand the handbrake this has applied to your fund’s performance – above and beyond the torrid times in equity markets.  Yet, despite all this, and the understanding that New Zealand’s economy is “relatively” stronger than many around the world, it is important to benchmark us against ourselves.

Although, for the time being, the dollar remains relatively buoyant.  The change in sentiment towards the New Zealand dollar will come quickly, when it comes.  And it’s for that reason I continue to think that prudent international investments (as distinct from holding foreign currency, in preparation for your next trip) is a smart play that will lead to improved wealth in the coming decade.  The big question is how to make the investment? The broad stock market, most likely, holds little prospect.

And though many online brokers now provide access to international shares, you need to have strong information lines to be taking on US or European shares directly.  The same could be said about international bonds – with the real problem that these prosper most when interest rates are falling and so their race may already be run.

Managed funds, including your DHB super (assuming you are in a growth or even balanced fund) offer a sizeable exposure to international shares including Commodities, infrastructure and emerging markets.  Alternatively you can use the International share and International listed property securities sector funds assuming you have the risk appetite.

Health Insurance

Health Insurance is an area that is possibly overlooked at times in favour of Life and Income Protection Insurance. Health Insurances main benefit is providing funds to pay for elective surgery procedures that can (without it) result in long delays as a result of waiting in the public health system. You can choose when, where, how and by whom you get treated, in consultation with your doctor. Examples of procedures/operations can range from a Cataract Removal ($3,800 – $4,800) to a Heart Bypass ($32,000 – $45,000).

I recently had to have a Stent and was pleased to have Tower Health Insurance meet the costs of this which, all up, totaled around $17,000. This certainly made the procedure financially painless and I found Tower helpful and easy to deal with.

If you wish to discuss Health Insurance options (without obligation) please contact us.

Commercial Investment Property

Across Australia and New Zealand, investors seeking stable, long term returns in volatile markets, are considering commercial real estate. Once reserved for speculators, developers and ultra-rich, commercial property investment is becoming an increasingly mainstream choice.

At first glance, the attractions of commercial over residential property are obvious, Landlords of commercial property achieve higher yields, longer leases and have more power when it comes to dealing with troublesome tenants. But, as in all asset classes, the benefits are offset by risks. In this case, unpredictable capital growth, higher vacancy rates and complicated leasing agreements.

Investors who prefer the security of blue-chip tenants such as banks, petrol stations and fast-food chains may also find themselves in fierce negotiations with professionals trained to squeeze every last dollar from the deal. As with any form of investment, it’s crucial to approach the commercial property market with your eyes wide open. There are potential pitfalls that cannot be ignored.

Lease upside

The structure of leases is a key advantage of commercial property investing over residential. While residential leases usually run for six to 12 months, leases on commercial property run for three to five years, or longer, with built-in options for the tenant to renew. Commercial tenants spend considerable sums fitting out the premises and they’re typically keen to stay put once they’ve set up in a particular location. Fixed rent increases are incorporated into most commercial leases, so the tenant’s rent rises by the inflation rate, an agreed percentage, or a mixture of CPI plus a set percentage each year. These terms are agreed at the start of the lease.

Generally, commercial leases are underwritten by a personal director’s guarantee or a bank guarantee. If the tenant defaults on rent, the landlord has the guarantee to call upon. With a residential property, the only guarantee the landlord has is the bond, which may be eaten up in cleaning or repairing the property after the tenant has vacated. Commercial leases usually include a “make-good” clause. If the tenant does not extend the lease at the end of its term, they are obliged to reinstate the property to the state it was in on the day they took occupation. That’s important for commercial properties as it might involve recarpeting, repainting or removing the fit-out. Unlike residential leases, commercial leases are typically paid net of expenses. That means the tenant pays outgoing costs such as council rates, land tax, utility bills, insurance, repairs and maintenance, security, gardening, and sometimes property management fees too.

Gross rent is quoted before those outgoings, but the net rent is what the landlord receives and what is used to calculate the property’s yield. If the lease is quoted as $200,000 a year gross, and outgoings cost $50,000 a year, most commercial property agents will advertise the net rent as being $150,000. If council rates suddenly jump or insurance rates go through the roof because a storm has gone through the area, or land tax is reassessed and doubles in value, [landlords] don’t have to wear the cost. The tenant wears the cost. In residential investments, rents are charged on a gross basis, so the landlord is responsible for covering costs such as strata fees, water bills, insurance and council rates from the income, and that erodes the yield.

Deciding which costs are included in a commercial lease is an important part of the initial negotiations between the tenant and landlord. Many landlords appoint a professional manager to negotiate the lease on their behalf and have a specialist lawyer look over the documentation.

Major tenants will have dedicated teams that handle negotiations from their side and have experience getting the best deal for the tenant, so it’s wise to get individual advice on establishing a lease. Commercial property landlords whose leases do not include management fees can expect to pay about 2 per cent to 5 per cent of the rental income as a fee, depending on the property’s size and the number and quality of tenants.

(Smart Investor Magazine, Commercial or Residential, August 2013, p32 and 33)