Your tax rate is likely to drop when you retire. You could save enough on your tax bill to take a very nice holiday, writes Mark Russell, of PwC.
Maybe you’ve been working for years in a good job, paying 33 per cent tax on your salary and income from any investments you might have. Your employer takes tax from your pay packet, and your bank or fund manager takes it from your investments.
You never have to think about tax. It’s been a very simple tax life.
Suddenly, you reach 65, and things change.
Most people will be getting NZ Super, many will still be working, and many will have a nest-egg, from KiwiSaver, investment funds, or selling a business.
For the first time, you have multiple sources of income, and different types of tax apply to each. Here’s how to get the best out of your new situation.
Get rid of debt
Many people today are reaching 65 with a mortgage or other debt. My first tip is: pay down all personal debt first.
The reason is simple: most returns you get on investments are taxed, and you don’t get a deduction for interest on personal debt.
If you are paying 5 per cent interest on a mortgage and you’re on the 33 per cent tax rate, you’ll need a pre-tax return on investments of at least 7.5 per cent to be better off than paying down the debt.
Say goodbye to the top tax rate
Now your income’s less, you’ll probably be on a lower tax rate, especially if you were paying 33 per cent.
Here’s some good news. You can have a lot of assets and be very well off before you’d have to pay the top tax rate after 65.
When you stop working, you might need to have a couple of million dollars invested, plus get NZ Super, before you’d be on the top tax rate.
Here are the current tax rates for 2019:
· From $0 to $14,000 is 10.5 per cent
· From $14,001 to $48,000 is 17.5 per cent
· From $48,001 to $70,000 is 30 per cent
· Over $70,000 is 33 per cent.
After stopping work, the proportion of tax most people pay on their investment returns will drop a lot.
Watch the trust
Many Kiwis hold their assets in trusts. Income a trust earns is taxed at 33 per cent if it is not paid out to beneficiaries. That was fine when you worked, if you’d have been taxed at 33 per cent anyway.
But if you now could be paying just 10.5 or 17.5 per cent on your personal income, it may not make sense to leave the money in the trust.
Often a trust represents a couple. If they were owning those assets directly instead, they could both earn up to NZ$48,000 and be taxed at a maximum of 17.5 per cent each. That will give you almost NZ$17,000 more in the hand each year.
So, if your trust is basically money for you and your partner, it’s worth thinking about whether to leave money in a trust, or at least pay out the trust’s income each year.
When you start getting NZ Super, you have to pick a tax code for it: ‘primary’ or ‘secondary’ income. If you’re working and you don’t get this right, you could face a tax bill at the end of the year.
Your primary income is whatever earns you the most money, possibly work or NZ Super. That income will be taxed as if it’s your only income.
But with secondary income, the Inland Revenue Department takes a bit more money out through the year, so you won’t get a tax bill. If you’ve paid too much tax, you’ll get the rest back automatically at the end of the year.
Change your RWT rate
When you started a savings account at the bank, you had to make a tax declaration of ‘resident withholding tax’. If your tax rate’s changed, you’ll have to let the bank know. The same tax rates apply as for income tax.
If you know you’re going to making less than NZ$14,000 or NZ$48,000, choose the 10.5 or 17.5 per cent rates. For people with a lot of money, the difference can be huge. If you get this wrong you can get any overpaid tax back, but you’ll be without the use of the extra money during the year.
Take care with PIEs
Portfolio Investment Entities (PIEs) include your KiwiSaver account, unit trust investments, and cash PIE investments at the bank. You’ve probably benefited from a top tax rate of 28 per cent in PIEs, compared to the top 33 per cent tax rate.
Once you’ve retired, you might qualify for a 10.5 per cent or 17.5 per cent PIE rate, which generally apply to higher income levels than the standard tax rates. But if your PIE tax rates change, you’ve got to tell your fund manager the new rate. With PIEs, if you overpay, you don’t get it back. If you underpay, IRD will send you a bill. It’s a one-way door.
To be entitled to a lower tax rate on a PIE or KiwiSaver, your income must fall below the thresholds in one of the last two years.
Let’s say you used to be on NZ$80,000 in your old job and you paid 33 per cent tax on your salary and had a 28 per cent PIE rate for investments. Now you earn less than NZ$48,000 a year. That’s the 17.5 per cent tax bracket for income – but not immediately for the PIE income.
You’ll still be paying tax on your PIE at 28 per cent for the first tax year of retirement, which could add thousands of dollars of additional tax So, should you pull your cash out of a PIE investment for a year?
KiwiSaver is a long-term strategy, and there would be a cost to replicating your investment outside of KiwiSaver, so probably not. If you have deposits in a cash PIE, it probably makes sense to switch to direct deposits for the first year.
Does it make sense to move back to the cash PIE after that year off?
That depends on your total income. If your total income is less than NZ$70,000, it usually makes sense to be in the PIE.
If your total income is more than NZ$70,000, you could be worse off in the cash PIE, since you’d pay 28 per cent tax on all PIE income, whereas you get the benefit of the lower marginal rates for direct deposits.
Your annual income would need to be over NZ$150,000 before it made sense to switch back to the cash PIE.
Published 29 February 2019
This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.
Sign up to our newsletter to receive the latest news, updates and event invites from JUNO investing magazine.