Mortgage or KiwiSaver

SHOULD I PAY OFF MY MORTGAGE BEFORE JOINING KIWISAVER?

The traditional wisdom is that paying down debt is the most important first-step for improving financial well-being.

Making additional payments on your mortgage is equivalent to earning a safe, tax-free return at your current mortgage rate (9%pa currently, but around 8%pa on average). Hence, paying off your mortgage compares very favourably with share (growth) portfolios, which have returned around 7% pa after-tax and fees, and feature much greater year-to-year volatility. More conservative portfolios should expect returns substantially lower than this again (3-5%pa).

However, the KiwiSaver scheme (as currently constructed) has the potential to turn this result on its head for many people. Paying off your mortgage will still give you a better annual return. But contributing to KiwiSaver gives you a huge head-start from the moment your money enters the scheme – through tax-credits and matching employer contributions (tax-free up to 2% of your income), your investment will achieve a return of 50-200% on day one. (See note 1)

KiwiSaver deposits receive a massive boost at the starting line. But would the higher returns from paying off your mortgage eventually close the gap?

Our rough calculations suggest that this is possible, but highly unlikely for the majority of KiwiSaver participants. Even with a high salary ($100,000 pa), mortgage rates of 8% pa, and a hum-drum KiwiSaver return (4% pa), a KiwiSaver account would still be ahead after 20 years.(See note 2)

However, the decision is not purely a financial one. There are pros and cons to entering KiwiSaver instead of retiring mortgage debt.


PROS:

  • Higher expected returns for most people after counting government and employer contributions.
  • Simply by owning a family home, most households already have most of the net wealth concentrated in the property market (and by extension, in the New Zealand dollar). Entering KiwiSaver offers valuable diversification benefits, protecting you from property or currency crashes.

CONS:

  • Equity in your home is far more liquid than your KiwiSaver account, and unlike KiwiSaver, can be accessed on a rainy day.
  • The current generous benefits for KiwiSaver contributions are not guaranteed. Future governments could limit or slash the benefits. Such changes may make paying off your mortgage a better option, but earlier contributions would still be locked in to your KiwiSaver account.
  • KiwiSaver participants can take a contributions holiday if their circumstances change. Banks are unlikely to be as forgiving. Paying off your mortgage does provide peace-of-mind benefits, especially if your income source is volatile.

 

1. This assumes that the employer is making the full 2% contribution. The variation is due to two things: the higher your income the less generous (proportionally) the tax credit; whether or not the employer contribution is ultimately borne by the employee as a reduction in wages. For incomes greater than $120,000, the matching return could be less than 50%.
2. KiwiSaver becomes relatively less attractive with higher incomes, longer investment horizons, higher mortgage rates (or credit card or personal debt interest rates), or lower KiwiSaver returns than in our example.