The PIE is Growing

Despite all the rhetoric through the recent election cycle, there was one piece of tax policy that seemed to slip from the attention of many – a proposed and previously budgeted increase in the trust beneficiary tax rate, tabled to rise from the current 33% to 39% starting on 1 April 2024.

The change is intended to align the rate at which trustee income is taxed with the top tax rate applicable to individuals. The goal is to prevent taxpayers from achieving a 6% tax saving by accumulating income within a trust, rather than distributing the income to individual beneficiaries who are on a 39% tax rate.

The proposal was part of a tax bill in Parliament until the dissolution on September 8, 2023, due to the general election. Christopher Luxon, while expressing reservations about this increase, cited fiscal constraints that may necessitate it.

He has suggested that any reductions might occur in the future, but not during the Government's first term. Predicting whether the previously proposed tax change will be presented to Parliament is anyone’s guess, especially with a tri-party coalition discussion. The state of the government books may have the final say.

Whether the trustee rate increases to 39% or not, individuals still contend with personal tax rates reaching up to 39%. These alterations in tax policy have prompted investors to reevaluate how they structure their investments and have underscored the advantages of the Portfolio Investment Entity (PIE) framework for numerous investors.

A PIE is a legal tax structure covering some New Zealand-managed funds that pool investor contributions and allocate them across various investments, for example, KiwiSaver & Kernel funds are PIEs.

PIE rules allow investors to pay taxes based on their Prescribed Investor Rate (PIR), which is generally lower than their RWT tax rate.

The Prescribed Investor Rate (PIR) is calculated based on taxable income over the last two years, including salary, wages, and other income reported in your tax return.

PIR rates for individuals are 10.5%, 17.5%, and 28%, while companies should use 0% (as the income and capital gains are taxable as part of company tax filings). Meanwhile, trusts can opt for 0%, 17.5%, or 28% based on their beneficiaries' situation.

With the current RWT rates at 10.5%, 17.5%, 30%, 33%, and 39%, and likely to soon have a trust beneficiary rate of 39% too, investors realise that there is often a material tax benefit from investing in a PIE structured fund.

To see the tax savings, one can compare the taxes paid by an investor at different RWT and PIR rates. For instance, let's assume an investor has $100,000 to invest, and the investment generates a 5% return. Putting all other factors aside, the contrast in tax paid under a direct RWT rate versus utilising a PIR rate within a PIE structure becomes evident:

The higher the personal tax rate, the bigger the tax savings under a PIR. Equally, investors on a lower RWT rate are not disadvantaged under the PIE regime.

Of course, there can often be other costs to consider, such as the management fee on a PIE. Yet, despite this, PIEs often give investors other benefits such as ease of investment, diversification, or access to investment options that may not be possible outside of a fund.

Looking at the example of a Cash Fund, we lay out how an investor should consider multiple factors when structuring and selecting their investments.

Cash funds have often been overlooked in favour of single issuer options like rolling term deposits and cash management accounts. However, with often better tax treatment, higher yields, and reduced risk from single-name concentration, they warrant serious consideration.

Taking the example of a cash fund, investors can see the impact on their net returns by using a PIE structured investment over a general direct investment.

At the time of writing, most cash funds in New Zealand are benchmarked to a 90-day bank bill index, yielding approximately 5.6%. Similarly, the highest interest rate for a 3-month bank term deposit stands at around 5.15% (as per Interest.co.nz on November 7th, 2023). Assuming a fund manager can achieve the 90-day bank bill index return after charging a management fee of 0.25%, we can compare the after-tax annualised yields for an investor subject to a 39% tax rate on their term deposit and a 28% PIR on their cash fund investment:

As you can see in this example, even with paying management fees on a PIE structured fund vs holding direct investments, the benefits of diversification and lower tax often outweigh the extra costs. Currently, that equates to almost 1% per year.

To sum it up, recent adjustments in the tax system over the last few years have amplified the appeal of PIE-structured investments for numerous investors. Consequently, both investors and their advisors should weigh the overall expenses associated with an investment, factoring in the tax implications, to enhance the final outcome aligned with an investor's specific objectives.