Kiwi savings account worked examples
06 Apr 2005
Worked Example 1
Sam is born today, and will have an account automatically created with a $500 endowment from the government. The government will also make repeat endowments of $500 when Sam starts school, at age 5, and again at age 10.
Sam’s parents decide to commit to saving slightly less than $4 a week for Sam, to make a $200 contribution each year. This contribution will be matched 1:1 by the government, so that annual contributions of $400 are made into Sam’s account.
Sam’s grandparents also decide to contribute to the accounts of their four grandchildren, and decide to give $100 a year to one of them. So Sam will receive $100 every four years.
This money is invested in a low risk investment, which is assumed to generate a nominal return of 5% p.a. over this period.
At 16, Sam gets a part-time job at a supermarket and decides to begin to save to go to university. Sam is able to save $1500 a year, and contributes this to the account.
By the time of Sam’s 18th birthday, the account will have a balance of $18,000.
This balance is made up of $5100 in contributions from the government, $3600 in contributions from the parents, $400 from the grandparents, $3000 from Sam’s job, and about $5,900 is due to interest earned on the account.
This provides a financial base, enabling many people to participate in tertiary education without taking on a student loan. Sam plans to work throughout university, and should be able to finance much of the cost of study through the Kiwi Savings Account balance.
Average student loan borrowing is currently about $6,000 a year, 70% of which is for tuition costs. And even with increased costs over the next 18 years, Sam’s reliance on student loans will be greatly reduced relative to the current situation.
And even with lower contribution rates, Sam’s account balance will still have a sizable balance. For example, if Sam’s parents could only contribute $2 a week and there were no contributions from grandparents, the account would still have a balance of almost $12,000 by Sam’s 18th birthday.
If Sam had decided not to enter tertiary education, but to work instead, the money in the account will continue to compound and will be available for other uses such as saving for retirement or a deposit on a first home.
Worked Example 2
Lee is a 24 year old secondary school teacher, who has just graduated and is in the first year of teaching, earning $40,000.
Lee’s immediate financial priority is to repay a $10,000 student loan and then to think about buying a house or starting longer-term saving for retirement.
As soon as the Kiwi Savings Account scheme is implemented, the 2% across the board tax cut will result in an annual contribution of 2% of Lee’s taxable income being made into Lee’s account. In Lee’s first year of work, this is a contribution of $800 and this amount will rise as Lee’s income rises. On current teacher pay scales, Lee could be earning $56,000 after seven years at which stage the 2% tax cut will result in an annual contribution of $1120.
10% of Lee’s income (above the threshold income of about $16,172) is required to be allocated to the repayment of the outstanding student loan debt through the tax system. And the proposed savings scheme will provide valuable additional assistance in Lee’s attempt to repay the student loan debt rapidly, and then to start saving for other goals.
Lee commits to saving $20 every week and receives the full government match at a rate of 0.5:1 as a consequence. So in addition to Lee’s savings of $1040 a year, the government will contribute $500 into Lee’s Kiwi Savings Account.
Adding these contributions together, Lee’s Kiwi Savings Account will increase by about $2340 a year, plus any interest earned on this balance. Lee decides to apply this amount to the repayment of the portion of the student loan debt that is due to tuition costs - and because Lee worked while studying, most of Lee’s student loan borrowing was to pay for tuition costs.
Lee is able to pay about $2400 as the minimum repayment through the tax system, together with another $2340 through the Kiwi Savings Account, for a total of about $4740 p.a. This enables Lee to pay off the student loan debt within a few years of graduating and begin to save for other goals at a rapid rate.
Once the student loan debt is repaid, Lee decides to save the 10% of income that was previously automatically diverted to student loan debt repayment, as well as continuing to save $20 week.
By the time that Lee is 32, it is reasonable to expect that (in addition to having repaid the student loan debt), the Kiwi Savings Account will have a balance of $39,000.
And if the kid’s saving scheme had been implemented previously, Lee would be even better off in terms of not having to have taken out a student loan, or at least a smaller loan. In turn, this will enable Lee to get into home ownership more rapidly or save a greater amount for retirement.
Lee also benefits from the recently introduced state sector retirement scheme, in which Lee’s employer matches contributions to a retirement savings account at a 1:1 rate up to limit of 3% of income (effective from July 2005). Lee decides to save through this scheme as soon as the student loan is repaid. At 3% of a rising salary, this amount will begin to accumulate rapidly with the benefits of compound interest.