When retirees' income drops sharply, their PIE tax rate can still be set based on two years of prior earnings — experts explain the rules and what to do about it.
For New Zealanders drawing down their savings in retirement, the tax rate applied to managed fund investments can come as a surprise. The prescribed investor rate (PIR) system determines how much tax is paid on returns from portfolio investment entities (PIEs), and the rules do not automatically adjust when a person's income changes.
What is a PIE and how does the PIR work?
A portfolio investment entity is a type of managed fund. When you invest through one, your returns are taxed at your prescribed investor rate rather than your marginal income tax rate.
Your PIR is set according to your income in the previous two tax years — and whichever year produces the lower rate is the one that applies. The three tiers are:
- 10.5% if your income is up to $15,600
- 17.5% if your income is up to $53,500
- 28% for income above $53,500
This means a significant fall in current-year income — such as when someone retires — is not immediately reflected in their PIR. The system was designed to ensure PIE tax was a "final tax" for most investors, avoiding the need for annual wash-ups, according to Deloitte tax director Phil Claridge. In some cases, this produces outcomes that could be viewed as unfair, he noted, while other investors benefit when their income has increased relative to the prior years.
The retirement problem
One retiree who wrote to RNZ recently described receiving a $1,469.75 tax bill after their PIE tax rate was set at 28% — based on income from two years earlier when they were still working. Their only income at the time was New Zealand superannuation, which should have put them in a lower bracket.
Claridge said the rules meant there was no mechanism to account for a sharp drop in income on retirement. "On the other hand, some other investors will benefit from lower PIRs when their income has increased relative to the prior two years," he said.
If the wrong PIR is applied, Inland Revenue can complete a "wash-up" — adjusting the tax paid retrospectively.
PIE term deposits: when they help and when they don't
For retirees holding term deposits, the question of whether to use PIE products or ordinary deposits depends on individual circumstances and tax rates.
Chartered Accountants Australia and New Zealand tax leader John Cuthbertson said the 28% PIR was the default rate, but it was not always the best option. "The 28% rate is appropriate for people whose marginal tax rate is higher than $53,501, but if your income is lower than that, your PIR could be 10.5% or 17.5%," he said. Notifying the investment provider of the correct rate could result in a lower tax bill.
He also noted an important caveat: PIE products typically offer slightly lower interest rates than their non-PIE equivalents, because providers factor in the tax advantage they pass on. "There's always a bit of an arbitrage that goes on there," Cuthbertson said. For context, rising interest rates have led many New Zealand borrowers to review their overall financial structures, with floating mortgage rates increasing following OCR moves, highlighting how rate changes ripple through household finances.
For someone whose ordinary term deposit interest would fall partly into a lower tax bracket before hitting the 28% marginal rate, the comparison becomes more nuanced. Whether a PIE term deposit is more efficient depends on how much of the interest would sit in lower brackets versus how much would be taxed at higher marginal rates.
Getting the rate right
For retirees and anyone whose income has changed, the key steps are:
- Check which of the previous two years produced the lower income and use that to determine your correct PIR
- Notify your investment provider if your current PIR appears incorrect
- Compare the interest rate on offer for PIE products against non-PIE equivalents — the spread can erode some or all of the tax advantage
Cuthbertson's general principle: "Income up to a rate that's taxed less than 28%, you'd want to fully utilise and then, once you get over that rate, then you're better at 28%."
This article is for general information only and is not personalised financial advice. Seek advice from a licensed financial adviser (registered on the FSPR) for guidance specific to your situation.