pensions for the twenty first century: retirement income … · 2012-06-14 · pensions for the...

Pensions for the Twenty First Century: Retirement Income Security for

Younger New ZealandersYou are invited to read this report and engage in one of the most important conversations of our time. The report, funded by Financial

Services Council members and others, was produced to provide the basis for New Zealand-wide consideration and debate. It takes a

longer-term perspective and incorporates new information and analysis on retirement income policy, challenges and opportunities.

Pensions for the Twenty First Century

The Financial Services Council of NZ

The Financial Services Council has 21 member companies and 17 associate members. Members are managing nearly $80 billion in savings and provide financial services to more than 1,800,000 New Zealand investors and policyholders.If you have a life insurance policy or a KiwiSaver account then there is a more than 80% chance it is managed by a Financial Services Council member.

Our thanks go to the following for their invaluable participation and/or funding:

FUNDING

FSC Members:Accident Compensation CorporationAIA NZAMP Financial ServicesANZ BankAsteron Life LtdBNZ Investments and InsuranceCIGNA Life Insurance NZ LtdFidelity Life Assurance Co LtdFNZGen Re LifeHealthHannover Life Re of Australasia LtdKiwibank LtdMercerMunich Reinsurance Co of Australasia LtdPinnacle LifePublic TrustRGA Reinsurance Co. of Australia LtdSovereign LtdSwiss Re Life & Health Australia LtdTOWER New ZealandWestpac Bank

Associate Members Bell GullyBNP ParibasBravura SolutionsBurrowes & CoChapman Tripp

Davies Financial & Actuarial LtdDeloitteDLA Phillips FoxErnst & YoungKPMGKensington SwanMelville Jessup WeaverMinter Ellison Rudd WattsMorningstar Research LtdPricewaterhouseCoopersRussell McVeaghSimpson Grierson

ADDITIONAL FUNDING

FSC MembersAIA NZAMP Financial ServicesANZ BankAsteron Life LtdBNZ Investments and InsuranceFidelity Life Assurance Co LtdHannover Life Re of Australasia LtdSovereign LtdSwiss Re Life & Health Australia LtdTOWER New ZealandWestpac Bank

Non MembersAon Hewitt

Project Advisers

Andrew Coleman, Motu Research, Member of the Savings Working GroupPaul Mersi, Member of the Savings Working GroupAdolf Stroombergen, InfometricsPaul R Rhodes, PwCGraeme Colman, Horizon Research

Independent International Peer

Reviewer

Professor John Piggott, UNSW, Director Australian Institute of Population Ageing Research (AIPAR)

Peer Reviewer of the Financial

Modeling

John Savage, formerly of NZIER


This report has been published by the FSC but the views expressed are not necessarily those of any member, funder or adviser

Retirement Income Security for Younger New Zealanders Page 1

Introduction 5

Executive Summary 6 Why is a new scheme needed? 6 The proposal 8 Our analysis 8

Section 1 - The future of retirement 10 Longevity after 65: trends in New Zealand 10

Section 2 - How fast is longevity increasing in New Zealand? 13

Section 3 - What does increasing longevity mean for the Government and taxpayers? 16

Section 4 - How well prepared are we for retirement? 18

Section 5 - Why won’t we save enough for retirement? 20

Section 6 - What are other countries doing about these issues? 22

Section 7 - How is New Zealand different from other countries when it comes to retirement incomes policy? 24 The pension gap with Australia 26

Section 8 - Is there a better way to fund retirement incomes? 28 What you get vs what you pay by retirement age 29

Section 9 - How can we preserve the option of retiring at 65 and provide more New Zealanders with a comfortable retirement? 30

Section 10 - What could KiwiSaver Plus look like? 32

Section 11 - What sort of incomes could KiwiSaver Plus provide for retirement? 34

Section 12 - How can we make this politically sustainable? 40

Section 13 - What would the transition look like? 42 Making the transition 43 Narrowing the pension gap with Australia 44

Section 14 - How would this change our future? 45

Section 15 - Can contribution-based retirement pensions be fair for women and the low paid? 46

Section 16 - Can a contribution-based retirement pension be fair for Maori? 47

Section 17 - What does this mean for people of different ages? 48

Section 18 - Why now, to start saving more for retirement? 49

Section 19 - Summary and recommendations 50

Recommended further reading: 51 Appendix 1 52 Appendix 2 53 Appendix 3 54 Appendix 4 55 Appendix 5 58 Appendix 6 59 Appendix 7 60

Table of Contents


PAGE

Table 1 – Number of New Zealand live births 1935-1979 10

Table 2 – Average life expectancy in New Zealand at 65, 1898 – 2011 11

Table 3 – Actual over 65 population compared to stats NZ Series 5 projections by year 11

Table 4 – Ratio of working age (15-64) to 65 plus population in New Zealand 1950 - 2060 (projection using SNZ Series 5) 12

Table 5 – Projected average life expectancy in New Zealand from age 65, 2011-2101 14

Table 6 – New Zealand population aged 65 & over under different longevity trends 15

Table 7 – New Zealand Superannuation (PAYGO) costs as percentage GDP 1970-2100 (FSC “Lancet” longevity) two years per decade 16

Table 8 – Estimated amount required per week to live comfortably - individual 18

Table 9 – Estimated amount required per week to live comfortably - couple 19

Table 10 – Average life expectancy gap (expectations compared with projections) 19

Table 11 – Percentage of people currently saving enough to retire on a comfortable income 19

Table 12 – Biases that distort our saving and investing behaviour 21

Table 13 – Changes in retirement income policy since 1990 23

Table 14 – How does New Zealand compare? 25

Table 15 – OECD retirement income replacement rate 25

Table 16 – Net replacement rate for average income earner 26

Table 17 – The current pension gap with Australia 27

Table 18 – The pension gap with Australia in 2055 assuming no New Zealand policy change 27

Table 19 – The relative size of SAYGO and PAYGO pensions when rates of returns and productivity change. 29

Table 20 – Average pension tax contributions and receipts by cohort 29

Table 21 – Risks and benefits of different retirement income funding options 31

Table 22 – Comparison of KiwiSaver now and KiwiSaver Plus key features. Both operating alongside NZS 32

Table 23 – Taking up the pension in either 2061 (at age 65) or 2066 (at age 70) 35

Table 24 – Taking up the pension in either 2061 (at age 65) or 2066 (at age 70) 10% contributions, 10 year phase-in 36

Table 25 – Taking up the pension in either 2061 (at age 65) or 2066 (at age 70) 12% contributions (10.9% effective) in

0.5% increments (12 year phase-in) 37

Table 26 – What KiwiSaver Plus could pay us in retirement versus PAYGO no change 38

Table 27 – Male on median male income retiring at 65 from 2061 39

Table 28 – Female on median female income retiring at 65 from 2061 39

Table 29 – What is the cost of funding NZS from savings (SAYGO) versus taxation (PAYGO)* 42

Table 30 – Costs of KiwiSaver Plus (SAYGO) transition as percentage of GDP (FSC “Lancet” longevity) 43

Table 31 – Costs as a percentage of GDP with no change PAYGO (current NZS) versus with SAYGO KiwiSaver Plus and PAYGO (NZS)

combined (FSC “Lancet” longevity) 44

Table 32 – Narrowing the pension gap with Australia with new KiwiSaver Plus retirement scheme by 2055 44

Table 33 – Pension comparison for males and females on 50% of New Zealand mean lifetime income 46

Table 34 – What does this mean for people of different ages? 48

Table 35 – Funding retirement incomes in 1955 and 2055 49

Table 36 – The price of procrastination is higher costs later 49

Table 37 – Summary and recommendations 51

Table 38 – Horizon Polling Budget 2011 – Q13 52

Table 39 – Horizon Polling Budget 2011 – Q6 53

Table 40 – Underestimating longevity 54

Table 41 – Understanding compound interest 54

Table 42 – Taking up the pension in either 2061 (at age 65) or 2066 (at age 70) (4% rate of return) 55

Table 43 – Taking up the pension in either 2061 (at age 65) or 2066 (at age 70) 10% contributions, 10 year phase-in 56

Table 44 – Taking up the pension in either 2061 (at age 65) or 2066 (at age 70) 12% contributions (10.9% effective) and 12 year phase-in 57

Table 45 – Total return by asset class in Australia over the past 25 years to end of 2009 58

Table 46 – One possible pathway to 10% contributions (5% from employer/5% from employee) 59

Table 47 – One possible timeline for the review of retirement income security policy 60

List of Tables


Young New Zealanders have the same high expectations about their future

quality of life as all preceding generations have done!

Recent work by Financial Services Council (FSC) into young New Zealanders’

expectations and aspirations concerning retirement, along with technical

research into longevity assumptions and the funding required to support the

future retired, makes interesting and compelling reading. I think they will

challenge your assumptions as they did mine. The FSC hopes that this report will

contribute to a new conversation amongst all the stakeholders involved in the

future planning, funding and managing of retirement for the under 40s and for

that generation themselves to take a position in what would work for them.

Financial Services Council has undertaken this work as part of a public / private

policy project to convene a conversation that will in due course deliver greater

certainty for all concerned. We appreciate that our political colleagues in each

political party will have views on this matter as will other stakeholders, and

several generations of young New Zealanders already born and well on their

way through their life journey. It is our hope that this document will inform,

inspire, ignite and excite people into that new conversation which in due course

may identify and bring certainty to the expectations these young people have

expressed about how they wish to experience their retirement.

We urge all stakeholders and political leaders current and future to see this

as both an opportunity and an obligation, and we look forward to engaging

constructively in order to move this project forward. The Financial Services

Council represents many industry players who currently are entrusted through

KiwiSaver, other investments, savings and insurance services, with managing

the long-term savings of both young and older New Zealanders alike. We do not

wish to disrupt older New Zealanders’ arrangements in any way. They are not

affected by proposals in this report. We do however believe that younger New

Zealanders have a desire and a need to fully understand what their opportunities

are, and what challenges they face. Further, we believe those of us in leadership

roles have an obligation to see that their long-term needs and interests are

addressed while they still have time to influence their levels of wealth in

retirement. That’s what this report seeks to offer.

We are partners in this whether we like it or not, and we hope that new

partnerships can emerge where public policy, private enterprise and personal

endeavour converge and conclusions can be drawn.

We also offer some new projections on longevity. If our assumptions are correct

then there are significant implications which need to be taken into account. We

hope that the public policy leaders both political and public service will do their

own research and either validate or dismiss our projections in order for future

commentary to be accurate and fully informed. We offer this report in good faith

as a starting point for one of the most critical conversations of our time!

We look forward to working with partners in this regard as well.

Rt Hon Dame Jenny Shipley

Chair of the Financial Services Council

Introduction


Executive Summary

The Financial Services Council (“FSC”) Long Term Saving and KiwiSaver

project outlines a retirement system that is designed for the 21st century.

It maintains the best features of the current New Zealand Superannuation

scheme, but is designed to meet the aspirations of New Zealanders under

40 who:

Our aim was to demonstrate, as the basis for an informed discussion, an

affordable plan that preserves older New Zealanders’ rights to NZS, but

offers younger New Zealanders and future generations of New Zealanders:

NZS is a “pay-as-you-go” funded retirement scheme that provides the same

base level of retirement income to all eligible New Zealanders once they

reach the age of eligibility. A “pay-as-you-go” scheme means this year’s

pension payments are funded out of this year’s taxation. This means that the

tax rates needed to fund the scheme are low when the number of people in

retirement is small, or when the level of the pension is low.

The small number of people born in New Zealand each year prior to 1950,

combined with relatively low longevity, meant NZS could be funded with

relatively low tax rates for most of the 20th century. However, increases in

how long we live after 65 means that the current form of NZS cannot be

maintained without requiring significant increases in taxes in the future. In

turn, this suggests one of two alternatives will occur:

Either way, it does not appear that the mix of low taxes and early eligibility

that have made NZS attractive until now can be maintained in the 21st

century.

The issue of how increasing longevity affects the design of retirement

income systems is not unique to New Zealand. It affects all OECD countries.

However, New Zealand has an unusual retirement income system that

may make it more difficult to adapt to the changing circumstances of the

21st century than the systems in other OECD countries. First, all OECD

countries except Ireland and New Zealand have mandatory retirement

income schemes that link the amount of retirement benefits to the amount

an individual has paid into the scheme, either as taxes or as contributions to

a mandatory personal saving account. This not only reduces the disincentive

effects of higher taxation, as people know they will get a large fraction of

their contributions back as retirement benefits, but it also means that most

New Zealand households have lower mandatory retirement incomes than

households in other OECD countries. If New Zealand policy were to raise the

age of eligibility further, New Zealand households would rely on their own

voluntary savings to fund their retirement to a greater extent than almost any

other people in the OECD.

Secondly, NZS is primarily funded on a “pay-as-you-go” basis. Since the

taxes that are collected to fund retirement incomes are immediately paid

out as pensions, this system of funding accumulates no capital. In contrast,

the alternative “save-as-you-go” funding mechanism accumulates capital

into an investment fund as the contributions are paid, and the fund and

accumulated earnings are used to pay pensions when people retire. As long

as the return to the fund is greater than the growth rate of the economy,

which has been historically true, this funding arrangement means that in


the long run lower taxes or contributions are needed to fund any level of

pension, or a greater pension can be funded from any level of contribution.

Our proposal is to create a retirement income system that, while maintaining

many of the attractive features of NZS, gives it much greater flexibility in the

future. We propose a system where universal entitlement to NZS will remain,

where the age of eligibility will be increased as longevity increases, and

where people make larger contributions to an enhanced KiwiSaver scheme.

It means that the power of compound interest can be utilised to increase the

amount of pension available from any level of contributions. It will enable

most people to have higher retirement incomes than they could expect

under the current fixed-rate NZS system by linking retirement incomes

to contributions. And it will allow people to use some of their personal

retirement income account balance to fund their retirement between the

time they turn 65 and until they are eligible to receive NZS.

This system will have some features that are similar to the Australian

Superannuation Guarantee scheme, introduced in 1992. Australia

requires employers to pay nine per cent (rising to 12 per cent by 2019)

of an employee’s income into a personal superannuation account that

can be used to provide income in retirement. In Australia these funds are

supplemented by a means-tested basic pension. The Australian scheme

means that the typical Australian currently aged in their early 40s will retire

on an amount twice as large as the typical New Zealander, if NZS remains

unchanged. The proposal we are suggesting is designed to ensure that this

gap does not get even larger for New Zealanders in their 20s, and those

younger still.


The proposal

to fund their retirement and for most to lift retirement incomes

We acknowledge that our proposal, which we have called KiwiSaver Plus, is

one of many that could be adopted, and we are even agnostic as to whether

it should be voluntary or mandatory. But our research has led us to believe

that this or a similar structure has many advantages.

expected under the current NZS scheme, enabling New Zealanders to

meet their retirement aspirations.

a personal account to fund retirement between the age of 65 and the

age of eligibility for NZS.

return, the scheme will eventually reduce the total cost of providing

retirement incomes for future generations.

higher age of eligibility is reached.

exhausted, it would become part of the person’s estate as would the

remaining payments of the fixed-term pension.

their retirement will save an inappropriate amount.

reducing the incentive of future New Zealanders to migrate to Australia

to take advantage of their scheme.

of NZS is unsustainable and suddenly cut the entitlements of those

already in or close to retirement.

Our analysis

In the course of this project, we conducted a variety of pieces of research,

using the large overseas literature on retirement schemes as our guide.

Our sources included the work of the OECD on pensions, the seminal

2009 article in the respected journal “The Lancet” on longevity trends and

the economic analysis of pensions drawing on the work of Nobel Prize

winner Peter Diamond and Martin Feldstein. Our primary findings include

the following:

live for 15 to 20 years after retirement, we now have a future where

someone who may not start their first job until age 25 after study,

training and their OE, may live almost as long in retirement as they

were in the workforce.

applying “The Lancet” forecast assumptions, would change the population

over the next hundred years. Life expectancy after reaching 65 has

increased by two years per decade for the last 50 years. If this trend

continues, their projections indicated that for New Zealanders born in

2011, 52 per cent of females and 44 per cent of males would reach 100.

This longevity trend increases the challenge of the policy and funding

issues that already exist based on current forecasts and expectations.

eligible for NZS at 65, the cost of NZS to the taxpayer will grow from four

to five per cent of GDP currently to 10 to 12 per cent later this century

(2080). That would require our tax rates to increase by 28 per cent.

cent of GDP, the age of eligibility for NZS was increased and the level

of benefits for those in retirement or about to retire was maintained.

a pension and increasing the retirement age. Most people who have

looked at these trends suggest it is inevitable that eventually New

Zealand will have to do so as well. Some countries, like the United

Kingdom and Sweden, have proposed moving their pension age out

automatically as longevity increases.

equivalent income to NZS without having very large increases in tax

rates, we need to find a way to fund the income gap between 65 and

the new age of eligibility.

of retirement benefits, or to increase the benefits from any level of


contributions, is to switch the funding mechanism from a “pay-as-you-

go” (PAYGO) basis where benefits are funded from contemporaneous

taxation to a mixed system that includes a “save-as-you-go”

(SAYGO) component, where benefits are funded from a capital fund

accumulated from earlier contributions.

expected to provide 60 per cent higher benefits for the same level of

contributions. If you save one per cent of your income while you are

working and leave it in an account earning three per cent a year, after

inflation, fees and tax the effect of compound interest gives you a 60

per cent higher pension than if you give one per cent of your income

as a pension to an older person, and get one per cent of a younger

person’s income as a pension when you retire.

require some people to pay more than they otherwise would have

had to pay, as they will need to fund the retirement of their parents

and grandparents and a greater part of their own retirement. This

transition will need to occur whether the Government explicitly adopts

an enhanced KiwiSaver system, or raises the age of entitlement and

simply lets people save for their retirements by themselves.

transition to a retirement income system with a greater SAYGO

component, as there are relatively few people aged over 65 compared

to the working age population. This means that working age people are

currently paying relatively little to fund their parents’ and grandparents’

generations, and are in a better position to let New Zealand make the

transition than will be the case in 20 years’ time.

mixed SAYGO-PAYGO system is feasible and beneficial.

a scheme like KiwiSaver so that most employees are contributing and

we would need to gradually lift contribution rates over a decade from

the soon-to-be three per cent from employers and three per cent from

employees to five per cent from each. One way of doing this would be

to move contributions by employers and employees up by half a per

cent a year over a decade as the economy recovers, until the combined

amount reaches 10 per cent of wages.

suggest aiming for a cross party agreement that at least 75 per cent

of the New Zealand Parliament will vote for the long-term plan. Failing

that, if the plan is agreed by a majority, but less than 75 per cent of

the Parliament, the Government will put the legislation to a referendum

to be voted on at the next election in 2014. If the Parliament agrees

to the legislation by a 75 per cent majority it could proceed without a

referendum. Future changes should only be done by 75 per cent of the

Parliament agreeing, or by another referendum.

as though moves to widen participation in a contribution-based

superannuation scheme (SAYGO) working alongside NZS could achieve

widespread support. We have suggested a staged work programme to

achieve a robust and widely supported sustainable retirement income

policy in New Zealand.

of those in or about to enter retirement. This is about securing the

retirement incomes of future generations, not about changing the

entitlements currently in place. It builds on the current NZS and

KiwiSaver schemes and makes NZS more secure for the future.

moment we still have enough people in employment to do the saving

required. If we delay both the costs and the politics of the change

become too difficult. If we save more now we can enjoy lower costs

later. This is a better long-term option for both young and old alike.


SECTION 1 The future of retirement

longer on average.

Most of us have heard about our ageing population of “baby boomers”,

those born between 1946 and the early 1960s. The Great Depression of

the 1930s and the Second World War made raising a family difficult but that

trend reversed in the post war economic boom and the number of births

in New Zealand peaked in 1961. Since then the number of children in a

family has also tended to reduce, accelerating the ageing of the population.

While people born during the baby boom are beginning to retire or become

eligible for NZS, the proportion of the population in the over 65 group will be

growing faster than the numbers going into employment. Some estimates

have the over 65 population growing four times faster than the workforce.

Each successive generation has better health than its predecessor, so many

of the people eligible for NZS continue in some form of employment after

reaching 65.

There have been quite substantial increases in the proportion of those over

65 participating in the workforce. In New Zealand it is much higher than in

many other developed countries. One reason is that our base pension, NZS,

is not income or asset tested. The other reason is that our pensions are

quite low compared with average incomes and we have a higher pension

access age than in some countries. There are both income and other

benefits if you can work beyond 65 and any retirement income policy should

enable this option to continue. We don’t know all the reasons for it but there

is evidence that people who stay on in employment not only enjoy higher

incomes but also appear to get other benefits from staying active in the work

force. We also now have much greater expectations from our retirement.

Our grandparents may have been content at retirement to make a once in

a lifetime overseas trip; but the current generation of new retirees expect to

enjoy an active lifestyle for longer and to do much more travel.

When Premier Richard Seddon introduced New Zealand’s first old age

pension in 1898 average life expectancy at 65 was for a further 12.2 years

for men and 13.3 years for women. If we look at the trend for increasing life

expectancy after 65 we can see how much things have improved since 1898.

Over the last century average life expectancy after 65 has almost doubled.

The FSC asked a PricewaterhouseCoopers actuary to project forward the life

expectancy at 65 for people born in NZ in 2011 based on the increasing life

expectancy trend being seen in highly developed countries.

Those projections suggest that if we follow the long-term trends seen

here and in similar countries 52 per cent of New Zealand women born in

2011 and 44 per cent of men born in that year will get to age 100. Our

grandparents expected to live for no more than 15 to 20 years in retirement

and, if they were mortgage free by retirement, their home was low

maintenance, the whiteware and car were new, they could live frugally on

NZS for the rest of their days.

1935

1937

1939

1941

1943

1945

1947

1949

1951

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1073

1975

1977

1979

Source: Infometrics from Statistics NZ


Now think about the person born in 2011. With university or trade training

followed by OE, that person may not get into a full-time career job before

age 25. If they retire at age 65 retirement could last for almost as long

as employment. In 30 to 40 years of retirement they will probably need to

completely refurbish their home and possibly replace three cars, not one.

These longevity projections are based on what we are already experiencing.

When the results for the 2006 Census were released the updated forecasts

projected 160,000 more people over 65 by 2051 than had been expected

on earlier middle assumptions, Series 5 projections. Those earlier Series 5

projections were based on average life expectancy at 65 increasing by just

over one year each decade. Statistics New Zealand produces a number of

projections for the future 65 plus population.

Most users use the middle assumptions Series 5 projections, assuming

they are most likely to be in the middle of the expected range. Around the

developed world official mid-range estimates have tended to underestimate

the growth in the 65 plus population. The graph below shows how earlier

projections have compared with the actual 65 plus population growth

over the last 20-30 years. The Series 5 estimates have needed to be

Year 65

Source: Infometrics from Statistics NZ

Source: PwC from Statistics New Zealand

1991

1996

2001

2006

2011

Actual

1982

1988

19941996

19992001

20042006

2009

1991

600

550

500

450

400

350


SECTION 1 Continued

consistently increased to match the actual growth in the over 65 population.

The long-term trend has seen around two years per decade improvement

in longevity. Between 1996 and 2006 the increase in New Zealand was

three extra years living in retirement. The projections we had prepared

just assumed that what had already occurred for over 50 years would

keep on happening. They did not assume any break-through that

may dramatically improve life expectancy, such as being able to grow

replacement human organs from stem cells, personalised medical

treatment or prevention programmes based on our individual genetic

makeup, or some anti-ageing pill. Nor did we assume that increased

obesity will stop this trend although obesity is associated with Type II

diabetes which tends to reduce life expectancy. Overall it looks like we

can look forward to both a much longer life and potentially a healthier

retirement, which is great. But what do these changes mean for the cost

to taxpayers of funding NZS for our longer retirements?

The graph in Table 4 shows how the ratio of people of working age to those

eligible for NZS has gone from 7 to 1 in 1970 to a projected 2 to 1 by 2060.

Note that we believe the Statistics NZ Series 5 projections underestimate the

likely longevity trend and therefore the ratio is likely to decline more sharply

than shown in the graph.

It should be noted that many people in the 15 – 64 age group such as

school or tertiary students may not be in the workforce, and could be

described as “dependent”, and a number of people over 65 are still in

employment and therefore are not “dependent” although they are likely to be

receiving NZS.

Source: Infometrics from Statistics New Zealand

1950

1970

1990

2010

2030

2050

2070


SECTION 2 How fast is longevity increasing in New Zealand?

The Series 5 estimates were based on an assumption that each decade

those people who had reached 65 could expect to live about one year

longer than their decade older predecessors.

An article in the British Medical Association Journal, The Lancet, in 2009

said that, based on the long-term longevity trend of around two more

years each decade, the majority of people already born since the year

2000 will live past 100 in highly developed countries like New Zealand.

Source: The Lancet, Vol 374, October 3, 2009

Summary

If the pace of increase in life expectancy in developed countries over the past

two centuries continues through the 21st century, most babies born since

2000 in France, Germany, Italy, the UK, the USA, Canada, Japan, and other

countries with long life expectancies will celebrate their 100th birthdays.

Although trends differ between countries, populations of nearly all such

countries are ageing as a result of low fertility, low immigration, and long

lives. A key question is: are increases in life expectancy accompanied by a

concurrent postponement of functional limitations and disability? The answer

is still open, but research suggests that ageing processes are modifiable and

that people are living longer without severe disability. This finding, together

with technological and medical development and redistribution of work, will be

important for our chances to meet the challenges of ageing populations.


SECTION 2 Continued

This table and the graph opposite show the population of over 65 year

olds we can expect if the trend is one, two, or three years a decade over

the next 100 years. We have used the FSC “Lancet” Series for our own

forecasts because we expect that it is more likely to be closer to the

actual longevity trend than the Statistics NZ Series 5 projections that

are most frequently used. The FSC “Lancet” forecasts assume that the

longevity of 65 year olds will continue to increase by two years each

decade in the future.

You can see from the graph that getting our longevity estimate right can

make a huge difference in the number of New Zealanders over 65 we

expect to have in 2061 or 2100.

If you are over 50 you probably are saying “so what, that’s an issue for

the grandchildren”. If we don’t start planning for the possibility, however,

we may face a situation where tomorrow’s taxpayer may be reluctant to

pay more tax to support the growing numbers in retirement. It is always

difficult making long-term forecasts, but equally it is not smart to ignore

likely future occurrences that will have a significant impact on retirement

incomes, health and aged residential care policies.

Better healthcare and diet, combined with reductions in cigarette smoking,

are believed to be part of the story about why we are living longer.

Scientists believe there may be constraints on longevity growth, such

as the number of times cells can replicate themselves, but anti-ageing

research continues.

With much of our expenditure on pensions, healthcare and aged

residential care being funded out of taxation, the increasing number of

people over 65 can be expected to increase the cost to taxpayers for

the balance of this century. If we do not get the balance of costs and

benefits between generations right we place the implicit contract between

the generations in jeopardy. When we are young we receive education

and health benefits funded by our parents and grandparents. Later as

taxpayers we fund the education of the young and the health services

and pension of our parents’ and grandparents’ generation. Demographic

changes are challenging the sustainability of some of these transfers.

scenarios Year 65


3000

2500

2000

1500

1000

500

0

1950

1960

1970

1980

1990

2000

2010

2020

2030

2040

2050

2060

2070

2080

2090

2100

2110

Sources:* Historical – NZ Stats. *Statistics NZ Series 5 –1 extra year of life after 65 each decade.*FSC “ Lancet” Projections – 2 extra years of life after 65 each decade.* Recent NZ 1996-2006 Trend (ELL) – 3 extra years of life after 65 each decade.


SECTION 3 What does increasing longevity mean for the Government and taxpayers?

The retirement of the baby boomer generation and the rapidly increasing

length of time we live past 65 (longevity) means we will have many more

people eligible for a pension and for more years in the future. If current

longevity trends continue, and we have no reason to expect that they will

not, then the number of people eligible for a pension will grow massively

by the second half of this century.

Currently, we are spending around four or five per cent of national income

(measured as GDP) on NZS. On the FSC “Lancet” trends currently

underway we can expect this percentage will grow to almost 12 per cent

of GDP by later this century.

Paying for this would require us to increase tax rates by about 28 per

cent, so, if that happened today, on our current tax rates the 17.5 per

cent income tax rate would rise to 22 per cent, the top 33 per cent

income tax rate would rise to 42 per cent, the GST rate would rise from

15 per cent to 19 per cent, and the corporate rate from 28 per cent to

36 per cent. This tax burden may be unacceptable to future taxpayers

who may decide through the political process to reduce the level of NZS

or tighten eligibility relatively suddenly to make it more affordable for

themselves.

In the past when we became aware that the cost of NZS was trending

toward seven or eight per cent of GDP we made changes to cut the cost

by moving out the age of eligibility for future recipients rather than cutting

the benefits of those already retired or close to retirement.

One way of dealing with this cost issue would be to gradually move out

the age of eligibility for NZS as longevity increases. NZS would continue

to be available without income or asset testing, but at a later date.

Income tested social security benefits like unemployment and sickness

benefits would continue to be available for those unable to work because

of sickness or unemployment up until they were eligible for NZS. There

would still be the option of continuing to retire at age 65 for those who

save during their working lives to fund an adequate income from age 65

until they became eligible for NZS.

Moving in that direction by increasing the rate of contributions to

KiwiSaver and having KiwiSaver cover all employees would allow future

generations to continue to retire at 65 without increasing the cost of NZS

for future generations of taxpayers.

To make such a transition we need to start increasing participation by

employees in KiwiSaver and gradually increasing the proportion of income

14%

12%

10%

8%

6%

4%

2%

0%

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

Source: Infometrics


saved in KiwiSaver accounts. You might ask why we don’t simply do

nothing and subsequently pay the 12 per cent of GDP required to fund

taxpayer based pensions into the future. The problem with that option is

that it may make New Zealand a less attractive place for people to spend

their working lives as it would require the next generation of employees to

pay more of their income in tax to support the growing number of people

over 65. If people in other countries such as Australia are funding their

own retirement incomes from savings through contributions out of wages

and salaries, their tax rates will be comparatively lower and that will look

more attractive than working and paying more tax in New Zealand to fund

retirement incomes mainly from taxation.

New Zealand was one of the very early reformers when it introduced the

old age pension in 1898, but the pension was only for those aged over 65

and of “good character”. It was funded out of taxation so the retired were

supported by the earning taxpayers.

Count Bismarck in Germany had introduced an old age pension

scheme in 1889 and that model was the one adopted around most

of the developed world, with the exception of New Zealand, Australia

and Ireland. In most countries, like Germany, the predominant

means of funding retirement incomes was contributions based on

employee income. Retirement benefits were then linked to the level

of contributions or pre-retirement income, much like the scheme used

in New Zealand to provide pensions for public servants. A basic aged

pension was available in Germany for individuals whose contributions

were insufficient to prevent poverty in old age.

The New Zealand system has the virtue that it pays a good basic pension

to everyone eligible without income or means testing. It provides a level

of income that has enabled us to eliminate poverty in old age for anyone

who owns their accommodation, without a mortgage, by the time they are

65. In New Zealand, regardless of what you earned during your life, you

receive the same level of pension. In the past that has meant many people

on low incomes and women who were not in the paid workforce for some

of their career often received a modest income boost after age 65. It has

also enabled many people to continue working past 65 as they do not lose

any of their pension income because of wage or salary earnings after 65.

While our economy and our working age population were growing faster

than the number of aged pensioners the cost to the taxpayer was relatively

modest, around four to five per cent of GDP. As our population ages and

now that people are living much longer after 65, the cost of taxpayer

funded universal age pensions will begin to increase as a percentage of

our national income measured as GDP.

To avoid these issues some countries have used Save As You Go

contributions to build up savings to fund retirement pensions rather than

relying only on the Pay As You Go (PAYGO) tax based system approach to

fund their major form of retirement pension.

New Zealand could learn from these approaches if we want to preserve

retirement at 65 as an option for all and lift retirement incomes.


SECTION 4 How well prepared are we for retirement?

In December 2011 the FSC commissioned a survey of New Zealanders

to look at how well we are prepared for retirement (Horizon Research,

Horizon Poll Panel, 2,558 respondents, at the 95 per cent confidence

interval, has a margin of error of +/- 2.1 per cent for the national sample).

Of those currently retired, a little over 50 per cent say they have an

adequate or more than adequate income. However, they were mainly the

people who were living in a home with the mortgage fully paid off. For

those still paying off a mortgage only a little over 15 per cent said they

had an adequate or more than adequate income to live on.

When current retirees were asked whether their income was as much as

they expected before retirement, some 61.5 per cent said “no”.

When asked about when they planned to retire, the average expected

retirement age was 67.6 years but, significantly, the numbers nominated

tended to cluster at 60, 65, 70 or 75 as expected retirement ages.

Only 29 per cent of New Zealanders thought NZS alone would be

sufficient to meet their retirement needs and only 10.1 per cent thought it

alone would provide enough for them to live comfortably in retirement.

On average, people thought about another $300 a week above the current

level of NZS would be needed for a single person to live comfortably and

another $330 a week above NZS levels for a couple to live comfortably.

Only one third of New Zealanders thought they would have enough in

retirement income from NZS alone to cover their basic costs, with another

third not knowing whether it would.

Typically, people underestimated their likely duration of life beyond 65 and

nearly 80 per cent of respondents had some concern that their savings

would run out before the end of their lives.

It is notable that the underestimation of longevity is currently greatest for

those furthest away from retirement, when saving would be most effective

in boosting retirement income.

Of those surveyed, 62.9 per cent said they were not currently saving

enough to give them a comfortable retirement.

Some 58.4 per cent believed that New Zealand could not afford to keep

funding NZS if eligibility remained at age 65.

In summary, most New Zealanders want to retire by 68 and want higher

incomes in retirement than are provided by NZS, but at the moment we

are not saving enough to make it happen. Over 60 per cent said they did

not know how much they will need to save and 45 per cent say they are

not really planning for retirement.

On these numbers it looks as though New Zealanders need help to

understand how much they will need to save and some sort of plan to

make that happen. Most New Zealanders want to retire on an income

higher than NZS but need help to get there.

$601 to $800

$551 to $600

$501 to $550

$401 to $500

$300 to $400

Source FSC Horizon Research Dec 2011* NZS for an individual living alone $339.92 per week after Tax at ‘M’ rate as at 1 April 2011

0% 5% 10%

15%

20%

25%


$601 to $800

$551 to $600

$501 to $550

$401 to $500

$300 to $400

Source: FSC Horizon Research Dec 2011* NZS for a couple $522.96 per week after Tax at ‘M’ rate as at 1 April 2011

0% 5% 10%

15%

20%

25%

30%

Source FSC Horizon Research Dec 2011

Source: FSC “Lancet Projections” and Horizon Research Dec 2011

100

90

80

70

2011

or e

arlie

r

2012

-202

1

2022

-203

1

2032

-204

1

2042

-205

1

2052

-205

8

2059

-206

1

FSC “Lancet” - WomenSelf - Women


SECTION 5 Why won’t we save enough for retirement?

Some 1.9 million New Zealanders now have a KiwiSaver account but some

of those accounts do not currently have regular contributions being paid

into them. For the KiwiSaver accounts where contributions are ongoing,

the typical contribution rates of two or four per cent of salary with another

two per cent from the employer (three per cent from 2013) are insufficient

to provide a comfortable income in retirement. With each successive

generation of people living longer it is likely the age of eligibility of NZS

will need to move out. It will require some serious saving to keep the

option to retire at 65, or to put our retirement incomes up to the level to

provide comfort in retirement, about two times the level of NZS. It will also

probably require starting that saving from when we begin working.

Before we had a welfare state people needed to save if they wanted to

have a comfortable retirement but most people were too poor to save

much and often relied on living with their children and hoping they would

be willing to share. In those days your social security came from the

number of surviving children you had.

We decided this wasn’t an acceptable arrangement and by 1898 in New

Zealand an old age pension was introduced. The fact that most developed

countries have an old age pension suggests that there is broad agreement

that voluntary savings alone will not prevent poverty in old age and that

many of us will not save enough unaided.

Saving for retirement sounds like a useful idea but we may not do it for a

variety of reasons:

Investment decisions are not always well informed.

New Zealanders have tended to invest in real estate in addition to the

family home rather than shares in companies although shares have

outperformed investing in “bricks and mortar” in the longer term.

People investing in shares or equities tend to buy the companies that pay

out a high proportion of their earnings as dividends rather than the ones

that can grow and employ more people because they retain earnings to

invest in promising opportunities.

Even when investing to fund retirement, many decades away, people tend

to over react to short-term trends. For example, they buy into shares or

funds that have outperformed the market recently which are likely to then

underperform in the near future.

Similarly, they buy when the market is hot and prices are high, meaning

the risk of a price fall is greater. When prices fall inexperienced investors

get out rapidly so prices drop further, depressing the market, and they

then miss out on participating in the rising market that usually follows.

The research undertaken in the last 40 years into behavioural economics,

in particular the work of Daniel Kahneman and Amos Tversky on how

people actually make economic and financial decisions, shows that we are

very prone to quirks and biases that are likely to prevent us from retiring

with the earnings we intended. The main ones are listed in Table 12.

As a consequence of these quirks and biases even smart people may end

up at retirement regretting they had saved less than they wanted.

Sometimes doing the right thing, like saving, giving up smoking or losing

weight is hard to achieve and people need help.

KiwiSaver is helping 1.9 million New Zealanders to do some saving. The

challenge now is to lift the level of saving so most New Zealanders can

arrive at retirement with mortgage-free accommodation and enough

savings for a comfortable retirement.


Loss Aversion

Regret

Self Control -

Source: Andrew Coleman, Motu Research

Table 12 – Biases that distort our saving and investing behaviour


SECTION 6 What are other countries doing about these issues?

Underlying issues with the long-term viability of pension systems in

developed countries have come to a head with the arrival of the Global

Financial Crisis, just as the first wave of baby boomers born after 1945

become eligible for a pension.

There will be a gradual ageing of the population as the baby boomers retire

and are followed by a smaller generation (their children and grandchildren)

becoming wage earners. Not only is the number of retirees increasing,

they are living much longer than had been expected. So governments are

paying more retirement pensions for longer just as the finances of most

governments are the worst they have been in two decades.

In some countries like France and Greece, benefit levels are being cut

and access to retirement pensions is being delayed with very little notice.

These are countries where some workers have a pension age of 60 or

less. Understandably those close to retirement have been very upset by

these sudden changes.

The general recessionary conditions and the extremely loose monetary

policy being used to prevent a collapse of house prices and share markets

has produced the lowest interest rates in almost three decades. When

interest rates drop, pension funds need more capital to deliver the same

income to retirees. As a consequence governments and employers in

Europe and the USA are being asked to increase contributions just to

maintain existing pension entitlements.

In Britain, the previous Government had decided that the pension age

would increase to 68 by 2046. The new coalition Government has

decided to lift the age of eligibility for a pension to 66 from 2018,

earlier than was proposed by its predecessor, to 67 from 2026, and is

considering bringing forward the date by which the pension age will

move to 68. In the recent Speech from the Throne outlining its legislative

programme, the British Coalition Government announced its intention to

index the age of eligibility for its age pension with increasing longevity.

Sweden and Denmark are both proposing that their retirement age will

continue to rise in line with increasing longevity. (In Sweden you can

obtain a pension from 61 but at a much reduced rate compared with a

later retirement age.)

The USA is moving its retirement age in stages to 67, as are Australia,

Denmark, Spain and Germany.

Accompanying these changes most of these countries are also reducing

barriers to the continued employment of people after they are eligible for a

pension. Many of these countries are forecasting a doubling of the cost of

public retirement pensions over the next 20 years if changes are not made.


AGE OF ELIGIBILITY

Australia

Future changes in eligibility age directly

Germany

Phased abolition of favourable tax treatment

IrelandTightening contribution conditions for access

Eligibility age to be increased to 66 from

United States



SECTION 7 How is New Zealand different from other countries when it comes to retirement incomes policy?

New Zealand is unusual in that its predominant source of retirement

income is in the form of a flat rate pension paid to the over 65s by current

taxpayers. In effect each generation of working age taxpayers pays for

their parents’ and grandparents’ retirement pensions. New Zealand and

Ireland are the only developed countries to take this approach. In most

developed countries the predominant source of income in retirement is a

pension related to the contributions made on previous earnings.

Tier 1 a publicly provided pension like NZS.

Tier 2 a mandatory personal retirement scheme or schemes.

Tier 3 a voluntary personal retirement savings scheme or schemes

like the current KiwiSaver.

A Tier 1 scheme like NZS usually pays out a pension unrelated to what

taxes or contributions you have made to the Government. In New Zealand

we pay a flat rate benefit to all people that have been resident in New

Zealand for the qualifying period and the benefit is subject to neither asset

nor income tests. This arrangement is relatively generous for people

who have had very modest incomes throughout their adult lives. Without

assets or income testing it provides a strong incentive to keep on working

past the age of eligibility for NZS, currently at age 65. For some people

on very low incomes for much of their working lives, working past 65

gives them the highest income they have ever had in their lives and New

Zealand’s approach has been very effective in almost eliminating absolute

poverty in retirement amongst our older citizens provided they own their

own home mortgage-free by 65.

Where New Zealand is very unusual is that unlike most developed

countries it does not have the mandatory second tier which enables the

majority of citizens in those countries to enjoy a comfortable retirement.

Ireland is the only other OECD country without a mandatory Tier 2

scheme, but features of their scheme, including widespread enrolment

in concessionally-taxed workplace-based contributory retirement savings

schemes, mean their retirement arrangements are closer to those of other

OECD countries than New Zealand.

In countries with a second tier, employees (and often employers) pay taxes

or make mandatory contributions into a fund while they are working. The

retirement incomes they receive are related to their previous earnings or

their level of contributions.

Schemes with benefits based on members’ previous earnings would be

described as defined benefit schemes. There has been a trend to put

a stop on new enrolments in defined benefit schemes and to develop

defined contribution schemes, in countries such as Australia or Chile. In

these schemes the level of benefits is dependent on the level of member

contributions and investment returns achieved in the fund.

Since 2007, New Zealand has had a Tier 3 scheme, a voluntary personal

retirement savings scheme called KiwiSaver. While contributors benefit

from some incentives these are modest compared with what other

developed countries provide.

New Zealand provides a combination of a universal base level pension

combined with a voluntary personal savings scheme, which does a good

job of preventing absolute poverty in New Zealand’s senior population. It

does not, however, mean most New Zealanders end up with a comfortable

retirement.

Someone on the average income in New Zealand receives a retirement

income from NZS that is a little over 40 per cent of their pre-retirement

income, whereas someone in Australia would receive nearly 60 per cent

of their previous earnings and the average for the OECD is almost 70 per

cent of previous earnings for someone on the average wage. In most

OECD countries including Australia, employees make regular compulsory

contributions toward their retirement savings and as a consequence enjoy

much higher incomes in retirement.


COUNTRY TIER 1 TIER 2 CONTRIBUTIONS

TIER 3

Australiascheme

9%

scheme11%

Irelandon contributions history

15%

or income tested

USA Public scheme 12%

Germany Public scheme 20%

Central Provident Fund 29%


70%

60%

50%

40%

30%

20%

10%

0%

Source: AMP Capital 2011 from Pensions at a Glance OECD 2009* Replacement rates are the percentage of pre-retirement income represented by the retirement income.

Aust

ralia


SECTION 7 Continued

The graph above shows that New Zealand, along with Ireland, is at one

extreme of international practice with respect to level and funding of

retirement incomes. First, for someone on the average wage we only

provide a pension worth 40 per cent of previous earnings and secondly,

our pension is almost entirely funded from current taxation, whereas most

other developed countries have most of their retirement pensions funded

from savings.

With the deterioration in developed countries’ government accounts since

the Global Financial Crisis, many governments are suddenly having to

cut retirement benefits and push out the date for eligibility for retirement

benefits. Increasing longevity is also requiring governments to review their

retirement incomes policies. In New Zealand there is merit in looking at

turning KiwiSaver into a Tier 2 scheme to ensure all New Zealanders can

enjoy a more comfortable and secure retirement.

Australian retirement incomes from their age pension and compulsory

Superannuation Guarantee are much higher than those paid in New

Zealand for several reasons:

Once you earn more than the median income the pension gap with

Australia becomes significant.

What this means is that if one New Zealand twin with the same

qualifications as the other went to Australia in 2011 and earned the

average wage in Australia, their retirement income in 2055 would be more

than twice as high as the twin who stayed in New Zealand and earned the

average wage here. For this comparison we assumed that wages would

increase in both countries at the same rate from now on. To achieve

that more than 100 per cent higher retirement income in Australia, the

Australians would have only needed to have made 44 per cent higher

contributions on average as a share of GDP. This pension gap will provide

a major incentive for our young people with the highest earnings potential

to move to Australia taking their tax revenue with them. This will make it

even harder to keep funding the NZS scheme on a PAYGO basis. We may

not be able to fix the fact that Australians already have higher incomes but

we can decide to have our own contribution-based super scheme to help

close the gap.

120

100

80

60

40

20

0

GREICE

LUX

NZ

IRE

AU

CZECAN

ISR

TUR

POR

US

SPN

FRA ITYNOR POL

SWZ

Source: OECD 2011

0 10 20 30 40 50 60 70 80 90 100


90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Australia

Source: Andrew Coleman, Motu Research* The replacement rate is the percentage of your previous earnings that your pension delivers from the compulsory system in the respective countries

PENSION IN 2055AUSTRALIAN PENSION FOR

IN AUSTRALIA

RATIO AUSTRALIAN PENSION FOR

IN AUSTRALIA

RATIO

34% 52% 59%

CONTRIBUTIONS

2011

2055

Average 2011-2055

* This table compares the compulsory retirement systems in both countries. Australia has its age pension and its Superannuation Guarantee whereas New Zealand has New Zealand Superannuation and no compulsory retirement savings scheme.**The ratio of Australian and New Zealand incomes assumes an exchange rate of $NZ1 = $A0.85, close to average value since 1990.Source : Andrew Coleman, Motu Research

: Australian Treasury


SECTION 8 Is there a better way to fund retirement incomes?

When Seddon introduced the old age pension system in 1898, New

Zealand was a country abundant with resources and opportunities, and

short of people. At that time our wages were as high as any in the world

and having the age pension paid from taxes made a lot of sense. The

politicians of the 1890s and their advisers expected that there would be

more taxpayers in each succeeding generation and that they would have

higher incomes from which to pay the pensions for a relatively small group

in the total population who would not live too long after retirement.

Compare that with the situation today. Not only do we expect the future

working age population later this century to be growing very slowly, if not

actually getting smaller, but many people expect the current generation

entering employment will be no better off than their parents and may even

be poorer. Could saving to fund retirement pensions do a better job?

Nobel Prize winner Peter Diamond has shown that, provided the earnings

rate on our savings was greater than the growth rate of the economy, then

saving for retirement by making contributions to an asset accumulating

fund (Save As You Go – SAYGO) would be more efficient than directly paying

for pensions from taxation (Pay As You Go – PAYGO). To manage risks he

suggests it’s best to combine both approaches. The former chairman of the

Council of Economic Advisers for President Ronald Reagan, Martin Feldstein,

in his 2005 address as the President of the American Economic Association,

also agrees that funding pensions from savings is not only much more

efficient but that a transition to greater reliance on savings for funding

retirement incomes is both feasible and desirable.

The key condition is whether the return on the assets we invest our

savings in is greater than the economic growth rate. The economic growth

rate depends on how quickly the workforce increases, and how quickly

labour productivity – the amount of output per worker – increases. In

the past 50 years, the workforce increased rapidly due to the high birth

rates during the baby-boom era and the increased participation of women

in the workforce. But such increases are not expected in the next 50

years. Rather, the number of children born every year is expected to be

almost constant, and the population aged 18 – 64 is expected to only

grow modestly, by maybe 0.25 per cent per year. Consequently, economic

growth will be largely determined by the rate of productivity growth.

Table 19 shows how the size of SAYGO pensions and PAYGO pensions

depends on the rate of return on saving and the productivity growth rate

of the economy when there is zero workforce growth. The table shows the

size of pensions if the average wage starts at $45,000 and increases at

the productivity growth rate, and if people contribute either 10 per cent of

their incomes into a saving fund or to a government funded pay-as-you-

go scheme. The productivity growth rate varies from one to two per cent,

and the rate of return from three to four per cent. In all cases, a SAYGO

funded pension is significantly larger than a PAYGO funded pension. If

the workforce increased by 0.25 per year, the cost of providing PAYGO

pensions declines by about 10 percent, because the costs of providing

any size pension are spread over more people, but even in this case the

SAYGO funded pension is considerably bigger in value than a PAYGO

funded pension.

Our modeling has been based on the set of assumptions shown in green.

On these relatively modest assumptions (a three per cent earnings rate

on savings and a 1.5 per cent productivity growth rate) savings are 62

per cent more efficient than taxes in delivering retirement incomes. You

might ask why we don’t fund all our retirement earnings by saving but a

tax-based pension is still needed for those already retired and those who

will retire in the next 20 years and would not have enough time to save for

all their retirement income needs.

If we wanted to move quickly on this, one generation would end

up paying for their own retirement pensions and those of the older

generations still alive, in effect paying twice but only getting one

retirement funded for themselves.

There is the option of moving gradually to a totally savings funded

retirement but this would take a long time and in the meantime pensions

still have to be paid from each year’s taxes to the generation that has

already retired.

Another alternative is to gradually move out the age of eligibility for NZS

as longevity increases and continue paying NZS from taxation on the

same basis for the last 20 to 25 years of life. The United Kingdom plans

to and Sweden already does this. Anyone could still retire at 65 by saving

sufficient for a retirement nest egg to provide an income between 65 and

a later age of eligibility for NZS. Putting those retirement savings aside

would give several advantages:

earning compound interest (interest paid on the interest earned

and left in a retirement account) is more efficient than paying for

retirement income out of taxation.

NZS means future generations will be able to pay less tax while

employed as more retirement income will come from compound

earnings on savings and less from taxation.

That retirement nest egg is a personal asset and can be taken

and used for retirement anywhere in the world and if you die

prematurely the balance in your account goes to your estate.


want to retire at 70 rather than 65 they can continue to build up

retirement savings for the additional five years and get a higher

income when they do decide to retire. Alternatively, there is an

option to retire at, or least take up a pension from, 65.

future taxes on incomes will provide a strong motive for additional labour

supply and much smaller dead weight losses from lower tax rates.

One fallacy that is commonly assumed is that we fully pay for our NZS

from the taxes we pay prior to retirement. From the analysis below it can

be seen that typically in retirement we receive about two to three times

what we contributed through taxes back in our working time.

There are several reasons for this:

by many more people than there were in retirement. For example,

at one stage seven working age people were supporting only one

person in retirement.

comes as a percentage of today’s average wage whereas we were

on lower incomes when we were paying our taxes so they were a

smaller dollar amount from our then lower incomes.

REAL RETURN RATIO

* The pensions assume the average wage begins at $45,000 and grows at the productivity growth rate. Each year a person contributes 10% of their income to either an accumulated SAYGO pension fund or to the Government to fund a PAYGO pension. Pensions increase at the productivity growth rate. The working life is 45 years and the retirement period is 19 years. When the working age population increases by 0.25% per year, the cost of providing a PAYGO pension reduces by 10%.Source: Andrew Coleman, Motu Research

25%

20%

15%

10%

5%

0%

1976

1981

1986

1991

1996

2001

2006

2011

2016

2021

2026

2031

2036

2041

2046

Average entitlement to future pension benefits gained each year alive 25-65, as a fraction of average annual income.

Average fraction of annual income paid as taxes to fund pensions.

Source: Andrew Coleman, Motu ResearchExample: Someone turning 60 in 2011 will have paid 8% of annual income each year to fund other peoples pensions but will gain entitlement to pension benefits equal to 18% of one years annual income. Over 40 years, their total pension entitlement is 7.2 years annual income, or a pension equal to 30% of annual income for 24 years.


SECTION 9 How can we preserve the option of retiring at 65 and provide more New Zealanders with a comfortable retirement?

With the ageing of the population and increasing longevity after 65, it

is inevitable that the age of eligibility for the taxpayer funded NZS will

gradually increase to keep the cost affordable for the smaller proportion of

the population in employment. If we want to preserve the option of retiring

at age 65 we will need to find a way to save and provide an income

between 65 and the age of eligibility for NZS. If we all save more during

our working lives we can also boost our retirement incomes to the level

that would give us a comfortable retirement. FSC commissioned polling

indicates that most New Zealanders believe they could live comfortably in

retirement on an income about two times the level of NZS.

For compound interest (the interest on interest earned by leaving money in

a retirement account) to work we need two things: to put the money aside

by not spending it; and then leave it alone to earn the compound interest

over many years. At the moment many people only do serious saving for

retirement after they reach 50 years of age. If you start earlier more of

your retirement savings “pot” comes from the compound interest rather

than the initial contributions made.

While we know saving for retirement is at least 60 per cent more efficient

than paying for today’s pensions out of current taxation there are many

different ways to do that saving.

The Government could simply increase taxes and pool the extra tax in a

retirement savings fund which could be managed using private sector

investment managers or a public sector agency such as the NZ Super

Fund or the ACC Fund. Alternatively, the Government could deduct

contributions from wages or salaries and put them into individual accounts

in a similar retirement savings fund with the option of public or private

sector management.

Another option would be to put those deducted contributions into funds

like the current KiwiSaver scheme managed by the private sector. That

gives scheme members the option of switching to another provider and

scheme if they are not happy with their current provider or scheme.

While each approach would enable our savings to be managed, each has

different risks.

These are outlined in the Table on the right.

During the superannuation debate back in 1975, many New Zealanders

were not comfortable with the idea that the Government would have

control over where our retirement savings would be invested. Having

everyone’s investments managed by one organisation does concentrate

everyone’s hopes on one place. That might make it uncomfortable for

the Government, retirement savers and the taxpayers as, if a Government

agency or its chosen private sector provider fails, the Government of the

day will inevitably come under pressure to make good the losses so the

taxpayer ends up paying.

If the Crown has the total fund managed by one organisation, whether it

is taxpayer or privately owned, the Government faces the “too big to fail”

dilemma. Even if it performs badly with its investments the reputation of

New Zealand and the retirement income needs of its investors means the

Government at the time cannot allow it to fail. An organisation managing

savings like this would therefore be incentivised to take on more risk than

may be prudent.

When the KiwiSaver scheme was introduced, the Government of the day

decided that having individual accounts managed by multiple private sector

providers gave the best balance of risks and the strongest incentives for

investment performance. While many people have stuck with their default

provider most people have chosen a scheme other than the one they were

allocated to initially, and despite the worst investment conditions in 50 years

most people appear happy with the existing arrangements.

To enable every employee in New Zealand to retire on at least the level of

the NZS from 65, and most people to achieve a retirement income close to

two times the level of NZS, contributions from employees and employers

will need to grow to equal 10 to 12 per cent of their earnings going into a

retirement account. In Australia, employers currently contribute nine percent

of earnings to each employee’s compulsory superannuation scheme. There

is cross-party support in Australia for the contributions to increase to twelve

per cent from the current nine per cent between now and 2020.

Expanding enrolment into KiwiSaver to cover all employees and stepping

up the contribution year by year until it reaches 10 to 12 per cent of

earnings is probably the best way to phase-in additional retirement

savings. We have called this KiwiSaver Plus.


ASSET

POTENTIAL FOR EFFICIENCY

SCALE

POTENTIAL

ACTUAL OR

ACCESS TO -

SIFICATION

PAYGO Nil Nil Nil Nil

SAYGO Public Tier-1

or the ACC Investment

Positive Some

SAYGO Public Tier-2

overseen by a govern-

Investment Team or

Positive Nil

SAYGO Private Inter-mediated

Positive Nil

SAYGO Private Non- Intermediated

Positive Nil Nil


SECTION 10 What could KiwiSaver Plus look like?

Our analysis indicates that the first nine of these objectives could be

achieved by having contributions equal to 10% of incomes, whereas

adding the last two features would require a further two per cent of

income in contributions bringing the total to 12%.

The KiwiSaver Plus scheme outlined below builds on the best features of

NZS and KiwiSaver while ensuring they work together to create a more

secure retirement income for all participants.

FEATURE

Contribution rates


retirement savings

-

Is the value of my retirement contributions

No

-

Is there a guarantee that

No

account balance above that Yes

Can you enrol your children or grandchildren

Yes

to buy a retirement income Yes Yes

money in my account if I Your estate receives the balance in your Your estate receives the balance in your account and the

When you reach the age of eligibility for

longevity may mean this age is lifted in the


SECTION 11 What sort of incomes could KiwiSaver Plus provide for retirement?

To help provide some context for what future retirement incomes will be it

is helpful to understand our current income distribution in New Zealand.

The median male income in mid 2011 was about $52,100. The median

means the income level where almost 50 per cent of the male population

earns more and almost 50 per cent earn less. The male average income

or mean for males in paid employment is higher at almost $55,000. The

mean is calculated by adding everyone’s incomes together and dividing

that number by the total count of the male population.

The mean is higher than the median because while a large number of

people have lowish incomes a small number of people have much higher

incomes pushing up the average.

The first scenario below assumes a contribution rate equal to 10 per

cent of earnings (five per cent from the employer, five per cent from the

employee). We have used a two years per decade assumed improvement

in longevity from age 65.

The pensions available at retirement in 2061 from introducing KiwiSaver

Plus are the result of making steady contributions at 10 pe rcent of

earnings over 40 years and the impact of compound interest (interest on

the interest left in the account).

All participants in KiwiSaver Plus will receive at least the income level of

NZS from age 65. Most people will be able to receive a pension for more

than the equivalent of NZS at 65. For those who can defer taking up a

pension to 70 the majority will achieve a retirement income close to the

level identified in our opinion polling as providing a comfortable income

in retirement for an individual or a couple of two times NZS. The next

three tables all use a three per cent real rate of return (after inflation, fees

and tax) and assume a 1.5% labour productivity growth rate). These are

conservative assumptions based on past trends. In Appendix 4 we have

the same tables based on a four per cent real rate of return over 40 years

and assuming a productivity growth rate of one per cent.

Fund managers are prepared to contract for a four per cent real rate of

return long term and the one per cent productivity growth rate is close to

what has been achieved in New Zealand over the last 10 years.

The proposed contributions track to produce these pensions is contained

in Appendix 6.


(To interpret the table see notes in orange)

6. How much would be in your retire-ment account at 70 if you delay taking up your pension till then.

7. The KiwiSaver Plus pension your account can purchase in 2066.

8. What you would have received if you had collected NZS from age 70.

AT AGE 65 AT AGE 70

Earnings in

$Fund Balance$

SAYGO

Self-Funded Pension $

No Change PAYGONZS $

Fund Balance$

SAYGO


No Change PAYGO

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

1. e.g. income levels Quintile 1 is the average income of those people in the bottom fifth of earnings as-suming that the person stays on that relative income for the whole of their working life.

2. The annual income for someone in this category in 2011.

3. How much will be in yourKiwiSaverPlusretirement account at 65.

4. The pension your KiwiSaver Plus account can purchase at 65.

5. What you would have received from NZS if the pension was still available at 65 in 2061.

Pensions paid from 2061 (age 65) or 2066 (age 70) comparing the no change PAYGO pension (NZS) with the proposed SAYGO (KiwiSaver Plus) pension (Assumes 10% contributions commence from day 1 (i.e. no phase in)

** As we assume that wages increase each year with productivity growth the PAYGO pension (NZS) paid will be higher by the time you get to 70.*** The mean income relates to earnings for those in paid employment as at June 2011. The other incomes are expressed as lifetime earnings relative to the mean. They do not represent a cross-sectional income distri-bution. The distribution by quintile is assumed to be the same for males and females.


SECTION 11 Continued

AT AGE 65 AT AGE 70

Earnings in

$Fund Balance$

SAYGO

Self Funded Pension $


Fund Balance$

SAYGO

Self Funded Pension $

No Change PAYGO

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

The Table shows what you can expect as a KiwiSaver Plus pension when you retire in 2061 at 70 if we phase in the target 10% contribution rate over 10 years.

*This would be topped up at 65 or when you decided to retire to provide the funds necessary to purchase a pension equal to NZS i.e. $27,368 and increasing with wages from then on until you were eligible for NZS.** As we assume that wages increase each year with productivity growth the PAYGO pension (NZS) paid will be higher by the time you get to 70.*** The mean income relates to earnings for those in paid employment as at June 2011. The other incomes are expressed as lifetime earnings relative to the mean. They do not represent a cross-sectional income distribution. The distribution by quintile is assumed to be the same for males and females.


The table below assumes we decide to include the 1% cost for insurance and the 0.1% cost of the capital guarantee on contributions. This requires contributions to rise to 12% of income to be an effective 10.9% contribution rate into your KiwiSaver Plus account phased in over 12 years.

AT AGE 65 AT AGE 70

Earnings in

$Fund Balance$

SAYGO



Fund Balance$

SAYGO


No Change PAYGO

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

** As we assume that wages increase each year with productivity growth the PAYGO pension (NZS) paid will be higher by the time you get to 70.*** The mean income relates to earnings for those in paid employment as at June 2011. The other incomes are expressed as lifetime earnings relative to the mean. They do not represent a cross-sectional income distribution. The distribution by quintile is assumed to be the same for males and females.



Under the three scenarios outlined above everyone who participates

receives at least the level of NZS from 65 and most people who defer their

retirement past 65 can achieve closer to two times the level of NZS most

New Zealanders consider they need to have a comfortable retirement.

Tables 27 and 28 show how the (SAYGO) KiwiSaver Plus self-funded

pension integrates with the taxpayer funded (NZS) pension you receive

from the Government. Based on a 10 per cent contribution rate we can

maintain access to an income at least equivalent to NZS at 65. Most

people would be able to achieve an income above NZS levels and a

majority of those who deferred picking up a pension till closer to the age

of eligibility for NZS would receive a level of income that would enable

them to have a comfortable retirement about two times NZS. Everyone

gets to enjoy at least an income equivalent to NZS from 65. The first part

of your retirement is funded by your own savings (the blue area under the

white line). This is the fixed-term pension you are required to purchase

if you participate in KiwiSaver Plus. The white line is the level of the

NZS pension which increases in line with increases in wages. Later your

pension is mainly paid for by the taxpayer (the red area under the white

line). The blue area above the white line is the pension income from your

KiwiSaver Plus savings, above what you used to purchase your fixed-term

pension, spread out over the rest of your life. You can use your savings,

above that required to purchase your fixed-term pension between when

you want to take up your pension and when you are eligible for NZS, any

way you like. The example below presents it as additional income over the

rest of your expected life.


Source: Infometrics

0

AGE

$PA

65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96

Source: Infometrics

0

Table 28 – Female on median female income retiring at 65 from 2061

AGE

$PA

65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99


SECTION 12 How can we make this politically sustainable?

Retirement income policy changes cast a very long shadow because they

affect our decisions on where to live and what to save during the 40 plus

years we are preparing for retirement and what we will receive in the 20-

40 years of likely retirement. This timetable covers the lifetime of almost

27 parliamentary terms. The decisions of today’s politicians will have an

impact on the retirement of people not yet born.

There are therefore major benefits in having some stability in the core

aspects of retirement income policy over the long term. We have

struggled with achieving this in the past.

Political stability can be achieved when:

the generations and between the political parties most likely to form

future governments.

The KiwiSaver Plus features we have proposed are designed to have

acceptability to the widest possible range of political opinion while being

affordable and fair for successive generations.

We need that acceptability across the generations and across the

community if we are to have a broadly sustainable policy.

To achieve such a wide consensus most people will need to agree on the

facts underpinning and the goals and values embedded in the proposals.

To help build the consensus required for a broadly stable retirement

income policy we have proposed a multistage process to examine the

evidence on the following topics:

- the adequacy of retirement incomes compared with our aspirations

- saving for retirement being more efficient than funding retirement

incomes from taxation

- whether increasing longevity requires us to reconsider how we fund

our future retirement income policy

- whether a transition to greater reliance on savings is feasible

- whether it can be fair across the generations and for women, Maori

and the low paid.


We have suggested an all party Select Committee on Retirement Income

Security oversees the preparation of a Discussion Document for public

consultation commencing later this year.

There would also be value in having a reference group of New Zealanders

under 40, representative of the diversity of New Zealand, to consider this

report and other evidence to help design the future of retirement income

policy in New Zealand.

Following this in 2013, we suggest a draft Bill be prepared under the

supervision of the all party Select Committee on Retirement Income

Security.

To encourage a cross party consensus to emerge we have proposed that

any legislation on this topic should require a 75 per cent level of support

in Parliament.

If that level of support is not achieved we propose that the legislation as

passed come into effect after a referendum at the 2014 election inviting voters

to vote for or against the package supported by a majority of Parliament.

This approach encourages the parties in Parliament to build a wide

coalition of support but would not prevent a proposal being submitted to

the voters by way of a referendum if that were not possible.

We have also recommended that future changes to retirement income

policy be supported by 75 per cent of Parliament or be the subject of a

referendum.


SECTION 13 What would the transition look like?

Our proposals address several issues with our current retirement income

policy based around NZS, funded by compulsory taxation of current

earners and spenders alongside a voluntary KiwiSaver scheme.

The likely trend in longevity will mean NZS at aged 65 requires 12 per

cent of GDP from taxpayers later this century compared with four to five

per cent today. If this results in tax rates increasing by 28 per cent then

those taxpayers will have the option of moving to Australia or elsewhere.

If those countries have mature retirement savings schemes they will be

able to pay less tax and receive greater retirement incomes than if they

remained in New Zealand.

To ensure we can keep our younger earners in New Zealand we need

to move to more reliance on a savings funded retirement income and

less reliance on tax based funding. We cannot do this overnight as one

generation might end up paying more than once because while saving for

their own retirement they would need to continue to pay taxes to fund the

NZS being received by their parents and grandparents.

We have established that funding from savings is at least 60 per cent

more efficient for funding retirement pensions than funding from taxation.

For that reason it would make sense to shift to savings based funding for

NZS anyway but we have other objectives.

If we decided to start funding NZS from savings rather than taxation we

would have to put more money aside initially but by 2060 we would be

reducing the total cost of retirement incomes. Unfortunately, this would

only pay the current level of NZS which most New Zealanders consider is

inadequate for a comfortable retirement.

* Costs of funding NZS from Tax No Change versus from Savings (Green Line) (including the cost of NZS recipients that have already retired) as a percentage of GDP (FSC “Lancet” Longevity)

14%

12%

10%

8%

6%

4%

2%

0%

Tier 1 SAYGO + Legacy PAYGO NZS

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

2105

2110


Most New Zealanders aspire to a comfortable retirement which requires a

level of income in retirement roughly twice the level of NZS. Many people

are not currently making contributions to a KiwiSaver account and the

typical contribution rate of two per cent from the employee and two per

cent from the employer (soon to go to three per cent plus three per cent)

is insufficient to move most people to two times NZS in retirement.

To make the transition we need both to raise the number of employees

covered by KiwiSaver and lift the typical contribution rate to five per cent

plus five per cent a total of 10 per cent.

Our recommendation is that over one decade we move the employee

and employer contributions up by 0.5 per cent a year, meaning the total

contributions go up by one per cent each year. This phase-in is designed

to make it affordable for both employers and employees.

Most years in New Zealand inflation is about two per cent and in dollars

of the day wages move by at least a similar amount. Most years wages

increase by more than inflation to reflect improvements in labour

productivity. As we can expect real wages to increase by one percent

a year, this does not require a reduction in current consumption during

the ten year transition. As this increase in contributions will be known

well in advance, employers and employees will be able to recognise

these changes when they agree wage increases. As increased saving

means less spending we have proposed that the phase-in to a 10 per

cent contribution rate not start until 2015/16 by which time we should

expect our economy has moved out of recession and employees should be

experiencing wage increases above the level required to just compensate

for inflation.

As we transition we need to continue paying for those already retired

(the green line), the PAYGO pension NZS for those retiring in the future

(the purple line) while we are increasing our contributions towards our

KiwiSaver Plus retirement (the orange line). Initially therefore looking at

the total cost (the blue line) we pay more overall for our retirement income

policy. Later on however Table 31 shows the total cost of the retirement

income policy (the blue line) becomes less than the cost of continuing NZS

with eligibility at 65 (the red line).

14%

12%

10%

8%

6%

4%

2%

0%

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

2105

2110

PAYGO NZS Future Payments



So for a total cost to the economy of 12-13 per cent at the end of the

century we achieve retirement incomes closer to two times the level of

NZS at retirement.

If we take on board the KiwiSaver Plus proposals and our contribution

lift to 10 per cent of income then we can narrow the pension gap with

Australia over time. If incomes are higher in Australia we cannot eliminate

the gap entirely but a maturing of our own KiwiSaver Plus scheme would

considerably improve our relative position.

Our modelling elsewhere has used a three per cent return after inflation,

tax and fees but here we have used the same four per cent return

assumption that the Australian Treasury used to make the Australian

median and average income forecasts. If we had used a three per cent

assumption for the New Zealand KiwiSaver Plus return the pension gap in

this table would have been overstated.

* Note: the blue line is funding retirement pensions considerably higher than the NZS pension funded by the red line of costs.

14%

12%

10%

8%

6%

4%

2%

0%

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

2105

2110

PENSION

AUSTRALIAN -

ONE RETIRING IN

IN AUSTRALIA

RATIO AUSTRALIAN PENSION FOR

-

IN AUSTRALIA

RATIO

52% 59%

*The ratio of Australian and New Zealand incomes assumes an exchange rate of $NZ1 = $A0.85, close to average value since 1990.Source : Andrew Coleman, Motu Research

: Australian Treasury


SECTION 14 How would this change our future?

If we are to have everyone in New Zealand able to enjoy a comfortable

retirement then most of us will have to save more than we currently are.

In Australia they made saving for retirement compulsory but also made

it tax advantaged relative to most other forms of investment. In New

Zealand we have compulsory taxation to fund NZS and have provided

incentives for participation in the voluntary KiwiSaver scheme. To put

more New Zealanders in reach of a comfortable retirement we will need

most employees contributing five per cent of their income, backed with

another five per cent from their employer.

Last year at around the time of the Budget, the FSC commissioned Horizon

Research to ask New Zealanders their attitudes toward compulsory

participation in KiwiSaver and also what they were likely to do if there was

a day of enrolment into KiwiSaver with the option to drop out later.

Given the heat of the debate on compulsion over the past 40 years it is

perhaps surprising that a majority of people by age, gender, ethnicity, income

and political party support, now favour compulsion. [See Appendix 1]

However when asked what they would do following automatic enrolment

into KiwiSaver with the option of withdrawing later, some 40 per cent or

more of the people asked under 40 years of age, said they would opt out.

[See Appendix 2]

As these people include the generations most likely to face a delayed date

of eligibility for NZS and a much longer life expectancy after 65, it does

suggest that a level of take up of KiwiSaver above 60 per cent will only be

achieved with either stronger incentives or compulsion.

Evidence from New Zealand and elsewhere indicates that even generous

incentives won’t ensure most people participate. If membership of

KiwiSaver and an increasing level of contributions were compulsory, then

the fiscal cost of incentives could be avoided.

These are decisions for the community to make but the do nothing option

appears to be unsustainable.

If tax rates have to continually increase to fund retirement incomes

for more people in retirement living longer, paid for by fewer people in

employment, then more and more of our best qualified young people

will move to countries such as Australia where they can enjoy higher

retirement incomes and lower taxes.

Most New Zealanders want their children and grandchildren to be able to

stay here. To make that possible we do need to talk about how we should

fund future retirement incomes in New Zealand.


SECTION 15 Can contribution-based retirement pensions be fair for women and the low paid?

Women live on average several more years than do men after 65. That

gap is narrowing but it still exists. Living longer is obviously good but if

men and women pay the same amount into a KiwiSaver account and then

turn that into an annuity (pension) on retirement a woman would be paid

less each year because she is expected to live longer.

It is also a fact that women are more likely to have taken time out of the

workforce to have a family or care for a relation. If you have less time

earning from paid employment and consequently lower savings it is likely

your retirement savings pot will be smaller as a consequence and your

pension will be smaller.

If women continue to be paid less they will also be less likely to achieve

the same level of retirement savings as a man with similar talents and

ability based on the same proportion of their income being put into a

retirement account.

Some people therefore argue that standard level benefits paid from

taxation are fairer for women. However, the same evidence can be used to

argue that men are short changed by tax paid pensions, as they are likely

to receive a lower payout in retirement compared with the tax they pay

from earning more in employment but living less time in retirement than

most women.

How does the KiwiSaver Plus plan suggest we deal with these issues?

First, the proposal is to keep NZS, but it is expected the age of eligibility

will move out as longevity gradually increases. NZS will continue to

provide everyone with a guaranteed income from the age of eligibility and

women are more likely to be in the group that lives the longest.

Secondly, we propose that the taxpayer, by way of Government, should

commit to top up the retirement account of anyone who has contributed

but who does not have sufficient savings to fund a pension equivalent to

NZS at 65. This not only helps women who may have spent time outside

the workforce it will also help anyone who has had low earnings over their

adult lives. It will also assist those who have suffered poor returns on their

investments which would have taken their retirement pot below the level

to fund a pension equivalent to NZS at 65. This may be quite important

if someone’s retirement came after a couple of bad years for investment

returns. We have also proposed that your contributions be guaranteed so

you must get back at least what you saved.

The cost of providing a top-up guarantee is relatively modest as few

people suffer a very low income for most of their working lives or spend a

lot of time outside of the workforce. While these arrangements will ensure

every participant will end up with an adequate fund for retirement we need

one more thing to address the fact that women live longer.

We propose that the Government consider holding a tender to supply

gender neutral fixed-term pensions so that anyone can use their

retirement nest egg to purchase a pension at least equivalent to NZS.

We propose that you would only need to convert a sufficient amount of

your retirement pot to purchase a pension equivalent to NZS. Any other

money in your account will be available for you as a lump sum to invest,

to purchase a higher pension or to spend as you wish. Some countries

pay the contributions for women or men while they are on parental leave

and some schemes split the contributions of a couple so they both have

an equal balance in their retirement savings accounts even where their

incomes are different.

This approach means that everyone who participates has the option of

retiring at 65 and that the arrangement is fair for women and the low

paid. As is currently the case if a couple was to separate or divorce the

combined value of the KiwiSaver Plus account balances would be split

evenly between the separating parties.

No Change PAYGO NZS Pension $

Pension $

No Change PAYGO NZS Pension $

Pension $

* This would be topped up to the level of NZS.


SECTION 16 Can a contribution-based retirement pension be fair for Maori?

The Pakeha population age structure is gradually evolving to look like a

skyscraper with very similar numbers in each age band until you get to

over 65 when more people begin dying off.

The Maori population meanwhile is more like Mt Taranaki, a lot of young

people but each older age band has fewer people in it and at the peak

there are very few people over 65.

Maori also do have a lower life expectancy at birth than Pakeha. Once

they get to 65 their life expectancy is still lower but not proportionally as

different from Pakeha as life expectancy at birth.

Some Maori have argued for a lower age of eligibility for NZS for Maori as

they pay taxes but are less likely to get to 65 or enjoy a long retirement.

As campaigns for quitting smoking and healthier lifestyles take hold and

if Maori incomes improve, we would expect the Maori/Pakeha differential

in life expectancy to narrow. If you are pessimistic about your life

expectancy an approach that allows you to build your own retirement

account and keep taxes lower may have attractions for many Maori. With

the current NZS if you die prematurely you have funded the retirement

incomes of the previous two generations but you yourself will not receive

such an income from the next two generations. As your KiwiSaver Plus

retirement savings belong to you, if you die prematurely the balance in the

account goes to your estate to benefit your family as do pension payments

for the remaining years of your fixed-term pension.


SECTION 17 What does this mean for people of different ages?

LIFE STAGE

education and training

future


SECTION 18 Why now, to start saving more for retirement?

The circumstances of last century made it a very good time to minimise the

cost of funding retirement incomes by having the working tax payers pay for

the pensions of the very small number of people over 65.

The trends this century are the complete opposite. The numbers over 65

are growing more rapidly than the numbers in the workforce and we are

living much longer in retirement.

There are three reasons why we should start saving more for retirement

sooner rather than later.

First, at the current time we still have many of the baby boomers and the

subsequent generations still in employment and capable of both earning

and saving more prior to retirement. We will soon transition to having a

much higher proportion of our population in retirement as greater numbers

retire and we live much longer in retirement.

Secondly, the benefits of compound interest take time. If we start saving

more now, the compound returns (the interest we will earn on the interest

we leave in our KiwiSaver accounts) will be much greater than if we delay.

If we delay, the proportion of our income we need to save to fund our

retirement incomes grows quite rapidly. If we delay too long we will not be

able to afford to both pay the taxes to fund the pensions of those already

retired and also save for the self-funded part of our own retirement incomes.

Thirdly, the politics of making any changes to pension policy gets more

difficult as the over-65 age group becomes a greater proportion of society,

as voters don’t like changing the pension entitlements of existing pensioners

because they recognise how difficult it is for them to change their work

and savings patterns. Politically sustainable alterations to pension policy

need to be agreed to well in advance. It will be easier to do this before the

number of people on a pension increases significantly. As younger working

taxpayers have the option of going to Australia or elsewhere to avoid paying

higher taxes if no changes are made, change should be made before it

becomes politically difficult. If no change occurs, we face the worst of both

worlds where we can’t afford the cost of the retirement income funded from

taxation but it is too late to make the transition to greater reliance on savings

to fund retirement incomes.

Table 35 – Funding retirement incomes in 1955 and 2055

Funding retirement incomes in 1955 Funding retirement incomes in 2055

if you start at age 25 on 10% contribution rate:

Account balance at 65 Account balance at 70

Female Female

Starting age

25

35

45

55


SECTION 19 Summary and recommendations

Table 37 – Summary and recommendations

ISSUE OR OPPORTUNITY

-

-ment incomes it is sustainable to fund from

Agreement that the age of eligibility for NZS

Funding retirement incomes from savings -

ment incomes from saving rather than from move to greater reliance on savings to fund

-

-the age of eligibility moves above 65 then

10-12% of our incomes to achieve that and

increase their savings steadily by 1% a year until contributions reach 10 to 12%

eligibility for NZS to have an income at least

NZS could be achieved on the basis of a reasonable investment return say 3% or

Zealanders could achieve a comfortable

discussion on the future retirement income

Agreement to gradually raise contribution

Agreement that some form of structured


http://www.motu.org.nz/publications/detail/motu_note_7_behaviour_

economics

http://www.motu.org.nz/publications/detail/motu_note_6_mandatory_

retirement_income_schemes

http://www.nelm.nhs.uk/en/NeLM-Area/News/2009---October/05/Ageing-

populations-the-challenges-ahead/

www.nber.org/feldstein/aeajan8.pdf

http://www.sciencedirect.com/science/article/pii/S1573442002800118

http://www.oecd-ilibrary.org/finance-and-investment/pensions-at-a-

glance-2011_pension_glance-2011-en

http://connection.ebscohost.com/c/articles/404081/macroeconomic-

aspects-social-security-reform

transition to greater reliance on SAYGO to

today on either the median or average

having earned either the median or average

cross the Tasman to double their

to start using savings more to fund

to greater reliance on savings for funding retirement incomes and the timetable for


TOTAL A B C E F

ALL 2321 100%

SEX

Female 51% 100%

49% 100%

AGE GROUP

18-24 years 13% 100%

25-34 years 17% 10% 100%

35-44 years 18% 36% 9% 100%

45-54 years 21% 100%

55-64 years 17% 100%

65-74 years 12% 100%

75 years or over 3% 4% 100%

Under 18 years 1% 100%

2% 100%

0% 19% 100%

14% 4% 100%

21% 100%

8% 100%

5% 100%

10% 100%

39% 13% 100%

0% 100%

3% 100%

Chose not to vote 16% 100%

9% 34% 14% 100%

Green Party 5% 100%

1% 27% 100%

Labour Party 25% 33% 100%

2% 28% 100%

National Party 34% 100%

3% 34% 5% 100%

2% 100%

United Future 1% 29% 16% 100%

Was not eligible to vote 0% 100%

Source: Horizon Polling Budget 2011


TOTAL A B C E F

ALL 2321 100%

SEX

Female 51% 100%

49% 100%

AGE GROUP

18-24 years 13% 100%

25-34 years 17% 10% 100%

35-44 years 18% 36% 9% 100%

45-54 years 21% 100%

55-64 years 17% 100%

65-74 years 12% 100%

75 years or over 3% 4% 100%


2% 100%

0% 19% 100%

14% 4% 100%

21% 100%

8% 100%

5% 100%

10% 100%

39% 13% 100%

0% 100%

3% 100%

Chose not to vote 16% 100%

9% 34% 14% 100%

Green Party 5% 100%

1% 27% 100%

Labour Party 25% 33% 100%

2% 28% 100%


3% 34% 5% 100%

2% 100%

United Future 1% 29% 16% 100%

Was not eligible to vote 0% 100%

Source: Horizon Polling Budget 2011

TOTAL A B C

ALL 1135

SEX

Female 48% 18% 100%

52% 100%

AGE GROUP

18-24 years 11% 100%

25-34 years 14% 100%

35-44 years 17% 34% 100%

45-54 years 20% 100%

55-64 years 15% 28% 100%

65-74 years 18% 100%

75 years or over 5% 30% 100%


2% 100%

0% 100%

14% 100%

19% 100%

7% 100%

3% 34% 100%

11% 100%

43% 100%

0% 42% 58% 100%

2% 46% 100%

Chose not to vote 18% 51% 100%

10% 100%

Green Party 3% 27% 100%

1% 100%

Labour Party 25% 100%

2% 100%


4% 40% 100%

1% 100%

United Future 1% 100%

Was not eligible to vote 0% 100% 100%


Source: FSC Horizon Research Dec 2011

Source: Motu Research December 2011

Last year the FSC asked Horizon Research to ask adult New Zealanders how

long they expected to live past 65. The results below indicate that most

people are likely to be underestimating their likely life expectancy past 65.

The estimation gap is largest in those age groups where they are most likely

to be able to save for retirement. The same research indicated that most

people had an understanding of what they would need to be comfortable

in retirement but most people could not make a good estimate about how

long it would take to double their money from a certain interest rate and

keeping the interest in the account to earn interest on interest. Other

research undertaken internationally reveals that most people have difficulty

understanding what size of retirement savings pot would be needed to fund

a level of pension.

Year of Entitlement for NZS at Age 65

Female Female Female

2011

2012-2021

2022-2031

2032-2041

2042-2051

2052-2058

2059-2061

Table 40 - Underestimating longevity

TOTAL

10 years11 years12 years13 years14 years15 years16 years17 years18 years19 years20 years21 years22 years23 years(24 years(25 years26 years27 years28 years29 years30 yearsTotal

23%

6.0%)7.4%)

100%


6. How much would be in your retirement account at 70 if you delay taking up your pension till then.

7. The KiwiSaver Plus pension your account can purchase in 2066.

8. What you would have received if you had collected NZS from age 70.

AT AGE 65 AT AGE 70

Earnings in

$Fund Balance$

SAYGO



Fund Balance$

SAYGO


No Change PAYGO

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

1. e.g. income levels Quintile 1 is the aver-age income of those people in the bottom fifth of earnings assuming that the person stays on that relative income for the whole of their working life.

2. The annual income for someone in this category in 2011.

3. How much will be in your retirement account at 65.

4. The pension your KiwiSaver Plus account can purchase at 65.

5. What you would have received from NZS if the pension was still available at 65 in 2061.

(To interpret the table see notes in orange)

Pensions paid from 2061 (age 65) or 2066 (age 70) comparing the no change PAYGO pension (NZS) with the proposed SAYGO (KiwiSaver Plus) pension (assumes 10% contributions commence from day 1 (i.e. no phase-in)

** As we assume that wages increase each year the PAYGO pension (NZS) paid will be higher by the time you get to 70.*** The mean income relates to earnings for those in paid employment as at June 2011. The other incomes are expressed as lifetime earnings relative to the mean. They do not represent a cross-sectional income distribution. The distribution by quintile is assumed to be the same for males and females.


This Table shows what you can expect as a KiwiSaver Plus pension when you retire in 2061 at 70 if we phase in the target 10% contribution rate over 10 years.


AT AGE 65 AT AGE 70

Earnings in

$Fund Balance$

SAYGO



Fund Balance$

SAYGO


No Change PAYGO

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5


The table below assumes we decide to include the 1% cost for insurance and the 0.1% cost of the capital guarantee on contributions. This requires contributions to rise to 12% of income to be an effective 10.9% contribution rate into your KiwiSaver Plus account phased in over 12 years.


AT AGE 65 AT AGE 70

Earnings in

$Fund Balance$

SAYGO



Fund Balance$

SAYGO


No Change PAYGO

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5

Quintile 1

Quintile 2

Quintile 3

Quintile 4

Quintile 5


Source GoldmanSachs Research Report 6 September 2010 p.35 Economics; A Study of Australian Housing: Uniquely Positioned or a Bubble?

YEARAUSTRA-

INTEREST

INTERNA-TIONAL

INTEREST

PROPERTYAUS-TRALIAN

INTERNA-TIONAL

INTERNA-TIONAL

ALTER-

ASSETS

A$ RESI-

PROPERTYPROP-ERTY

5 year CAGR

10 year CAGR

15 year CAGR

20 year CAGR

Cash

Australian Fixed Interest

International Fixed Interest

Australian Shares

International Shares

Alternative Assets


* If we decided we wanted to include a base level of insurance for hardship events and a capital guarantee, the contributions would need to go to 12 percent (10.9% effective) to do so. This would be achieved by having two more years with 1% increases each year until the contribution level reached 12% (6%t from the employee and 6% from the employer).

% % % % % % % % % % %

Total

Current

Total

Total

Total


2012 2013 2014 2015

JULY – SEPTEMBER 2012-

ing of Retirement Incomes covering

-able incomes in retirement for most

SEPTEMBER 2012

-

an All Party Committee on Retirement

OCTOBER 2012Public Consultation launches

Retirement Income Policy meets and

DECEMBER 2012.

FEBRUARY 2013

of submissions and recommendations for

MARCH 2013

Income Security meets and agrees

APRIL 2013.

APRIL/MAY 2013

MAY/JUNE 2013All Party Select Committee

JULY

AUGUST/SEPTEMBER 2013

NOVEMBER 2013

If the Bill does not receive a

FEBRUARY 2014All Party Committee meets to

MAY 2014Referendum Public Information

legislation NOVEMBER 2014.Automatic enrolment from 1 APRIL 2015.


QUALIFYING AS ANNUAL RATE

Single - living alone

Single - sharing

Source: Ministry of Social Development

Here are the standard rates of NZ Super from 1 April 2012 after tax has been deducted at rate ‘M’.

Financial Services Council of New Zealand

Level 12, City Chambers Cnr. Johnston & Featherston Streets

PO Box 1514, Wellington 6140 New Zealand

Ph: +64 4 473 8730 Fax: +64 4 471 1881

Email: [email protected]

www.fsc.org.nz

www.yourwealth.org.nz

For further comment

pensions for the twenty first century: retirement income … · 2012-06-14 · pensions for the...

Documents