Is Kiwisaver a Clever Scheme? Peter Harris, Head of Saving Product Working Group 2004

Is KiwiSaver a clever scheme? Peter Harris, Head of Saving Product Working Group 2004

I have been asked to address four topics:

 Origins of KiwiSaver  What are the clever features?  Incentives, tax and compulsion issues  Lessons from public sector schemes

The origins of KiwiSaver

I am not going into this aspect of the presentation in much detail.

KiwiSaver was a product of converging circumstances. When New Zealand switched to the tax neutral TTE regime in the early 1990s, most of the incentives for occupational superannuation schemes disappeared, and many of them closed to new entrants. At first, this made little difference: those who wanted to be in a scheme were in one. But as time went by, successive years of labour force new entrants were disenfranchised, and over ten plus years the numbers became quite substantial. An illustration is that the percentage of the employed workforce in occupational pension schemes fell from 23 percent in 1990 to 14 percent in 2002: it nearly halved in a little over a decade

As with so much in the New Zealand political economy, momentum on new policy development is key person dependent. In this case the key person was Lynn Middleton, one of the national secretaries of the PSA. Lynn had done a masters thesis on women’s savings for income in retirement, and was highly motivated to create savings opportunities for PSA members. She made this a priority issue for PSA activism, and pressured two key Cabinet Ministers – Trevor Mallard and Michael Cullen, to set up a working party to examine options. That resulted in an employer subsidised scheme for the state sector; the State Sector Retirement Savings Scheme or SSRSS.

In creating SSRSS, the government – perhaps inadvertently – exposed an anomaly : the absence of a robust retirement savings vehicle outside the state sector.

This is where the second key person enters the scene. Michael Cullen had persistently argued that one of the structural weaknesses of the New Zealand economy was its low savings rate. He also had a personal view that individual savings were too low. These two policy objectives are not necessarily compatible – it is possible to increase national savings by running fiscal surpluses – and not necessarily best addressed through a single policy instrument. (See later). He did see economies of scale and administrative

convenience in focussing on the workplace as the conduit through which savings could be encouraged. The result was the establishment of the Savings Product Working Group.

That working group designed what I would describe as the architecture of KiwiSaver. A different structure, and different people, designed the incentive systems that were overlain on that architecture. The incentives were introduced about three years after the working group report.

So KiwiSaver has two distinct elements, with different strengths and weaknesses.

The clever features of KiwiSaver

The working group had tightly targeted terms of reference, and an important feature of them was that they were explicitly told not to look at tax incentives and subsidies: that would follow later.

The result was that it did a very thorough survey of the literature, of schemes operating around the world, and of things that have been tried, to see what worked and what didn’t.

With due respect to the Commission whose name nobody can remember, education on its own – while important - does not cut it.

The working group reported one case study in the USA where employees who were not members of the 401K plan the employer was offering (there, employers must offer access to the tax advantaged savings plan but employees have to elect to join) attended a seminar on the advantages of participation. On leaving the seminar, all said they would join. Six months later only 14 percent had.

I am not going to go into the findings of the working group report in detail, but the conclusions can be grouped under two headings;

Administrative complexity and cost.

Behavioural impediments to joining schemes.

The group identified administrative inefficiencies in the savings regimes of various countries: multiple small balances, complicated rules, high fees, “gone no address” account holders and the like.

The administrative complexity issue was addressed by having a single source of enrolment in a scheme, central collection of funds, a dedicated unique contributor identifier and allowing membership of only one scheme at any one time (with a right to transfer to another).

The behavioural impediments were powerful. Inertia was a strong influence: people tend to do tomorrow what they are doing today. If they are saving today they are likely to be saving tomorrow and vice versa. There are also major confidence issues: people don’t know when to start saving, how much to save, where to save and so on. The report simply took all of those complications off the table: automatic enrolment at the start of employment with the right to opt out: set contribution rates: deduction of contributions at source: default providers and default investment choice.

My view is that this architecture is the strength of KiwiSaver. The working group believed that it would have worked even if there had been no subsidies, albeit through a slow build. Subsidies certainly accelerated uptake, but with uneven strengths and weaknesses. The literature I have seen indicates that this architecture is very close to world’s best practice. Let me put false modesty aside: it is world’s best practice.

So what of the second dimension: incentives?

Incentives

There is a major debate in the literature on whether direct subsidies and tax advantages do actually raise the level of savings, or

(a) merely redirect where private savings are made; and (b) are accompanied by equivalent (or greater) reductions in government savings, with a negative impact on net national savings.

The most comprehensive review of international empirical studies that I am aware of, Antolin and Ponton (2007)1 suggests that tax incentives

 have very little, if any, impact on the net savings of higher income groups, but can increase savings within this group in the years near to retirement;  do tend to increase savings by low and middle income groups;  have a larger impact on lower income groups if they are accompanied by an extra payment from another party, be that the employer or the government;  are more effective in increasing savings if they are delivered in an environment of “soft-compulsion” (such as a compulsory enrolment with an opt-out option);  are significantly captured by the top twenty, or even ten percent of income earners, even when attempts are made to cap incentives or pay them as rebates.

Summarising, then, incentives may increase private savings, especially through KiwiSaver type processes, but have an inequitable impact. There is no study that I am aware of that looks at whether any increases offset reduced public saving under KiwiSaver. Intuitively, the case to assume a net national increase in savings is weak.

In the five years to 30 June 2013, members contributed $6.4 billion to KiwiSaver schemes, employers $3.5 billion and the Crown $5.3 billion. There was therefore a direct contribution by the Crown of 35 percent of money going into KiwiSaver. Put another way, the Crown stumped up one dollar for every two that was extracted either from willing contributors or coerced employers. More than half of all private contributions would have to have been new savings, and not just savings diverted from other sources into the tax advantaged vehicle, for there to have been an increase in national savings.

Apart from the question of whether or not there should be any form of tax preference, there is the issue of whether the existing forms of preference are cost effective and equitable. In my book, a major design fault is making the kickstart available to children.

1 Antolin, P. and E. Lopez Ponton (2007): “The Impact of Tax Incentives on Retirement Savings: A Literature Review” OECD/IOPS Global Private Pension Conference Proceedings http://www.oecd.org/dataoecd/60/20/40332454.pdf

333,000 KiwiSaver members are under 18: 31 percent of the eligible population. 23 percent of members have no income source. This is not saving: it is simply farming a tax benefit, and I would guess that most of those who have farmed it have fiscally aware parents who would almost inevitably be in the higher income groups.

I do not buy the age discrimination argument. There are plenty of things people cannot do until they are 18: making joining KiwiSaver one of them simply adds to an already long list.

Scheme stability

Retirement savings and their decumulation are lifelong processes, and will benefit from some stability of policy so that people can plan with confidence. The architecture has been remarkably stable and resilient. The incentive system has been highly unstable. The table shows the changes made to incentives, which average one a year since the inception of the scheme.

Announcement Effective Provisions from

Budget May, 2005 1 April $1,000 “kick start”. Fee subsidy. 2007 Standard contribution rate of 4% of income, option to move to 8%. Employer contribution optional. First home subsidy if conditions met. Budget May, 2007 1 July Fee subsidy confirmed at $40 per member per 2007 annum. 100% tax credit to match member contributions up to $20 per week Budget May, 2007 1 April Compulsory matching employer contributions of 2008 1% of employee gross salary increasing by 1% each year until 4% subsidy reached in 2011/12. 100% KiwiSaver Employer tax credit up to $20 per week. 11 November 2008. Taxation 1 April Minimum employee contribution rate reduced to (Urgent Measures and 2009 2%. Annual Rates) Bill Compulsory employer contribution reduced to 2%. Budget May, 2011 1 July Tax credit for employee contributions reduced to 2012 50% up to a maximum equivalent to $10 per week Budget May, 2011 1 April Employer contributions to be subject to ESCT at 2012 employee’s marginal tax rate. Budget May, 2011 1 April Minimum employee contribution rises to 3%. 2013 Compulsory employer contribution rises to 3%.

Compulsion.

Compulsory KiwiSaver is actively promoted by funds management lobby groups, and is the policy of both of the major political parties.

We can put industry advocacy into the category of special pleading. At the time the working group reported, occupational superannuation schemes had $10 billion funds under management. There are now $16.6 billion in KiwiSaver accounts. I would think

that the vast majority of those are new balances, not diverted funds. So the industry has more than doubled. $5.3 billion of the total is from Crown contributions. This is by far and away the most heavily subsidised industry in New Zealand. The money is also massively supported by state regulatory and administration systems. The state signs up clients, collects their contributions and delivers the money into provider bank accounts: that whole insurance industry sales force is no longer needed! It may well be that there are third party benefits, and personal, social and economic spin-offs, but the fact is that this industry has fed well at the KiwiSaver table.

National favours compulsory enrolment with a right to opt out. Labour favours compulsion for all but some exempt groups at the outer ends of the income spectrum. Under present KiwiSaver arrangements, contributors can take contributions holidays, either on hardship grounds, or as of right after one year, and these can be renewed as often as the contributor likes. Cosmetics aside, this is the same thing as a right to opt out. The only differences are timing (when National triggers the comprehensive contributor swoop, and when the de facto opt out option kicks in: immediately under the National policy and after a year under Labour’s).

I am not sure if Labour’s compulsory scheme will tighten up on contributions holidays. If it does, that raises a whole raft of issues around hardship and the right to cease contributions, which inevitably introduces complexity and arbitrary treatment of classes of contributors.

But however hard of soft compulsion is, we need to be wary of unintended consequences.

The big one for me is that under compulsion, the government is not only saying that you must save, but it is actually saying how you should save. Younger people might prefer to save for a deposit on a home – which will become more pressing if the Reserve Bank retains its aggressive stance on house purchases – to pay off a mortgage, or to pay off student debt and so on.

If the government says that you must save in a particular way, the immediate demand will be that the government guarantees capital invested. As soon as it does that, we are into a South Canterbury Finance scenario: some providers will offer high risk/ high return investment options in the knowledge that if it goes wrong, the government will bail the investor out. That in turn will raise the question of whether there is a need to regulate the form of permitted investment with all of the complication involved with that.

Finally, there will inevitably be a link between savings and some erosion of New Zealand Superannuation entitlements into the future, undermining the hugely cost effective and equitable features of that scheme, and personalising inflation and longevity risk that NZS so successfully pools.

Pick at the cuff with compulsion, and the thread unravels a long way up the sleeve.

Comparisons are often made with the compulsory Australian scheme. That one does reduce entitlements to their equivalent of NZS. It is not government guaranteed, but there are features that have negative implications for us. There, they have what they call a “preservation age”. It is currently 55, rising to 60 over the next decade. People can access their super if they retire at or after preservation age, and draw part of it out if they don’t. The effect is to permit, and in some ways incentivise, early retirement (to

reduce the abatement of the universal pension). Australians do retire early: the average age at retirement is under 60, whereas 17 percent of our over 65’s are still in the labour force: up from 7 percent in 1986. Just as we worry about a rising dependency ratio, we start to put in place building blocks that make it worse!

Besides all of this, the question remains as to what problem compulsion targets.

72 percent of people in the 18 – 24 year age group – surely the target group – are already in KiwiSaver. I presume a big chunk of the rest are students or unemployed. More than half of those in the mid 20’s to mid 50’s are members. Many of the rest will be paying down mortgages or investing in their children’s education.

If the policy target is to increase national savings, the fiscal balance is the most direct route towards it.

Lessons from SSRSS.

SSRSS was overtaken by KiwiSaver and effectively folded into it, but there are some lessons to be learnt from it. These relate particularly to arguments that default investment options should reflect life-stage risk tolerances, with a high level of assets invested in growth assets (equities and property) when contributors are younger, shifting towards more income assets (fixed interest securities and so on) as contributors age. Clearly the industry favours this: the fees from growth asset investment are higher.

The interesting thing about SSRSS was that after its introduction, it was found that large numbers of young people had selected conservative investment choices. A survey of the reasons for this generated a disarmingly simple answer: there is no need to be greedy, we have a long time to let compound interest work its magic!

The life stage default investment choice rests on an implicit assumption that historical trends that show growth assets have higher returns over the longer term than income assets, albeit with greater volatility, will continue into the future. That is a fairly bold assumption. But even if it holds true, I can’t see why it should be foist onto a contributing generation by default: surely education and informed choice is every bit as good a public policy instrument as paternalistic patronage?

A least regrets policy – say having a balanced rather than a conservative portfolio as the default option – seems sensible. It would be interesting to speculate on what attitudes to KiwiSaver would have been if young people had been drafted into growth investment choices and then the GFC struck! A conservative default was a saving grace.

A final thought

The retirement policy mix in New Zealand seems to be well balanced. Changing it to mirror what other countries do might give us exactly what other countries have! Be careful what you ask for: you might just get it.

Peter Harris

17 April 2014