Simple, effective and (relatively) inexpensive: New Zealand retirement provision in the international context.

• Author: Rashbrooke, Geoff
• Position: Report

Abstract

The introduction of the defined contribution KiwiSaver scheme into the New Zealand retirement income policy landscape has caused some expressions of concern, particularly in the light of the associated government subsidies. This paper looks at the combination of KiwiSaver and the existing fiat-rate universal NZ Superannuation in the context of international retirement income provision. It explores the rationale of KiwiSaver in terms of anticipated outcomes in combination with NZ Superannuation, and makes a case that New Zealand is well positioned compared to other countries, in terms of simplicity, effectiveness and cost.

INTRODUCTION

Issues of pension reform are being discussed in nearly all Organisation for Economic Cooperation and Development (OECD) countries, with population ageing a significant driver. (1) OECD state pensions in the past were generally financed on a pay-as-you-go basis (PAYG (2)). PAYG financing is particularly susceptible to population ageing, which alters the balance between the numbers of those engaged in the paid workforce and those retired.

On the other hand, full funding of retirement (where member and employer contributions are made to an investment account, and the investment return depends on market conditions and is not usually guaranteed) also presents difficulties, because it too relies on the future workforce producing enough for the consumption needs of the retired, and paper promises can be eroded by inflation. There is an emerging consensus that some mix of PAYG and full funding of retirement provision is likely to be optimal.

Australia is now leading the way, with mandatory, fully funded, defined contribution (3) (DC) arrangements supplemented by a residence-based, means-tested age pension. Others--notably Denmark, Hungary, Poland and the Slovak Republic--have moved to include such arrangements as a significant component of their policy. Both voluntary and mandatory occupational DC schemes get state subsidies (usually through the tax system) in a number of countries, with Ireland, Australia, Canada, the United States, Iceland and the United Kingdom (UK) spending the most as a percentage of Gross Domestic Product (GDP), according to OECD data.

This international interest in pension reform has given rise to a considerable amount of research and analysis. In this paper, New Zealand's state retirement savings arrangements are compared to those of other countries. The criteria applied here are:

* simplicity--how easily is the framework understood, how straightforward is it for people to understand what they will get, and how much administration is required?

* effectiveness--how do the payment outcomes relate to levels of income prior to retirement (replacement rates), and how does the framework affect those who want to stay on in paid work after attaining the pension eligibility age?

* cost--what is the cost as a percentage of GDP?

The two components of the New Zealand retirement policy framework that put money in people's hands at retirement are NZ Superannuation and KiwiSaver. This paper looks at the combination of these components as a whole, including outcomes from NZ Superannuation (current) and KiwiSaver (projected), and compares these with current designs and outcomes in 26 other OECD countries. Data for the comparisons are taken from OECD and European Union sources.

SIMPLE

NZ Superannuation is generally acknowledged to be the simplest retirement pension set-up in the OECD. There is no means testing, no contributions history to track, and only a fairly basic residential requirement to meet. There are naturally some complications in the machinery, such as the interface with social security pensions from overseas and the annual adjustment process, but by and large the overriding principle--that New Zealanders in retirement should have enough income to belong to and participate in their society--is straightforward, and its current expression as "65 at 65" is eminently comprehensible. (5)

Other OECD countries generally have a minimum pension for the old, but set at a poverty alleviation level, and it is usually means tested. The primary state pension is frequently earnings related to a greater or lesser degree, and even where it is a flat rate, the full rate is payable only where there is a full contribution history. It can be difficult for people to ascertain their likely entitlements; the UK's Basic Pension plus State Second pension plus Pension Credit is especially complicated as a case in point.

The design concept of KiwiSaver is also simple. Contributions of 2%, 4% or 8% of salary to the scheme are deducted from employee earnings, an employer contribution of 2% of salary is added, and these are transmitted through the tax collection system to providers to accumulate to a lump sum available from age 65 or later to supplement NZ Superannuation. (6)

It is true that KiwiSaver could have been made simpler. For example, making it compulsory rather than using auto-enrolment would have removed the complexity inherent in the opt-out and opt-in choices. Having a maximum of, say, three providers with only four (or perhaps even fewer) investment choices would also have made things much simpler. And open competition among providers is adversely affected by the present inability to compare their charges in an easily comprehensible fashion. There have also proved to be some difficulties in conveying how it works in practice. The capped subsidy is misnamed as a "tax credit", which does not assist comprehension. Transition arrangements for existing superannuation schemes have also added to the complexity.

The preferred policy, however, was to give New Zealanders as much choice as possible. With the benefit of an established and well-respected source of financial information in the form of the Retirement Commission, allowing choice can be seen as not unreasonable, particularly as having to make KiwiSaver decisions may lead to greater interest in financial matters generally, and hence to an improvement overall in financial capability. In any case, one should not confuse the problems that need to be worked through in introducing KiwiSaver with the simplicity of its intent. One may reasonably expect a growing general...