Raising participation in KiwiSaver is central to the Savings Working Group (SWG) strategy to increase New Zealand's savings rate.
We expect a number of the enrolment-related and benefit design recommendations to find favour with policymakers, though most will need to be carefully implemented if adopted. However, the recommendation for a single state sector default scheme seems to involve something of a leap of logic.
This Brief Counsel complements a companion Brief Counsel earlier this week on the SWG's tax proposals
Core KiwiSaver recommendations
- Auto-enrol in KiwiSaver, with the right to opt out within two to eight weeks, everyone who is in employment, between the ages of 18 and 65 and is not currently enrolled.
- Lower the age of entitlement to government and compulsory employer KiwiSaver contributions from 18 to 16 (with auto-enrolment from 16 if this change is adopted).
- Pay the $1,000 kick start for new joiners in annual $200 instalments over five years, with payments contingent on ongoing contributions.
- Retain the 2% minimum employee contribution rate (to keep entry barriers low) but restore the default contribution rate to 4% of pay
- Remove the tax exemption on the 2% employer contributions.
- Enable partial early withdrawals (as of right) to people with "shorter life expectancy".
- Outlaw (again) the "total remuneration" approach to employer KiwiSaver contributions1.
- Replace the six default funds with a "single low-cost default scheme" investing solely in index-based shares and bonds.
The SWG's report is both well-written and well-reasoned. A number of its recommendations clearly will not find favour with the Government. Others suggest worthwhile initiatives for evolving KiwiSaver and (in so doing) improving New Zealand's dire net savings rate.
This change would apply over and above the current auto-enrolment arrangements and would need to be managed on a very well-telegraphed "D-Day". Even then, it would create major, although once-only, complexity and compliance costs.
Very careful consideration will be needed concerning the implications for:
- employers who are exempt from the auto-enrolment rules due to offering other schemes which KiwiSaver was intended merely to complement, and
- employees who are already contributory members of other employer-schemes.
On the second point, the report acknowledges that non-KiwiSaver schemes are valuable contributors to the net savings rate (and indeed recommends extending KiwiSaver-style incentives to other schemes where contributions "are locked in for reasonably long periods"). It would likely be wasteful to auto-enrol those employees when most can be expected to opt out due to "double-dip" prohibitions, contractual KiwiSaver offsets and a forced double-up of member contributions.
Full entitlements from age 16
The report acknowledges that this "lifts the cost of employment a little and may have some negative impact on youth employment levels". We would suggest that serious consideration be given to the 2004 Savings Product Working Group's suggestion that automatic enrolment not apply to employees who earn less than a prescribed minimum amount.
"Drip-feeding" the kickstart
The rationale here is to smooth the fiscal cost of the wider auto-enrolments recommendation and to assist in fostering a savings habit by rewarding members for making ongoing contributions to KiwiSaver. Both aims are valid.
Restoring default employee contribution rate of 4%2
It is unclear whether (and, if so, how) the SWG envisages this change applying to existing KiwiSavers. In principle (and to avoid some potentially fraught outcomes for current default subscribers) we think it should apply solely to new joiners. The last default rate change (from 4% to 2%, on 1 April 2009) also applied only to new joiners.
Removing the ESCT exemption
Employer contributions to KiwiSaver (or to a locked-in account in a complying superannuation fund) at the rate of 2% of total taxable pay are currently paid tax free. The SWG recommends removing this exemption and applying standard ESCT rates as a proxy for income tax.
ESCT is a withholding tax, so at current (income-linked) ESCT rates, this would reduce a 2% employer contribution to KiwiSaver to between 1.79% and 1.34% after ESCT was deducted.
The SWG's rationale for this recommendation is that the current ESCT exemption is:
- inequitable, in that it provides greater advantages to higher-paid employees, and
- a "hidden" subsidy and therefore not the most effective way for the government to incentivise KiwiSavers.
If employer contributions to KiwiSaver are to be taxed the same as other employer superannuation contributions, KiwiSaver members should be able to redirect the compulsory employer contributions payable for their benefit to traditional employer superannuation schemes (where they will be payable on leaving service).
This proposal would be the fourth major watering down of KiwiSaver incentives. On 1 April 2009, fee subsidies and employer tax credits were discontinued and the tax-exempt component of an employer's KiwiSaver contributions was reduced from 4% to 2% of pay.
Relaxed early withdrawal rules
The SWG recommends allowing partial withdrawals, as of right, before New Zealand Superannuation age for persons "for whom the eligibility age is inappropriate or unsuitable". It cites those in lifelong physical work, Māori, people with disabilities and "other groups with shorter than average life expectancies".
In our experience such a facility would create significant evidentiary difficulties and attendant cost and complexity. Arbitrary and at times unfair factual distinctions would be likely. The stated goal is to encourage people to save extra in KiwiSaver "knowing they could withdraw it if needed" – but this is the policy underlying the existing significant financial hardship, second chance home purchase and serious illness withdrawal facilities.
Adopting the Australian complying superannuation fund early retirement facility (which applies universally) would in our view be better in principle, and in view of pending trans-Tasman savings portability.
Outlawing "total remuneration"
The rationale the SWG offers to support its position that employers "should not be able to pay out their KiwiSaver contributions irrespective of whether employees join KiwiSaver" is that:
- the positive incentive created by the employer contribution is eroded by businesses that pay employees on a total remuneration3 basis, and
- if total remuneration applies, the only non-government financial incentive to join KiwiSaver is the current ESCT exemption (which the SWG recommends should disappear).
Paying KiwiSaver compulsory employer contributions in addition to an employee's gross salary or wages, conditional on the employee joining and contributing to KiwiSaver, is already the standard and default approach. Though it offers certainty in relation to wage costs for employers, the incidence of total remuneration is low.
Wider auto-enrolments might tempt more employers to move to total remuneration, but ultimately the cost of employer contributions will always be passed back to employees through lower salary or wage increases. The concept of "genuine additions" to pay is perhaps a little illusory.
Any change here would be a noteworthy further legislative flip-flop. In 2007 the then Government specifically confirmed an employer's ability to adopt a total remuneration approach (after some initial uncertainty). This option was then prohibited during 2008 but permitted again in December 2008.
One key difficulty which emerged from the initial prohibition was that employers were prevented from offsetting compulsory KiwiSaver contributions against contributions made to other schemes (typically themselves paid on top of salary). This was due to a wide prohibition on offering any lesser terms or conditions based on KiwiSaver membership.
Single default scheme proposal
This is in our view an extreme solution which is not warranted. We think the recommendation gives insufficient weight to factors such as reasonable fees constraints, the steady decline in fees and expenses (as a proportion of assets) and wider competitive tensions among providers.
Were it adopted, it seems the six default providers would be obliged to surrender all default members to the single nationalised provider, in six mammoth (and potentially goodwill destroying) transfer exercises. Those providers would likely then rue their initial success.
Proposals such as the (contradictory) suggestion that consideration be given to introducing rules aimed at reducing "churn" between default schemes are considerably more measured.
We doubt that the defeatist single scheme proposal will find favour.
Other reform ideas floated by the SWG
The SWG also raised a number of ideas which it stopped short of recommending. These were:
- auto-enrolling self-employed and non-employed persons aged 18 (or, if applicable, 16) or over, with the ability to opt out
- removing or reducing the government's matching contributions for those on higher incomes
- permitting self-managed funds (these are common in Australia), and
- increasing the government's matching contributions to $2 for every $1 contributed – "either with no change to the current maximum annual credit limit, or in conjunction with a reduction in the current limit".
In addition, the SWG discusses whether the Government should directly intervene to develop an annuities market, itself providing annuities, or "providing the ability to buy an increased entitlement to NZ Superannuation" (in each case on a full cost-recovery basis).
We agree with the SWG's comments that, were this to happen, it would be necessary that any extra New Zealand Superannuation entitlements purchased in this way be "contractually based (and thus immune from any changes that future Governments may make to the underlying NZ Superannuation entitlements)".
Other SWG proposals provide welcome endorsements of policymakers' and others' recent efforts in seeking to require regular, clear and simple scheme reporting and improved financial literacy.
1. As an aside, the SWG's report was released on the eve of Punxsutawney Pennsylvania's annual Groundhog Day.
2. Footnote 1 refers.
3. "Total remuneration" means a remuneration package that includes any required KiwiSaver contribution. If an employee elects to join a KiwiSaver scheme, their salary reduces by the amount the employer is required to contribute. This approach is common in Australia, where superannuation is compulsory.