Section 10 - Compulsory private saving


10.       On compulsory private provision[109]

Many New Zealanders think we should all be forced to save for retirement in compulsory saving accounts.  Others go further and suggest that all welfare spending in New Zealand should be financed through compulsory saving accounts, such as happens in Singapore[110].

The compulsory, defined contribution, Tier 2 retirement savings scheme, adopted by Chile in 1981, copied by Australia in 1986 and by many other countries since, tries to force citizens (and their employers in some cases) to set aside financial claims and to lock those up until the state pension age[111].  From then, there are varying degrees of control on what Tier 2 savings can be used for and usually close links between the Tier 2 benefit and the Tier 1 pension.  These vary from a direct offset (Sweden) to a complex array of income- and asset-tests that embrace most financial assets, including the proceeds of the Tier 2 accumulation itself (Australia)[112].

There are three main sets of difficulties with the kinds of arrangements promoted most notably by the World Bank in 1994[113]:

  • Controlling human behaviour over as many as seven decades - from first employment to death in retirement – seems too difficult.  It starts with convincing everyone to join.  Success here seems correlated to a country’s overall governance standards: the higher those standards, the more likely it is that ‘compulsion’ means ‘everyone joining’.  The World Bank itself concludes that this defining characteristic of Tier 2 schemes seems not to be working in most of Latin America[114].
  • ‘Compulsory’ Tier 2 schemes inevitably require thickets of regulations that become more complex over time.  There is so much to control and so many who might prefer to do something else; and they are constantly thinking of new ways to avoid Tier 2 or to mitigate its effects.
  • Tier 2 schemes must be directed by the government even if, as in Australia, they are not actually run by the government.  ‘Privately’ managed schemes cannot avoid the constant oversight of regulatory authorities.  Australia is currently engaged in such a review by its Productivity Commission to “assess the competitiveness and efficiency of the superannuation system”[115].  It is far from the first review.  The government has delivered a lucrative business to the financial services industry and must inevitably, on the members’ behalf, be deeply involved in the oversight of all aspects of that business, especially as it also indirectly affects the future cost of Tier 1.
  • Given the natural propensity of individuals to set their own objectives and timetables, even if the Tier 2 scheme successfully captures the memberships and mandated contributions, the rules cannot prevent members’ changing their other behaviour to compensate.  Australia provides some good examples of this.  First, the income/asset-tests that link Tier 2 (and all other assets) to Tier 1 are numbingly intricate and intrusive[116].  Next Australians seem to arrive at retirement with greater debt, having effectively ‘pre-spent’ their retirement savings[117].  Australians also seem to retire early to collect their Tier 2 saving accounts[118] and spend those before the means-tested Tier 1 pension starts[119].  Finally, the necessary means-tests directly affect post-‘retirement’ labour force participation rates.  We have more to say on this in section 16 below (When do New Zealanders retire?).  In 2010, the participation rate for age 65+ in New Zealand was 17%[120]; in Australia, it was 10.7%[121].  It’s not possible to put all of that difference down to means-tests but it is likely to be a significant influence.

There is no way governments can control offsetting financial behaviour.  If governments want the Tier 2 scheme to increase self-provision for retirement, we should expect evidence that is in fact happening.  Counting the money in the Tier 2 scheme’s accounts (an approach favoured by financial service providers) does not tell us what is happening to household wealth[122].

Whether or not existing compulsory, pre-funded Tier 2 schemes increase household savings (or even national saving) should be a central question asked by countries that are considering such a scheme.  Countries with such a scheme should ask the same question.  The answer is very likely to be equivocal and will probably fail to justify compulsory private provision as a public policy plank[123].

[109] This section is based on a submission by Michael Littlewood for the Retirement Commissioner’s 2016 Review: Ageing populations, retirement incomes and public policy: the four ‘first principles’ of policy-making - A submission to the Commission for Financial Capability (accessible here).
[110] See Welfare: Savings Not Taxation, Roger Douglas and Robert McCulloch (2016) accessible here.
[111] In fact, Australia allows access to the compulsory savings before the state pension age.  Currently the ‘preservation age’ is age 55, increasing to age 60 by 2024.  This ‘gap’ encourages Australians to retire before the state pension age (currently age 65, increasing to age 67 between 2017 and 2023).  The Australian government announced in the 2014 Budget that the state pension age will further increase to age 70 by 2035 (see here).
[112] Australia’s asset-test was toughened from 1 January 2017 (see here).  The threshold for the test was raised but the ‘taper rate’ (the reduction in pension for each $A1,000 of assets) was doubled from $A78 a year to $A156.  For a home-owning couple, there is now no Age Pension with ‘qualifying assets’ of more than $A816,000.
[113] Averting the Old-Age Crisis – Policies to Protect the Old and Promote Growth (1994) The World Bank accessible here; later refined into a ‘five pillar’ model in Old-Age Support in the 21st Century – the World Bank’s Perspective (2005) by Robert Holzman and Richard Hinz.
[114] “…nearly half the countries have coverage rates below 30%” - from Closing the Coverage Gap – Role of Social Pensions and Other Retirement Income Transfers (2009), Robert Holzman, David Robalino and Noriyuki Takayama (accessible here).
[115] The Australian Productivity Commission has published an ‘issues paper’ Superannuation: Assessing Competitiveness and Efficiency (July 2017) accessible here.
[116] Australian authorities require information from each pensioner on a regular basis: see here for the assets test and here for the income test.  There is even a ‘deemed rate’ of return on financial assets for the income test, regardless of the return actually earned (see here).  Centrelink is the agency responsible for implementing the tests in Australia.  Its website lists eight different kinds of income (including some deemed income) and nine different types of assets that have to be considered twice a year.  The potential for bureaucratic mistakes is significant. For more on means-tests in Australia, South Africa and the UK, see Means Tests: an evaluation of the justice of imposing high rates of clawback on those of modest means, Anthony Asher (2006) accessible here
[117] People should normally try to reduce overall debt as they approach retirement.  That seems not to be the case in Australia.  In the eight years to 2012, retirement savings among 50 to 64-year-olds grew 48%, other financial assets by 3% and real estate assets by 58% but property debt increased 123% and other debt by 43%.  By ages 60-64, debt was 42% of retirement saving balances: see Household savings and retirement – where has all my super gone? A report on superannuation and retirement for CPA Australia (2012), Simon Kelly (accessible here).
[118] The OECD estimates that Australia’s ‘effective retirement age’ in 2009 was 64.8 (males) and 62.9 (females).  By contrast, New Zealand’s was 67.1 (males) and 65.0 (females): see Average effective age of retirement in 1970-2009 in OECD countries (2010) accessible here.  The Australian Bureau of Statistics reported in December 2013 that the “…average age at retirement for recent retirees (those who have retired in the last five years) was 61.5 years.”  Men’s average was 63.3 and women’s 59.6 (see here).
[119] The post-retirement asset test in Australia also leads to an ‘over-consumption’ of housing services as the primary residence is exempt under the test: see Residential Transition Amongst the Australian Elderly (2007), John Piggott and Renuka Sane, Australian Institute for Population Ageing Research (accessible here).
[120] By 2015, the labour force participation rate for age 65+ in New Zealand had increased to 22.1% - source: Statistics NZ accessible here.
[121] Comparison of the New Zealand and Australian Retirement Income Systems, Ross Guest (2013) accessible here at page 15 (citing ILO data).
[122] A 2006 household wealth comparison between Australia and New Zealand shows that Australians have higher proportions of wealth in retirement saving accounts (19.1% in Australia and about 4% in New Zealand) but much less in ‘business investment’ (7.6% in Australia and 22.2% in New Zealand): see Household wealth in Australia and New Zealand (2010), RPRC PensionBriefing 2010-5 (accessible here).  Aggregating just these two components of household wealth produces 26.7% of total household wealth in Australia and 26.2% in New Zealand.  We have more to say on this comparison and the New Zealand data in section 14 below (Households’ financial position).
[123] Pensions and Saving: New International Panel Data Evidence (2006) by Ricardo Bebczuk and Alberto Musalem, CEF Policy for Financial Stability (accessible here) was a 48-country study from 1980 to 2004.  It examined the impact of pension saving on gross national saving rates and concluded that the changes made by ‘reforming countries’ (that introduced compulsory Tier 2 schemes) to ‘improve’ their national saving rate don’t seem to have had much effect on this number.

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Governments need clarity around the objectives of such an intrusive strategy.  If the real problem is the likely future cost of the Tier 1 pension, that should be addressed directly, leaving citizens to decide what cuts might mean for them.  Compulsory Tier 2 schemes may improve the depth of capital markets and that may have been a justification for Chile’s scheme in 1981, but the downside is that Tier 2 will be captured by the financial services sector.  The current level of compulsory contributions is unlikely ever to be considered ‘enough’ by that sector as the messages in Australia that now call for a lift from the new limit of 12% to an eventual 15% of pay[124].

Compulsory private provision has similar versions of the difficulties described for tax concessions (section 9, paragraphs (a) to (f) above).  They are complex (by definition), distortionary (again, by definition), expensive to administer and constrain flexibility (by definition).  They also suffer from the fundamental flaw that compulsion may not ‘work’ (raise overall saving levels, not just savings in compulsory accounts).

We have more to say on this wider issue below in section 15 (Households’ financial position – a proper longitudinal survey needed).

Just as individuals adjust their behaviour in response to public policy interventions, so too do financial service providers.  However, what’s good for providers is not necessarily good for savers or for the country[125].

We need more and better information about the effects of compulsory Tier 2 retirement saving schemes in other countries, but particularly in Australia.  Most of our financial institutions are owned out of Australia and there is no doubt that the compulsory ‘SG’ regime has been good for financial service providers in that country since it was first introduced in 1986.  That is not a reason to support the introduction of compulsory retirement savings in New Zealand or an extension of KiwiSaver to that effect.

Part of the public policy justification for such an intervention in Australia is the direct linkage between private assets/incomes (including from compulsory superannuation savings) and the Tier 1 Age Pension through the income and asset tests[126].  No such linkage was considered with KiwiSaver’s introduction but that will become an obvious issue if KiwiSaver ever were to become compulsory as was suggested, for example, by Michael Cullen in a November 2016 speech[127].

If we force citizens to save for retirement, we are really saying that, when they reach the state pension age, they will receive a smaller state pension.  Means-tests are an almost inevitable consequence of compulsion.  If New Zealand really wants to talk about compulsion then we also need a conversation about how to reduce the age pension by those compulsory savings.

[124] In Don’t Increase The Super Guarantee (Centre for Independent Studies, 2016 – accessible here) Michael Potter argues that an increase to 15% would cut wages, discourage workforce participation, prejudice appropriate responses to population ageing, worsen the efficiency of the financial services system and increase risks to households and the economy.  “One important goal of the SG increase is to increase retirement incomes.  However, it is not clear that retirement incomes are inadequate”.  And, as the author details, that is just the starting point of problems for the proposal.
[125] In Reassessing the impact of finance on growth (2012), Stephen Cecchetti and Enisse Kharroubi of the Bank For International Settlements (accessible here) suggest that “…the level of financial development is good only up to a point, after which it becomes a drag on growth.  Second, focusing on advanced economies, we show that a fast-growing financial sector is detrimental to aggregate productivity growth.”  The tipping point seems to be about 6.5% of real GDP per worker.  Australia’s is more than 11%.
[126] Australia seems to have only recently formally decided that reducing future Tier 1 payments is actually a primary objective of the compulsory Tier 2.  A bill currently being considered by the Australian Parliament suggests that “the aim of superannuation is to provide income in retirement to substitute or supplement the Age Pension” – Clause 5(1) of the Superannuation (Objective) Bill 2016 (accessible here).
[127] KiwiSaver: where to from here?, speech to the Workplace Savings conference (November 2016), accessible here, at page 4.  Michael Cullen does not discuss a means test but does suggest something he called a “hypothecated superannuation tax” as a “return for the current level of subsidies and an easing of [Employer Superannuation Contribution Tax]” (at page 5).  This new tax would be payable to the NZSF on the death or payment of a benefit to the member.  The author thought this “could have a dramatic impact on the long-term levels of other taxation required to fund New Zealand Superannuation.”  In other words, it would effectively be a tagged ‘tax cookie jar’ along similar lines to the NZSF itself.


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Questions New Zealand needs to discuss on compulsory private provision:

  1. What precisely has been the effect of Australia’s SG Tier 2 retirement savings scheme on:
    a.     Australians’ overall (not just retirement) saving and wealth accumulation patterns?
    b.     Public policy?
    c.     Retirees’ income levels?
    d.     The Australian financial services industry?
    e.     Households’ business investments?
    f.      Labour force participation patterns (before and after the state pension age)?
  2. How do the income and asset tests work in Australia (and elsewhere, like Mexico, Chile etc.) and what have been the effects of those tests on Australians’ financial behaviour?
  3. Is there any international evidence that compulsory Tier 2 savings schemes ‘work’ by increasing overall household savings and by improving the security of retirement income claims against the economy?
  4. And what is their impact on economic growth?