Pensions for the Twenty First Century: Retirement Income Security for

Transcription

1 Pensions for the Twenty First Century: Retirement Income Security for Younger New Zealanders You 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.

2 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 Corporation AIA NZ AMP Financial Services ANZ Bank Asteron Life Ltd BNZ Investments and Insurance CIGNA Life Insurance NZ Ltd Fidelity Life Assurance Co Ltd FNZ Gen Re LifeHealth Hannover Life Re of Australasia Ltd Kiwibank Ltd Mercer Munich Reinsurance Co of Australasia Ltd Pinnacle Life Public Trust RGA Reinsurance Co. of Australia Ltd Sovereign Ltd Swiss Re Life & Health Australia Ltd TOWER New Zealand Westpac Bank Associate Members Bell Gully BNP Paribas Bravura Solutions Burrowes & Co Chapman Tripp Davies Financial & Actuarial Ltd Deloitte DLA Phillips Fox Ernst & Young KPMG Kensington Swan Melville Jessup Weaver Minter Ellison Rudd Watts Morningstar Research Ltd PricewaterhouseCoopers Russell McVeagh Simpson Grierson ADDITIONAL FUNDING FSC Members AIA NZ AMP Financial Services ANZ Bank Asteron Life Ltd BNZ Investments and Insurance Fidelity Life Assurance Co Ltd Hannover Life Re of Australasia Ltd Sovereign Ltd Swiss Re Life & Health Australia Ltd TOWER New Zealand Westpac Bank Non Members Aon Hewitt Project Advisers Andrew Coleman, Motu Research, Member of the Savings Working Group Paul Mersi, Member of the Savings Working Group Adolf Stroombergen, Infometrics Paul R Rhodes, PwC Graeme 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 Page 2

3 Table of Contents 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 Retirement Income Security for Younger New Zealanders Page 1

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5 List of Tables PAGE Table 1 Number of New Zealand live births Table 2 Average life expectancy in New Zealand at 65, 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 (projection using SNZ Series 5) 12 Table 5 Projected average life expectancy in New Zealand from age 65, Table 6 New Zealand population aged 65 & over under different longevity trends 15 Table 7 New Zealand Superannuation (PAYGO) costs as percentage GDP (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 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 Table 28 Female on median female income retiring at 65 from 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 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 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 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 Retirement Income Security for Younger New Zealanders Page 3

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7 Introduction 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 Retirement Income Security for Younger New Zealanders Page 5

8 Pensions for the Twenty First Century 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 Page 6

9 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 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. Retirement Income Security for Younger New Zealanders Page 7

10 Pensions for the Twenty First Century 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 Page 8

11 contributions, is to switch the funding mechanism from a pay-as-yougo (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 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. Retirement Income Security for Younger New Zealanders Page 9

12 Pensions for the Twenty First Century 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 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 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 Source: Infometrics from Statistics NZ Page 10

13 Year 65 Source: Infometrics from Statistics NZ Now think about the person born in 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 years. The Series 5 estimates have needed to be 600 Actual Source: PwC from Statistics New Zealand Retirement Income Security for Younger New Zealanders Page 11

14 Pensions for the Twenty First Century 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 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 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 Page 12

15 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. Summary Source: The Lancet, Vol 374, October 3, 2009 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. Retirement Income Security for Younger New Zealanders Page 13

16 Pensions for the Twenty First Century SECTION 2 Continued scenarios Year 65 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 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. Page 14

17 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 Trend (ELL) 3 extra years of life after 65 each decade Retirement Income Security for Younger New Zealanders Page 15

18 Pensions for the Twenty First Century 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% Source: Infometrics Page 16

19 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. Retirement Income Security for Younger New Zealanders Page 17

20 Pensions for the Twenty First Century 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 0% 5% Source FSC Horizon Research Dec 2011 * NZS for an individual living alone $ per week after Tax at M rate as at 1 April % 15% 20% 25% Page 18

21 $601 to $800 $551 to $600 $501 to $550 $401 to $500 $300 to $400 0% 5% 10% 15% Source: FSC Horizon Research Dec 2011 * NZS for a couple $ per week after Tax at M rate as at 1 April % 25% 30% FSC Lancet - Women Self - Women or earlier Source: FSC Lancet Projections and Horizon Research Dec 2011 Source FSC Horizon Research Dec 2011 Retirement Income Security for Younger New Zealanders Page 19

22 Pensions for the Twenty First Century 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. Page 20

23 Table 12 Biases that distort our saving and investing behaviour Loss Aversion Regret Self Control - Source: Andrew Coleman, Motu Research Retirement Income Security for Younger New Zealanders Page 21

24 Pensions for the Twenty First Century 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 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. Page 22