Brian Gaynor: Saving up trouble for the twilight years

The low level of private savings is one of the key issues facing the economy.

Organisation for Economic Cooperation and Development figures show New Zealand lags well behind most of the 30 member countries in terms of private retirement assets.

As the table shows, New Zealand ranks 20th in terms of pension and life insurance assets with only US$3800 per head. Portugal is the only Western country with a lower ranking.

New Zealand's per head retirement assets are only a fraction of the United States' US$45,700 ($71,700), the United Kingdom's US$41,400, Denmark's US$40,100, Ireland's US$36,300 and Australia's US$29,000.

As far as total pension and life insurance assets as a percentage of gross domestic product goes, New Zealand ranks 23rd of the 27 countries, ahead of only Hungary, Poland, the Czech Republic and Turkey.

New Zealand's post-World War II baby boomers are poorly prepared for retirement and will be a big burden on taxpayers over the next 20 to 30 years.

The OECD statistics also demonstrate that New Zealand has to borrow abroad because of the low level of domestic savings. These borrowings have a long-term negative impact on the current account or balance of payments deficit.

The low savings rate, particularly compared with Australia's, also means that our companies are vulnerable to takeover offers from companies in high-savings countries.

The two countries with the highest savings rates, Switzerland and Iceland, have compulsory superannuation schemes.

Most large Swiss companies started providing pension schemes after World War II. A 1972 referendum enshrined this in the constitution and, in the mid-1980s, all companies were required to provide a pension scheme for their employees.

The compulsory system was introduced because the Swiss Labour Party had tried to nationalise the existing private pension schemes and there was widespread concern that the state would have to expand in order to provide a decent standard of living for under-provided retirees.

Iceland has a three-tier pension system - a public pension, which is tax financed and means tested; a mandatory pension system for all employees; and tax incentives for individual pension plans.

The mandatory scheme has its origins in the 1969 general wage settlement when unions agreed to forgo wage increases in return for compulsory pension funds. Under these schemes, most Icelanders can expect an annual pension equal to 60 to 70 per cent of their wage or salary.

The Netherlands, which is third on the OECD pension assets list, has a partial compulsory scheme. The Government has encouraged companies to offer pension plans and these are negotiated between unions and employers. The Government offers attractive tax concessions to ensure most employers and employees participate in schemes.

Ten other OECD countries have compulsory superannuation: Denmark and Finland, which introduced compulsion in 1985, Australia (1992), Mexico (1997), Hungary (1998), Poland (1999), Sweden (2000), Slovak Republic (2005), South Korea (2005) and Norway (2006).

The Norwegian scheme, when it takes effect on July 1, requires employers to establish a defined contribution or defined benefit scheme. Employers must contribute an amount equal to at least 2 per cent of the employee's earnings.

Most countries without compulsory superannuation have some form of tax incentive to encourage savings. The three main tax regimes can be summarised as follows:

1) Exempt, exempt and taxed (EET). This is where pension fund contributions are tax exempt, the investment returns are also tax exempt but withdrawals are taxed.

2) Exempt, taxed, taxed (ETT). Contributions receive a tax incentive but investment returns and withdrawals are taxed.

3) Taxed, taxed and exempted (TTE). Contributions and investment returns are taxed but withdrawals are tax-exempt.

As a rule, the first regime is more attractive than the second and third and the second is more attractive than the last. The other alternatives, TEE and TET, are similarly unattractive.

The top 17 countries in the accompanying table have either compulsory superannuation or an EET regime. EET schemes are particularly attractive because employees get a tax incentive when they put their money into a pension fund and the investment returns are tax free. Taxes on withdrawals are not a disincentive to saving.

The countries with the least-attractive savings regimes, those with a TEE, TET or TTE regime, are the worst performers in terms of pension fund assets. These are Hungary (TEE) the Czech Republic and Luxembourg (TET) and New Zealand, the only country with a TTE system.

New Zealand has the least-attractive regime of any OECD country because there are no tax incentives for contributions and investment earnings are taxed. Withdrawals are tax-exempt but this is not a strong incentive to save.

Based on the trends between 2001 and 2004, New Zealand will slip further down the table because the six countries ranked immediately below it, particularly the Eastern European ones, are experiencing strong pension fund asset growth whereas New Zealand's is virtually static.

The introduction of KiwiSaver and the removal of capital gains tax on pooled funds that invest in New Zealand and Australian equities is an attempt to create a more favourable savings regime. Unfortunately, it is too little and too late.

Finance Minister Michael Cullen is too concerned about his short-term Budget position and the new initiatives, which start on April 1 next year, will do little to improve the country's dismal savings performance.

The KiwiSaver scheme doesn't have habit-breaking incentives and pooled funds that invest outside Australia and New Zealand will continue to be subject to a capital gains tax (this tax is being removed only on pooled funds that invest in New Zealand and Australian equities).

New Zealand needs to introduce compulsory superannuation or an EET scheme if there is to be any meaningful increase in the savings rate (the EET scheme would be more attractive if withdrawals became tax exempt once the individual reached the age of 65).

One of the more negative consequences of our dreadful savings record is that our next-door neighbour has a compulsory scheme and its pension fund assets are growing rapidly.

This enables Australian predators to gobble up New Zealand companies because they have access to a huge pool of equity capital.

At a recent presentation in Sydney, AMP chief executive Andrew Mohl predicted that total Australian private pension assets would grow by $2.2 trillion in the next decade and reach a phenomenal $3 trillion by 2015.

As the total value of the NZX is only $60 billion, Australian investors could buy the New Zealand sharemarket nearly 40 times with the $2.2 trillion of additional private fund assets that they are expected to accumulate by 2015.

New Zealand is rapidly becoming an economic colony of Australia, mainly because our neighbour has a huge pool of funds to buy our companies and we have limited funds to defend them.

The recent decision by National Australia Bank to look at the possible sale of its fully owned Bank of New Zealand is a case in point. New Zealand is in no position to buy back the bank because the purchase price would consume well over 10 per cent of the country's total private pension fund assets.

* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.