Retirement - Old-age income never easy

By WAYNE THOMPSON

Developed countries face important structural problems working out a logical, consistent, affordable and sustainable retirement income system.

That is the conclusion of Michael Littlewood, an Auckland private consultant and member of the 1992 Todd taskforce on retirement.

He has looked at the retirement income systems of five developed countries not too dissimilar to New Zealand, and one emerging nation. Most of them differ from us.

He sees the main structural problems as:

* A tax-favoured retirement saving industry.

* Unrealistically high state provision that tends to crowd out private provision (not just financial savings).

* Excessive Government regulation - often a consequence of tax incentives and/or compulsory private savings for retirement.

Mr Littlewood looked at countries that exhibit different features of retirement income - the United States, Britain, France, Australia, Germany and Chile.

Cash incomes for retired people come in three major categories: tier 1 is public or state pensions; tier 2 is private and occupational pensions or superannuation; and tier 3 is private investment and savings.

Australia provides a relatively low-level, income and asset-tested Tier 1 benefit ($6880 single and $11,400 married a year). That is about 26 per cent (single) to 43 per cent (married) of the average ordinary time wage. It is paid from general income tax. It is also largely tax free.

An extensive, highly complex, compulsory, tax-subsidised private savings regime produces taxed benefits (lump sum or pension) at tier 2.

Employer-sponsored schemes can be part of the compulsory tier 2, but it is dominated (by weight of members) by union-fostered, award-based, defined contribution schemes.

Tier 3 has concessionary tax rates paid on contributions, investment income etc.

Chile has a low-level tier 1 benefit ($1370 a year or about 75 per cent of the minimum wage) paid after 20 years' coverage from general income tax. This is reduced by income from the compulsory tier 2 scheme.

An extensive, compulsory, tax-subsidised, private, defined contribution savings scheme produces a taxed pension at tier 2 from an employee's contribution equal to 10 per cent of pay plus costs.

Employer-sponsored schemes are rare, but savers can use the compulsory scheme for voluntary, tax-subsidised, additional benefits.

The United States has a largely tax-free, contributory, unfunded state scheme that relates its pension, in part, to the contributor's pay and contribution record and has a survivor's pension attached.

The tier 1 pension is usually paid regardless of other income, although at higher levels of other income it becomes partly taxed. The pension age was 65 but is rising to 67.

An extensive, complex, tax-subsidised, private savings environment operates through a variety of structures and is aimed at employees and individual savers. It produces taxed supplementary benefits at tiers 2 and 3.

Britain has a relatively low-level, flat-rate tier 1 benefit that is built up by a lifetime of contributions by both employers and employees and carries with it a survivor's benefit.

The benefit is taxed as income, but is not tested against the recipient's other income. Increases are linked to prices, not wages.

There is also a state-run tier 2 pension calculated by reference to earners' income described above. As with the United States, there is an extensive and intricate system of tax-subsidised private saving schemes at tiers 2 and 3.

France has an intricate, expensive separately managed social security system delivering at tier 1, from age 60, benefits equal to 50 per cent of covered earnings (that is, average revalued earnings over 25 years of up to $32,100) after 40 years.

Tier 2 is also dominated by the state, with mandatory, pay-as-you-go, defined benefit pensions that supplement tier 1. The eventual pension depends on the "points" bought by the contributions.

Contributions are tax deductible for both tiers 1 and 2. The value of the accruing benefits is not taxed in the beneficiary's hands and the eventual pensions are taxed.

In Germany, a complex social security scheme delivers tier 1 from age 65 at a cost of 19.2 per cent of covered pay for pensions alone. The full benefit is between 40 per cent and 45 per cent of covered earnings (of up to $65,000).

An extensive system of tier 2 schemes pay, mostly, defined benefit pensions that are meshed (or "integrated") with tier 1 and are often financed on a book reserve basis by the employer.

Separate schemes (Support Funds, Pension Funds and Direct Insurance) also exist. An employer's contributions to Direct Insurance are now partially taxed.

Wellington consultant David Preston says in a paper, commissioned by the Office of the Retirement Commissioner, that social insurance is the main type of public pension adopted by developed countries, requiring people to make a compulsory contribution from their earnings to social insurance funds.

Most social insurance schemes require contributions from both employers and employees. Some also receive Government subsidies. Retirement pensions paid out from social insurance funds are mainly based on members' earnings and contributions, which means pension levels vary.

In practice, a number of developed countries allow some low-income groups to receive cross-subsidies from other contributors through guaranteed minimum pensions.

Many funds that take a pay-as-you-go approach are experiencing a financial crisis as the population ages and the ratio of pensioners to contributors rises.

Many developing countries, such as India or Indonesia, use a variation on the compulsory contribution approach - provident funds that pay out a lump sum based on accumulated contributions plus interest.

Countries with social insurance systems usually develop a second level of social assistance from Government funds for the poor.

Australia is one of the few developed countries with a core public pension system based on social assistance principles. It now also has compulsory contributory superannuation.

New Zealand is unique among developed countries in having a universal pension (New Zealand Superannuation) as its only form of public pension for those who have reached retirement age.

However, Norway, Sweden, Denmark and Iceland operate a part-universal pension system, where older citizens receive a modest universal pension from the state in conjunction with an earnings-related contributory pension based on a social insurance model.