Speech: Cullen details TET plans

Good morning. It is a pleasure to be here. I would like to talk with you today about an important issue that is as close to your hearts as it is to mine; superannuation and retirement income.

One of the first actions of this government was to boost the level of New Zealand Superannuation. Since then, the government has introduced the New Zealand Superannuation Bill. I see this as one of the Coalition Government's most significant initiatives. The Bill is designed to provide for the long life of a realistic, universal, flat rate, non-means tested New Zealand Superannuation entitlement. We need to act now to sustain the pension at current levels as its total costs increase in line with changes in the age structure of the population.

The post-war baby boomers will start to retire in about 15 years time, and because the birth rate has fallen, they will not be replaced in the workforce in the same proportion. This is not a temporary cost bubble. We, like the rest of the developed world, face the prospect of a permanently older population structure.

Unlike the rest of the developed world, we have some breathing space to prepare fo that shift in the population structure.

We will protect the future of New Zealand Superannuation:

1. by defining the (married rate) entitlement as being no less than 65 percent of the after-tax average wage;
2. by providing for other parties to "sign on" to the set of entitlements, and for a process of consultation before any aspect of the entitlement regime can be changed;
3. by establishing a fund that partially "pre-funds" NZS and makes it easier for future governments to meet its cost even as the proportion of those in the 65 plus age bracket increases.

I believe that this regime provides a basic, no-frills level of personal security for retirement.

Security in retirement is the least that citizens should expect from their governments in a civilised, developed country. It is also the most they should expect. It is not the function of the government to maintain in retirement the incomes that people earned during working life. That is the responsibility of the individual.

This is one reason to reject compulsory individualised, earnings based savings: the government is intruding too far into what ought to be personal decisions about how to spread consumption over the life cycle.

Having said that, while NZS will provide enough to enable participation in life, it is not designed to do more than that.

An adequate standard of living in retirement requires

1. that other policies required to facilitate "positive ageing", including the provision of adequate health care facilities, be developed and implemented; and
2. that individuals should be encouraged to provide for an additional "second tier" retirement income to augment NZS.

NZS is not meant to replace personal savings. Indeed, it is designed to encourage personal savings. Under earlier policies, where NZS reduced in some proportion to the level of private income in retirement, private savings were discouraged: people were saving for the government rather than for temselves.

The question for the government is whether a secure NZS is enough. If people have confidence that NZS will provide the basic bread and butter, will they be sufficiently motivated to save to provide the jam?

In comparison with other developed countries, New Zealand has very few incentives available to individuals who save for retirement. Saving through a structured, retirement focussed vehicle like a superannuation scheme or pension fund is taxed in exactly the same way as money in a savings account in a bank.

In these circumstances, people tend to save in ways that leave them ready access to their money or more options for using it: term deposits rather than pension schemes. They also seek out avenues where returns are not taxed – like buying second houses where the capital gain is not taxed.

The net result is that savings rates are low, and the form that savings take is not very efficient from the point of view of the wider economy.

This has led the government to review the basis on which private savings are taxed or otherwise encouraged.

The standard international terminology is to see retirement income being based on three "tiers" or "pillars": the first is the universal, government-funded pension, the second is the income derived from employment based superannuation schemes, and the third is personal savings.

The government has a clear policy on the first tier. What of the second and third?

Whether it is good or bad, employment based superannuation is in retreat in New Zealand. There are a number of reasons for this.

• As people change jobs more regularly, the basis for a work based pension scheme – the "career’, or "job for life" – is eroded. It becomes expensive to switch pension plans, or to maintain a large number of small schemes each built up with a different employer. Employers have weaker incentives to use pension schemes to hold or reward long-serving workers.
• As union coverage and the coverage of collective bargaining have reduced, there are fewer opportunities to negotiate pension schemes as part of the employment package.
• There is growing acceptance, by both employers and workers, of the concept of a "total remuneration package", under which workers choose how to spend or invest their own money.
• The focus on cost containment has seen employers axe the pension subsidy as an avoidable extra.
• The tax regime cannot generate any advantages for a worker, and runs the risk of taxing their savings at a higher rate than the same money received as a wage.

In New Zealand, then, there is no clear distinction between the second and third tiers of provision for retirement income: employment-based pension schemes are but one form by which individuals save.

The question is whether the government can or should do more to encourage extra saving. A supplementary question is whether there should be any bias within that encouragement to particular types of savings, like through employment-based pension plans.

While the government can’t compel people to save, it can encourage them to do so.

This means aligning the tax system with appropriate incentives to save.

The two key constraints are:

1. any incentives must not be too expensive fiscally, or else stimulating private savings crowds out other spending on programmes that have wider public benefits, including, I might add, the provision of health services to the elderly;
2. incentives should add to the level and rate of savings, and not merely result in a shift in the form of savings or a transfer of savings from current vehicles in order to seek new tax advantages.

Existing tax arrangements are referred to as TTE: contributions to any superannuation scheme are out of taxed income; the earnings of superannuation funds are taxed;

but when pensions are paid out they are exempt from tax (in much the same way as the tax system would treat savings in a bank account).

At this stage we are thinking of putting up a new, parallel option to the current regime under which savers could opt for a TEt regime. This means payments into the fund would be out of tax paid income – the same as applies currently.

However, the earnings of the fund would be exempt from tax and at the end of the life of the scheme, that element of pensions that represent the withdrawal of the (tax paid) capital contribution would be exempt, but that portion representing the tax exempt earnings on the fund would be taxed (hence the little "t").

Details would have to be worked out and would depend on the form in which pensions were drawn down, but in general, roughly half of the payments out of a pension fund are a return of capital contributions and the other half the earnings of the fund.

There is the question of controlling the loss of revenue associated with the new option. The losses can easily be overstated for four reasons.

Firstly, the change is essentially a change in when tax is collected, not how much is collected. At present, tax is collected early. Under TEt some is collected as now, but some is deferred until when the pension is paid out.

Secondly, the TEt would only be an option. It would not replace TTE. People who wanted to stick with their existing arrangements would be entitled to do so. Most people with reasonably mature TTE schemes are close to getting the tax exempt pension and they clearly would not want to change.

I must stress that existing, tax exempt pensions being revedved by those who have already retired will not be affected in any way whatsoever.

Thirdly, there is already some migration of pension funds into foreign based, tax exempt structures. TEt is already a live option for many savers, so it is not clear that a lot of new savings would go into the regime.

Finally, to the extent that extra money does go into TEt structures, there is an expansion of the tax base, even if it is only collected at the "t" end.

This leaves the issue of containing the (temporary) loss of revenue and limiting the amount of switching of savings.

Here there is a smorgasbord of options, and a package can contain more than one serving.

The options include:

• Limiting qualifying deductions to those made "at source".

• Limiting the annual amount that can be placed in a TEt scheme.
• Limiting the total amount that can accumulate in a TEt scheme.
• Restricting access to TEt to schemes that "lock" savings in, either for a minimum number of years or until some designated retirement age.
• Restricting access to a TET scheme to those who are below some designated age, at or near retirement.
• Requiring schemes to limit the amount of any benefit that can be withdrawn in a lump sum, to reinforce the pension orientation of scheme design.

The debate on second/third tier provision has yet to get underway. However, it should be seen as the logical extension of the first stage initiative to rebuild confidence in New Zealand Superannuation.

Dignity in old age is an important tenant of this government. You, more than any other group will be acutely aware of the bitter politics and broken promises that has surrounded the issue of superannuation.

The Government is acting now to remove politics from this issue and until someone or another political party come up with a better solution – and to date, no one has – I believe that only through partial prefunding can we protect the value of New Zealand Super. And through sensible changes in our tax laws we can encourage and promote private savings, so the elderly of New Zealand, now and in the future, may live in dignity.