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Current superannuation issues

Thursday 7th of October 2004

This newsletter covers four matters:

the final report of the Savings Product Working Group,

the launch of the new state sector retirement superannuation scheme,

the review of the tax regime for investment income, and

recent tax and regulatory changes.

1. The Savings Product Working Group Introduction and background The Savings Product Working Group (SPWG) report was published on 15 September 2004. While the need for a review of workplace superannuation was signalled in the most recent PRG report, the SPWG roots seem to lie in the Government looking to establish in the private sector an equivalent to the new state sector retirement scheme. The group, headed by Peter Harris (former trade union economist and adviser to Michael Cullen), included Diana Crossan (Retirement Commissioner), Ross Kent (Alliance Capital), Andrew Leys (Southland Credit Union), Bernard Reid (Watson Wyatt) and Mike Woodbury (Chapman Tripp). Proposals for a new savings scheme The SPWG proposed that:

employers with more than 5 employees will be required to have the facility for employees to have salary deductions made to a savings scheme,
all new employees will be required to enrol in a scheme and deductions will automatically be made from their pay. Employers will not be required to contribute to the scheme,
the contribution rate is 5% above a threshold income level of $16,712, subject to a minimum contribution of $10 per week. This means that no one earning less than $27,122 would need to contribute. The threshold was chosen to match the threshold for student loans,
scheme providers will be approved by a Government agency and employees can select the provider they want to use. Employers can also select their own preferred provider,
contributions will be collected through the tax system with a special tax code applying. The contributions will be directed to a central scheme administrator and then passed on to the employee’s selected scheme, and
employees will be able to opt out at any time after 30 days membership of a scheme.

The SPWG implementation timetable shows the new regime in place by March 2006, although March 2007 is more likely. Sweeteners The terms of reference included exploring locking in contributions until a specified age. However, the SPWG report considered that with no “sweetener” such as tax incentives there was no justification for locking the contributions away. Despite noting that the decision on such Government funded sweeteners was part of the Government’s budgetary process, a number of sweeteners were suggested, including:

meeting the administration costs of the central scheme administrator,
meeting some of the fund management fees charged,
providing some basic life insurance cover for members,
making an incentive payment on the joining of a scheme, and
providing a reward payment after the balance in the account exceeded some amount or after a set period of time of making contributions.

The report noted that any sweeteners would act as a disincentive for existing schemes to remain in place. Existing schemes Integration of a new regime with existing schemes is an issue for any major regime change. Historically, NZ has taken the approach of requiring existing schemes to change to the new regime, as happened when defined benefit schemes were required to change their benefits in 1989. The SPWG report proposes that existing schemes can, subject to certain modifications, become approved schemes for the purposes of the new regime. Proposals to change the existing regime The report has considered and made proposals on the problems that exist with the current superannuation scheme regime. The proposals cover the need for revisions to:

the tax regime, in particular the rate of tax on investments for lower rate tax payers, as well as the liability of schemes to tax on capital gains in contrast to the absence of a liability for private investors,
the prospectus regime, where problems still remain for some employers,
the requirement that all schemes must be set up for the principal purpose of provision of retirement benefits,
the status of employers as scheme promoters, including the question of whether they are also investment advisers,
transfer provisions, to allow some transfers between schemes without the need for member consent, and
scheme amendments, where the adverse effect to members’ interests may be more reasonably interpreted.

Comment While there are still over 250,000 employees in schemes, coverage is only 14% of the workforce and the number has reduced significantly since 1990. In some respects the SPWG report seems like the first Government-sponsored report in a long time that is actually advocating superannuation and savings in New Zealand. Importantly, it is clear that Dr. Cullen sees poor savings levels as one of New Zealand’s serious long-term economic problems, one that he wants to address. The report makes a strong appeal to put aside the debate on whether or not savings per se is important, seeking comments on the specifics of the proposed scheme and how it should be implemented, rather than on whether the scheme should be implemented. Nevertheless, it is hard to see why, under the current superannuation and tax legislation, employees would not seek to opt out at the first opportunity. Feedback The report welcomes submissions, to be received no later than 31 October 2004. Implications for employers Employers with existing schemes may wish to make submissions regarding any difficulties they see for their schemes if the SPWG proposals are put into effect. Some employers may wish to support the proposals on behalf of their employees. Others may comment on perceived additional resource demands. All employers should follow the debate on workplace superannuation, with an awareness that, as in many other countries, we may in time see a Government mandated workplace superannuation regime. Back to top of page 2. State sector retirement savings scheme The launch of the State Sector Retirement Savings Scheme (SSRSS) on 1 July 2004 received wide publicity and has been widely recognised as a success. The scheme was a joint initiative between the PSA, the Government and state sector employers and its launch and success has implications for the whole superannuation savings industry. The SSRSS has:

employee contributions matched by the employer up to 1.5% of salary in year 1, increasing to 3% in year 2. After this, there is no agreed contribution rise but there is an expectation that the rates might yet be further increased. The employer rates are after payment of SSCWT,
those employees who joined on day 1 being able to backdate contributions for 6 months and receive matching backdated employer contributions,
the cost to employers funded centrally by Government rather than being taken out of department budgets, a return to the previous GSF funding arrangements,
employees given a choice of 3 master trusts, provided by ASB, AMP and AXA,
benefits generally locked in until the age of 55, and
coverage limited to schools and the central government departments whose employer is the State Services Commission, some 40 employers in total.

The take up rate averaged 44% of eligible employees, with the department rates varying between 25% and 88% of employees. A significant step The SSRSS is the first meaningful superannuation initiative for employees from Dr. Cullen, and signals to the private sector that superannuation is important. The success of the scheme tells employers that employees want to join a scheme as long as the scheme parameters are acceptable. The SSRSS has created pressure for a similar scheme to be established outside central government, for example in the health and local government sectors. We believe that superannuation is now on the agenda for all employers. Interestingly, the scheme has been built on the employer deduction model, taking a different approach from the previously all embracing “total remuneration” model and the issue of annuities has also been raised, with awareness that any lump sum is only as good as the income it can produce. MJW contribution Melville Jessup Weaver were heavily involved in the process of selecting the master trust providers to the SSRSS. As a firm independent of any investment manager or master trust, we are ideally placed to advise on such matters. Back to top of page 3. Review of tax regime for investment income It has been a long time since New Zealand had a sensible tax regime for investments. A tax neutral regime has proved as elusive as an All Black World Cup finals win – both last seen in 1987. A review is now being undertaken by a working group headed by Craig Stobo (formerly at BT and Treasury). The spur for the tax review was Australian unit trusts offering New Zealand fixed interest investments on a gross return basis. This and any further developments would have seen a significant reduction in the New Zealand tax base. The objectives set for the working group were to achieve consistency between direct investment and investment through and between managed funds. All options that may be promoted are required to protect the integrity of the tax base, minimise compliance costs for investors and industry, and not penalise lower income savers. Revenue neutrality is not to be an objective in itself. In particular, the review is looking to address the tax disadvantages faced by the local funds management industry when compared to direct private investment and to investment in overseas grey list country based funds. A private share investor will in the main not pay tax on capital gains, and a person wanting to invest in overseas shares with minimum tax impost will do so through UK listed investment trusts paying no capital gains tax and having only limited dividends and minimal withholding tax. It is expected that the options under consideration will include:

introducing the risk free rate of return method for assessing tax due, under which tax on investment returns is paid each year on a fixed basis irrespective of the actual returns achieved, and
placing the ultimate tax liability back to the individual, with the managed fund only being required to make an initial payment on behalf of the investor.

Comment While the review is directed at the taxation of investment income, it has wider implications for the superannuation industry. Any change should improve the tax position of schemes and make them more advantageous for members. A key factor in the debate on changes to the tax rules and tax rates is that the Government is running a substantial surplus (even after making annual payments of the order of $2 billion to the “Cullen Fund”) and can choose to defer tax payments now and receive those tax payments later. It is possible to view the changes made by Dr. Cullen in the state sector as the trigger for other developments. As noted, the work of the SPWG and its conclusions are important but we find puzzling the expectation that people will make a major effort to save on a voluntary basis. New Zealand sits alone with its unique tax regime. However, the underlying problem is that creating tax neutrality is technically not possible. That being the case, perhaps the only option is to create a deliberately tax favourable regime. That could be where Dr. Cullen is heading. Back to top of page 4. Recent tax and regulatory changes Prospectuses An exemption from the need to have a prospectus for employer superannuation schemes was introduced under the Securities Act 2004. This was accompanied by the requirement to include more information in the Investment Statement. The exemption has not covered all workplace superannuation schemes. Problems still exist for small employers and groups of employers who have a joint scheme but are not “associated” as defined in the Act. SSCWT change Employers can with effect from 1 April 2004 make superannuation contributions on behalf of an employee and make tax deductions at the employee’s marginal tax rate, subject to the 33% maximum. Those employee’s earnings are based either on the preceding year’s earnings or on a current year estimate. Clearly, for defined contribution schemes:

this change is a major plus for lower rate tax payers, and
higher rate tax payers have the opportunity to significantly reduce their immediate income in return for a boost to their retirement savings.

For defined benefit schemes, the change may be of value to the employer if, on average, the members’ marginal tax rate is less than 33%. Superannuation Schemes Act Recent changes to the Act include:

giving prospective members the right to request more information when joining,
giving existing members a similar right to request greater information, and
an extension of the matters that must be included in the Trustees Annual Report.

Back to top of page Although every care has been taken in the preparation of this newsletter, the information should not be used or relied upon as a basis for formulating business decisions or as a substitute for specific professional advice. For further information please contact:
John Melville
Wellington Phone (04) 499 0277 Mark Weaver
Auckland Phone (09) 300 7155

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