The Problem:
New Zealand households aiming to enjoy a retirement income better than the ‘No Frills’ lifestyle they could afford living solely on National Super, may unfortunately be in for a sharp reality check.
Many New Zealanders may be off-track for a comfortable retirement and we are urging the Government to undertake a more formal review of the savings situation in New Zealand. Prioritising measures that will lift our savings rate and see those savings invested more productively.
Moving from low returning assets to high returning assets and increasing our savings rate over 25 to 40 years will have an enormous impact on people’s ultimate lifestyle. To give you an example, if you’re 25 years old today and you save 5 per cent more of your income (up from the 6 per cent of your income which many KiwiSaver investors are currently saving) and move from a conservative to a growth investment strategy, that could be worth over $700,000 more to your retirement.
As advisers and investment managers, we have a long-term duty of care to ensure our clients are well placed in their retirement. The Government also has a duty of care. It’s time for them to adopt a long-term approach so that New Zealanders can plan properly for their retirement.
We appreciate that savings is a politically sensitive issue. But it’s especially important for the Government to take the lead here and outline what the situation is with NZ Super moving forward. Households need to be able to plan accordingly before it’s too late and the community finds itself in an unhappy place.
Despite household assets and wealth increasing due to soaring house prices and strong equity markets, New Zealand’s household savings rate has actually been negative over the past several years. This contrasts with positive savings rates of about 4.6 per cent for Australia and 5 per cent for the USA and Europe. This means in aggregate New Zealand households are spending more than they are earning – drawing on current savings or using debt to fund their current spending.
Household Savings Rate by Country[1]
There’s a deficit on the other side of the ledger too, as our inadequate savings are failing to keep pace with our spending expectations in retirement.
Massey University and Westpac produce a regular survey showing how much one-person and two-person households are spending during retirement. They then group expenditure levels under two headings – a Choices retirement and a No Frills retirement.
Massey finds that a two-person Metro household is spending roughly $57,000 per year for a Choices lifestyle in retirement. Milford has combed through the Massey data and concludes that a true Choices lifestyle would require least $10,000 more per annum. For example, the Massey data only allows for a couple to have one modest meal out each week and it also allows very little for travel, including smaller trips within New Zealand.
Massey says that if a couple wants to enjoy its version of a Metro Choices lifestyle, a couple needs to have $486,000 (in today’s dollars) at retirement to supplement their NZ Super. Our view is that to enjoy a truly Choices retirement – what we’re calling a Choices Plus retirement – a couple would need to have about $630,000 (in today’s dollars) at retirement.
Two further critical assumptions of this analysis is that a household’s investments will have a real return of 5 per cent per annum during retirement and the household is consuming all their liquid savings in retirement. Any change in these assumptions has a material impact on the savings required. For example, if you invested your retirement savings in term deposits and only received a return around the inflation rate, the lump sum you would need would be more than 40 per cent higher.
Then, there’s the extra downside complication of having to pay off your house if you are not already freehold. Meaning you must add your mortgage repayments on top of your target retirement savings. Statistics NZ data tell us that the median household with a mortgage is paying a little over $400 per week in mortgage payments. Assuming an outstanding loan term of 20 years, this would imply total remaining repayments of $415,000 (with principal outstanding of $262,500).
The takeout from our analysis is that if people have an expectation of something better than a No Frills retirement, they are going to need a substantial amount of savings and those savings will need to have been wisely invested. Although many Kiwis aspire to a higher quality of retirement lifestyle (a Choices retirement), they are not on-track to achieving it.
The Fix:
So, what strategies should New Zealand adopt to get us on-track to the lifestyle we aspire to in retirement?
As a matter of urgency, New Zealand needs to lift its savings rate.
Before he became Finance Minister, Grant Robertson said he wanted to see KiwiSaver minimum contribution rates lifted from 3 per cent to 4.5 per cent. The problem here is that many Kiwis are already very stretched financially and cannot afford to contribute more.
A more effective way to encourage people to save more, would be to incentivise them to do it. For example, allowing people to make tax-deductible KiwiSaver contributions, capped at a certain amount each year. While still allowing them to contribute over and above the annual cap on a non-tax-deductible basis. Currently the median New Zealander is earning about $49,000 p.a. yet anyone earning over $35,000 p.a. has no tax incentive to save more than 3 per cent to their KiwiSaver account. Australia, the US, the UK and Canada all have stronger forms of tax incentives to encourage extra retirement savings – and all these countries have higher savings rates than New Zealand.
Making matters worse, the small amount we are saving is being invested too conservatively.
81% of KiwiSaver members have 10 or more years until retirement, yet just 32 per cent of KiwiSaver money is invested in growth-oriented funds. This is a huge mismatch because growth funds will almost certainly outperform conservative funds over longer time periods.
For example, the average KiwiSaver default fund, which is roughly 80 per cent invested conservatively in bonds and cash, delivered a return of 5.4 per cent per year over the first 10 years of KiwiSaver, compared to the average KiwiSaver growth fund, which delivered 6.7 per cent per year. Note that this period includes a major market downturn, in the form of the Global Financial Crisis, and such downturns normally favour conservative funds. Project these returns forward and a 25-year-old investor would be more than $200,000 better off at retirement simply by choosing a growth fund over a default fund (adding up to roughly $10,000 extra of annual retirement income – see graph below). Furthermore, the better performing KiwiSaver growth funds have done much better than the average, with the top 25 per cent of managers delivering a return of 8.5 per cent per year over the first ten years of KiwiSaver.
Growth (6.7%) vs. Default (5.4%) at retirement
Calculation assumptions: Starting gross salary at age 25 of $50,000, $0 starting KiwiSaver balance, 3% employer and employee KiwiSaver contributions, no withdrawals, no additional contributions, 2.5% p.a. salary growth, returns are after fees and before tax, lump sum not adjusted for inflation. This is an estimate only. Past performance is not a guarantee of future performance.
Having a conservative fund as the KiwiSaver default fund is akin to giving our community poor investment advice. And in this case the poor advice is coming from the Government and it’s costing Kiwis hundreds of thousands of dollars in their retirements. A decade on from the start of KiwiSaver, it seems to have proved too hard for default providers to move their clients into growth funds. Clearly, action is now called for from the Government.
If we take Australia as our yardstick, their Superannuation money is roughly 65 per cent invested in equities. Which means not only are Australians getting wealthier through higher savings, they are also investing their savings in a much smarter way for maximum retirement gains.
We believe this is the major policy issue for KiwiSaver going forward.
The final piece of the jigsaw is a Government-sponsored detailed study of individual savings patterns and retirement requirements.
This report should include a clear statement on the sustainability of NZ Super. It is important that the public know how much Super they can rely on so they can plan accordingly.
Milford is also advocating for savings-based tax incentives as in other higher-saving developed economies. This would encourage additional retirement savings and help reduce our negative household savings rate. Lastly the government should consider the adoption of an aged-based approach to default KiwiSaver fund enrolment. This would help ensure younger investors with long investment time horizons are being allocated to more growth oriented investment strategies. A savings-challenged block of New Zealanders should not continue to be thrown reflexively into conservative funds that will not generate the returns they require to sustain the lifestyle they aspire to in retirement.
It would be a major step to improving New Zealand’s quality of life if we could turn the current saga of under-performance into one of comfortable retirements funded by effective saving and smart investing. New Zealanders deserve no less.