Mary Holm: Don't write off lump sum plans

The idea of making tax on annuities fairer may be asleep in the shade but it's not a dead horse. Voters could wake the Government up. Photo / Thinkstock

Noting your apparent interest in promoting the use of annuities, I thought you might wish to be aware that late last year, the Government removed from its tax policy review programme a planned review of the taxation of annuities.

I suggest that unless or until the Government is prepared to step up, review and address the inequitable taxation of annuities, I think that you are flogging a dead horse.

The horse is not dead, but just taking a nap in the shade somewhere. And that's not good enough. Gee up, Neddy!

Annuities - for those who don't know - provide regular payments, usually in retirement. You give a life insurance company a lump sum at the beginning, and in most cases the payments continue until you die.

Twenty years ago, maybe a dozen companies offered annuities in New Zealand, but that number has dwindled to one - at least partly because of unfair taxation.

I've been disappointed with Government responses to various calls for fairer tax treatment. But I don't think we should give up. Governments can change their policies - or voters can change the government. More on this later in the column.

Ignorance a problem

I agree that decumulation products will be vital to ensure retirees get the help they need in managing their lump sums during retirement.

However, Fidelity Life (the only company still offering annuities) sold three annuities across the whole country last year, so clearly there isn't enough demand to warrant other insurers developing similar products.

Do you not think the underlying problem is really about financial literacy and getting retirees to trust large financial institutions with their hard-earned savings? And if so, who is responsible and how do we address this?

Firstly, another explanation for readers. "Decumulation" is the opposite of accumulation. It's the process of using up your savings in retirement.

I suspect one big factor in the low demand for annuities is people's ignorance of them. Whenever I've spoken or written about them, a common response has been: "That would be really good for at least part of my retirement savings."

You're probably right, though - some people are reluctant to hand over a large sum to an insurance company.

Who's responsible? Everyone who has let people down with any financial product or service, which has undermined confidence.

How to address this? Perhaps by pointing out insurance companies are rated and monitored pretty closely. We usually trust a highly rated company will pay out on a life insurance claim, so why not an annuity?

For another alternative, read on.

Govt should be provider

Last week you had the head of Mercer New Zealand acknowledging that "annuities are a high-risk/low-margin product". So private enterprise is reluctant to enter the market.

The New Zealand Government should set up as an annuity provider because it's the only entity that can never fail, and take investors' money with it.

Also, it doesn't have to make a margin. Breaking even is acceptable. And it has plenty of ways of spending the capital inflows.

Many retirees who previously received a monthly payment based on their final salary now have to invest their own lump sum. As the pilot said last week it's not easy, and most importantly it's not reliable.

The Government already sells bonds and is de facto owner of Kiwibank, so it could tack the annuity business on to those departments/businesses.

Such a guaranteed product might even attract worldwide interest, as there is so little competition. The larger the pool of participants, the smaller the risk.

My University of Chicago professors - who tend to favour free markets - would shoot me for saying it, but you make a good argument. This might be an area in which government could do what private enterprise has largely failed to do, at least in recent years.

Your idea isn't actually all that different from what Martin Lewington of Mercer wrote about last week. Under Mercer's idea, people could pay the government to receive higher NZ Super payments.

The very existence of KiwiSaver supports the Mercer idea and yours. Through KiwiSaver, both Labour and National governments have encouraged New Zealanders to save for retirement. There's almost a moral obligation for a government not to leave people wondering what to do with their savings when they reach retirement.

How about it politicians? Send me a brief explanation of how you would either encourage private companies to offer annuities or get the government into this, and I'll publish it here.

Speaking of which, an exec at Fidelity Life took me up on a similar offer to pass on information about annuities to readers. Here's his letter:

Variety of features

As an insurance company first and foremost, we view annuities as "longevity insurance" against the risk of living too long.

However, last year we sold a handful of annuity contracts, which reflects firstly the low demand in New Zealand, and secondly, and probably more importantly, the lack of knowledge or awareness of annuities of New Zealanders.

Other reasons for low take-up could also include:

* No current superannuation schemes require the purchase of an annuity.

* Tax on annuities is penal as it's usually at the company rate as opposed to the purchaser's marginal tax rate.

* People prefer to have the money to hand now rather than locked up for life.

* Typical features/options of the Fidelity Life annuity:

* Monthly instalment payable for life.

* Optional guaranteed period available - for example, paid for a guaranteed 10 years. If the purchaser dies during that time, the instalment is paid to the estate for the rest of the guaranteed period.

* Single life or joint lives.

* Annuity can be level or indexed at a fixed rate.

* Proceeds are tax-paid.

Fidelity will allow KiwiSaver members to make partial withdrawals from their account if they wish to keep some of their funds invested after age 65.

Those features are typical of what was offered by most companies some years ago.

The guaranteed period prevents a family from feeling ripped off if their parent plonks down a large sum for an annuity and then dies soon after. And with a joint annuity on two lives, payments continue until both people have died, usually at a lower rate after the first death.

Indexing means you can arrange for the payments to rise by, say, 2 per cent a year to allow for inflation. However, some experts say that may not be necessary as people tend to spend less as they get older.

Martin Lewington of Mercer tells of other options. "Variations on these products include variable annuities where the annuitant receives, as income, a fixed number of units in an investment fund rather than a fixed payment; this may fluctuate based on investment returns. Or deferred annuities, which allow the retiree flexibility to defer their payment to a later date and receive it at either a fixed or variable rate."

Annuity payments vary depending on your age and gender. Older people get more than younger, and males more than females, as they are expected to live for a shorter time. The features mentioned above also affect payment levels.

People are sometimes disappointed when they learn about the size of their monthly payments. They need to remember, though, that if they live an unusually long life, they can get a pretty good deal.

Buying annuity offshore

My wife and I are shortly to sell a commercial property, which has given us a regular income in retirement. We are wondering where to invest the money to provide income and have thought about putting part into annuities. But, as you point out, there is only one provider in New Zealand.

What do you think of buying an annuity from a UK company? With the strong NZ dollar one could buy a larger sum. The income will be in sterling, but if the New Zealand dollar weakens again we shall be on a win. What do you think?

It wouldn't hurt to get a few quotes from UK companies. You might well benefit from going into a competitive market.

Then again, there's foreign exchange risk. Don't count on our dollar weakening against the pound. In fact, you should work through a scenario of it strengthening, and decide if you can live with that. You should also look at the tax situation, which could complicate the picture.

When you're the boss

Now the tax-deductibility of "my" company's contribution to my KiwiSaver account has become non-deductible, there is no benefit in my company subsidising my contribution. Previously it was a 2 per cent tax-free distribution to me, the owner.

How do I continue contributing to collect the hand-out (sorry, subsidy), but discontinue my company's contribution?

I'm assuming you are what is called a "shareholder employee", whose company pays a salary or wage to which the PAYE rules apply.

Although the situation is changing, your assessment of the change isn't quite right. Firstly, it hasn't taken effect yet. It starts from April 1, 2012.

Secondly, you seem to misunderstand what has changed. After that date, the employer contribution into a KiwiSaver account will be subject to the employer superannuation contribution tax (ESCT), at roughly the same rate as income tax. Instead of, say, $100 going into a KiwiSaver account, somewhere between $67 and $89.50 will go in, with the rest going to Inland Revenue.

However, from your company's point of view, it retains its deduction for income tax purposes, says Inland Revenue. "The full amount of the employer superannuation contribution (which includes any ESCT) can be deducted against the company's gross income."

From next April, if you want to simplify life and just make your own personal contributions to KiwiSaver, you should take a contributions holiday.

Any employee can do that after they have been in KiwiSaver for at least 12 months. Just go to www.kiwisaver.govt.nz, do a search on "contributions holiday" and fill out and send in the form.

Once you've received approval from Inland Revenue, you can stop employer and employee contributions.

"The employee is then free to make voluntary contributions, in the same way as a self-employed person, of any amount. These can either be paid direct to the scheme provider or through IRD," says the department. "However, don't show voluntary contributions on the employer's monthly PAYE schedule."

I suggest you contribute $87 a month or $1043 a year, so you continue to receive the maximum tax credit, which is now 50c for every dollar you contribute, with a maximum tax credit of $521 a year.

Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her website is www.maryholm.com. Her advice is of a general nature and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.