Rozanna Wozniak: It's no easy task to make people save for retirement

COMMENT

In a little more than two years, many workers should have the opportunity to curb their prolific spending habits just a tad and start saving.

If the proposals mooted last month by Peter Harris' working group are accepted by the Government, the process will be almost painless, with savings deducted from pay packets along with income tax.

The public policy objective of the Harris proposals is to increase the pool of private savings. But will the scheme succeed in its present guise?

In short, no. Quite simply, the playing field is uneven, with odds stacked against it. Yet with some changes and building on the experience of the successful state sector retirement savings launch, the Harris scheme could be successful.

However, the Government needs to accept that without a significant incentive, consumer behaviour will not be modified. It also needs to acknowledge that the incentives that exist to pursue investment individually, and the tax benefits for property investment, put a workplace savings scheme at a significant disadvantage.

Roll the clock forward a couple of years to April 1, 2007, and consider the case of two investors. Susan and Julian are both 25, and for the sake of this comparison are both earning the average wage of around $38,000 a year - he in the private sector, she in the public sector.

Susan is contributing 3 per cent of her gross pay to the state superannuation fund, matched by another 3 per cent from her employer, in effect the taxpayer. She chose a conservative fund because she would rather see all her contributions plus interest when she retires and not worry about the ups and downs of share and property prices on her investment.

Julian is working in the private sector. From April 1, 2007, he will conveniently be starting work with a new employer and will be one of the first to join a workplace savings scheme. He will have a different Inland Revenue code from most of his workmates.

It will skim 5 per cent of all earnings over $16,721 into a fund selected by his employer. That will work out at about $20 a week pre-tax - about the same as Susan is putting into the state sector scheme. He also picked a conservative scheme.

Let's now assume that both funds return an average of 3 per cent a year after tax, fees and inflation. Both Julian and Susan are assumed to work through to 65 - he in the private sector, she in the state sector.

At 65, Julian will have savings of an estimated $81,372. Susan will have $174,397. About half of Susan's benefit has been generated by the employer contribution, funded mainly by the taxpayer (including Julian).

There are also significant rule differences. Julian can withdraw half of his savings after the first five years and continue drawing out 50 per cent every three years. If he does so, he will retire with no more than a few thousand dollars.

You only need to look at how New Zealanders have behaved in windfall situations to realise this is a likely result. For example, when electricity lines companies distributed their shares, many were cashed in within a few weeks.

Susan does not have that flexibility. Susan's superannuation is largely locked in until she is 55 or until she retires, whichever is later. She could suspend payments if her pay could be better spent paying off a mortgage or loan. If she takes maternity leave, she can choose to maintain payments, which will attract a matching contribution from her employer.

If increasing the pool of savings is truly the Government's aim, an extension of the principals of the state sector scheme to the private sector will achieve more than the proposals of the Harris working group.

Employers may claim they cannot afford to make contributions. Compulsion to do so amounts to a state-ordered general wage order more reminiscent of the 1970s. But the blow could be softened by a reduction in the company tax rate from 33 per cent to 30.

Before refining the proposals, the Government will do well to note some of the shortcomings (and positive aspects) of the state sector retirement savings scheme. Only 44 per cent of eligible state sector employees have joined. More than half rejected what amounts to a 3 per cent pay rise.

State super scheme members have the daunting task of picking one fund from the 15 or so approved. If they are diligent, there are all those investment statements to read, assess and make choices on to match their appetite for risk. The workplace savings proposals put that burden on employers. They will be expected to select a fund into which employees' contributions are initially channelled.

Employers do not want the moral burden of selecting a fund that may turn out to be a poor performer, or worse, fail. Furthermore, are employers any better equipped to make those assessments than their employees? How does an employer choose a single fund for potentially thousands of employees of different ages and with different attitudes to risk? Or will the employers' inherent feeling of responsibility encourage selection of a conservative option with the lowest fees?

The odds of the proposed workplace superannuation scheme delivering a significant increase in savings are considered to be modest. To be successful, the scheme requires an effective incentive, it must consist of a manageable range of investment options and it must provide a more even playing field for the tax treatment of investments compared to the one we have.

The Finance Minister, Michael Cullen, has indicated he is prepared to remove the capital gains tax element that applies to superannuation funds and actively managed investment funds, but not to individuals who directly own shares.

It remains to be seen how that move compares with the recommendation of the working group chaired by Craig Stobo, the former head of BT Funds Management. This review could significantly affect the success of workplace superannuation.

It is unknown to what extent the working group will successfully deal with issues such as the inconsistencies between local and overseas investment, and the fact that managed funds are not taxed at the marginal tax rate of the underlying investor.

We await with interest the results of the Stobo working group, which is due to report at the end of the month.

* Rozanna Wozniak is the chief economic adviser to Spicers Wealth Management.