KiwiSaver: options for modification or retention of existing scheme

KiwiSaver is one of two major policy initiatives designed to lift the level of household saving, the other being lower taxes on personal saving in Portfolio Investment Entities. The overall objective of the KiwiSaver scheme is to encourage New Zealanders to acquire long-term savings and asset accumulation habits in order to improve their financial well-being particularly in retirement; and to make KiwiSaver an enduring and affordable scheme for members, employers, and taxpayers.

A short-term objective is to reduce areas of the scheme that do not impact positively on savings incentives and to apply those saved revenues to higher-value areas. It is considered that the most immediate higher-value use of the revenue is a reduction in personal tax rates as this will improve savings incentives through an increase in the after-tax returns from savings.

The KiwiSaver and PIE reforms include more favourable tax treatment for saving in the form of financial assets. They also make personal saving easier and more “automatic”. The existing KiwiSaver scheme provides that:

• Employees can choose to either contribute 4% or 8% of their gross salary or wages to their KiwiSaver account, with the default rate being 4%;
• Employers are required to make compulsory employer contributions to their employees’ KiwiSaver schemes. The required rate of contributions commenced at 1%, rising to 4% on 1 April 2011;
• Employers receive an employer tax credit of up to $20 a week per employee through the PAYE system, to offset the cost of compulsory employer contributions; and
• Employer contributions are exempt from employers’ superannuation contribution tax (ESCT), subject to some limits. The exemption from ESCT applies to the lesser of an amount equal to the employee’s contribution, or 4% of the employee’s gross salary or wages. Any employer contributions over the exemption are subject to ESCT.

There are concerns around the value of the government's expenditure on KiwiSaver for several reasons. Firstly, the cost of the KiwiSaver tax incentives is substantial and increasing due to higher than expected uptake. Secondly, there are significant concerns over whether KiwiSaver's incentives are overly generous - particularly given the related PIE tax incentives. Further, there is now doubt as to whether KiwiSaver expenditure represents an efficient use of resources given the scheme's potential to:

• facilitate the re-allocation of existing savings rather than generating additional new saving;
• reduce overall levels of savings because of reduced levels of Government saving; and
• make the distribution of retirement wealth more inequitable.

In particular, there is concern that people on low incomes may not be able to afford to join KiwiSaver and gain access to the incentives. There is also some concern that employers and employees will struggle to meet their minimum contribution commitments in tightening economic conditions. The first annual KiwiSaver evaluation report identifies affordability (in particular the minimum 4% employee contribution rate) as a feature of the scheme that could be discouraging enrolments by low income earners.

For these reasons, a reduction of the government's expenditure on KiwiSaver is favoured to fund the tax reductions which have a greater potential to be growth enhancing.

In addition to the preferred option discussed below, the alternative options that were considered to modify KiwiSaver to address these issues included:

• Reducing the minimum contribution rate to 2% for all KiwiSaver Members (i.e. new and existing members) including for existing members who currently make a minimum contribution of 4%. This option is likely to attract some new entrants to the scheme. However it is unlikely that many of these new entrants would be amongst the lowest income earners, who would typically have an increase in their disposable incomes as they move into retirement and receive New Zealand Superannuation. Existing members whose contributions will be reduced from 4% to 2% will have increased options to invest in other forms of long-term saving (or to increase current consumption. The savings incentives are preferable under the preferred option because existing members retain their current contribution rate at 4% unless they elect to contribute at the lower rate of 2%.
• Retaining the employer tax credit (ETC). This option was not considered a viable option as it is considered that there are other positive inbuilt savings incentives in KiwiSaver to encourage improved savings habits and greater savings levels. Such incentives are further complemented by favourable tax treatment under the PIE regime for savings. Therefore the retention of the ETC, even at a reduced amount, creates unnecessary and unsustainable extra fiscal cost. For the same reasons, the status quo, or a smaller reduction in relation to either the employer superannuation contribution tax exemption or the fee subsidy were not considered to meet the objectives sought.

In relation to member tax credits (MTCs), two alternative options were considered:

• Reduction of the MTC to 2% of wages One option involved a MTC of $20 per week but capped at 2% of wages. At a contribution rate of 2%, employees earning less than $52,000 per year would put in less than the current contribution rate of $1040 per year. So if the maximum MTC is capped at 2%, those employees could not obtain the maximum MTC, which could reduce their incentives to save and to develop effective savings habits. This also creates equity issues if a person has no income, for example, where contributions are out of capital or a partner's income or the member has a loss for tax purposes. In addition, Inland Revenue has indicated that basing the MTC on income and contributions (rather than just contributions) would create significant delivery problems. Requiring income data and associated changes to systems has significant administrative and compliance costs, and adds to the scheme's complexity. For these reasons this option was not preferred.

• MTC capped at $780 per annum - minimum contribution rate of 2% but MTC continues to match member's contributions up to maximum of $780. This option goes part way to addressing the concerns raised by the Council of Trade Unions' option (discussed below), within a tighter fiscal constraint. While the fiscal cost is lower than the preferred option, on balance, this option is not preferred as earners may be worse off than under the present arrangements. Although this option is less costly than the preferred option, it is considered that the savings incentives of the preferred option are preferable to those provided by this option. Furthermore, the additional fiscal cost is justified by the increased incentives for earners, particularly lower-income earners, to save.