The introduction and success of KiwiSaver has undoubtedly helped New Zealanders save more effectively, but it won’t be enough to ensure that participants in the scheme will be comfortable when they retire. People are living for longer and the status quo isn’t going to cut it for future generations.
Many Kiwis are currently relying heavily on the value of their home (often their only key asset) and NZ Super to fund their retirement. The rapid rise in residential property values means that the ideal of owning a home is becoming a mere fantasy for many. Home ownership is at its lowest in 50 years at just under 65%, and it’s expected to decline further.
To ensure future generations have sufficient investments to fund their retirement lifestyle, bold decisions are required in this year’s budget and beyond.
A key area that deserves some serious attention is making employee contributions and investment income accrued within the fund exempt from tax.
This isn’t outrageous in any sense of the word when you look at other countries’ approaches to superannuation. Many countries offer tax incentives for retirement savings by exempting contributions, exempting investment income generated and taxing future payments – otherwise known as EET. It encourages active saving while significantly increasing an individual’s nest egg.
New Zealand, on the other hand, opts for a TTE approach. Contributions are taxed on the way in and investment income is taxed as it is earned, while subsequent payments are exempt from further tax. To put the impact of these two regimes into context, consider the following: you invest $100 in a retirement fund for 50 years at 6% nominal return with a marginal rate of say, 30%. If tax doesn’t accrue on the investment income and is only applied on withdrawal, the after tax result is $1,319. However, under New Zealand’s current system, investment income is taxed as it is derived, but not on withdrawal; which reduces the amount to $782. This significant drop in ROI highlights the punitive nature of our current system.
Given the adverse tax outcome that the TTE approach delivers, there is no real surprise that those who have funds often invest them in the housing market. The generous tax treatment of housing relative to other investments compounds the housing problem and promotes investment in less productive areas of the economy.
Clearly an EET tax system would provide massive benefits for individuals. It would create greater wealth and less reliance on the state for assistance in later life. An increase in savings better employed would also lead to wider economic benefits such as greater access to capital, job creation and greater productivity, which in turn would reduce our reliance on overseas borrowing.
Of course there’s an immediate cost as any decrease in taxes will reduce the revenue intake for the Government. It is unlikely that this cost could be replaced without generating the revenue from somewhere else.
There is no doubt that taxes distort decision making – so why not modify the tax system to encourage investment into more productive areas?