“Demographic Trends and Implications for Retirement Savings”

from the

FSC ReportPensions for the Twenty First Century:

Retirement Income Security for Younger New Zealanders

by

Peter Neilson, CEO, Financial Services Council

Presentation to

Workplace Savings NZ National Conference“How Much is Enough”

1.05pm Friday 17th August 2012Pullman Auckland Hotel

Auckland

What the Report is Not About

1. How we will provide retirement incomes in the next 20 years so if you are already retired or soon will be, it is not about you.

2. Relitigating the debate about National Savings.

Findings• Longevity is increasing faster than most of us have expected.

• The combined impact of the baby boomers retiring and the growing length of our lives after 65 will make NZS unaffordable unless we move out the age of eligibility beyond 65 by indexing the age of eligibility with longevity. (The alternative of lowering the level of NZS is unlikely to be acceptable to most New Zealanders.)

• If we want to retain the option to retire at 65 and have a higher income than just NZS we will need to save more to fund our own pensions to fill the gap between when we want to retire and when we will be eligible for NZS.

• To do this we will need to start saving more soon to reach the 10% - 12% of incomes necessary to not only fund the gap but also to give us a chance of achieving a comfortable retirement. We propose that this phase-in last ten to twelve years to make it affordable.

• We suggested NZS should remain as is without an income or asset test.

• We would require New Zealanders to purchase a fixed term pension to pay at least the equivalent of NZS between the age of 65 and when you became eligible for NZS, if you wanted to retire prior to the age of eligibility for NZS.

2

If We Are to Achieve Our Own Desired Retirement Income?

We need to know:

1. How much we will need to live on for the retirement we seek (income adequacy).

2. What we can reasonably expect from the Government (retirement income policy).

3. How long we are going to live in retirement (longevity).

4. How much we will need to save to achieve a level of income (returns on savings).

5. What sort of plan we need to get there (savings plan or habit).

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NZ Superannuation has been a very successful policy in:

• Eliminating absolute poverty for the aged provided they own their own accommodation by the time they retire and not providing any barrier to continued employment or the accumulation of assets.

There are some other issues with current income policy:

• The current level of benefit is inadequate for a comfortable income in retirement , whether funded from taxation or savings.

• Funding from taxation is relatively inefficient compared with funding from savings.

• On current longevity trends the cost of paying NZS at 65 will grow from 4-5% to 12% of GDP later this century.

• As we have relatively free movement with Australia, as their Superannuation Guarantee Scheme matures there will be a growing pension gap with Australia. An incentive for our highest potential earners to move countries.

• Eventually the mature compulsory retirement income policy in Australia (the Aged Pension and Superannuation Guarantee) will provide much higher retirement (2 x or more) incomes than New Zealand at modest additional cost (less than 50% more as a percentage of GDP).

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Source: Infometrics from Statistics New Zealand

Number of New Zealand Live Birth 1935-1979

5

Average Life Expectancy in New Zealand at 65, 1898 - 2011

  Birth Year Year 65 Males Females

Historical 1823 1898 12.2 13.3

1898 1963 12.8 16.9

  1901 1966 12.9 16.9

  1906 1971 13.3 17.7

  1911 1976 14.0 18.0

  1916 1981 14.9 18.7

  1921 1986 15.5 18.9

  1926 1991 16.7 20.1

  1931 1996 17.8 20.6

  1936 2001 18.7 21.2

1946 2011 20.0 22.3

Source: Infometrics from Statistics New Zealand

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Source: PwC from Statistics New Zealand

Actual over 65 Population Compared to Statistics NZ Series 5 projections by year

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We have no argument with Statistics New Zealand’s Projections

Statistics New Zealand prepares many projections:• These very long term projections are very hard to get right because

we are predicting what will happen to people over the next 100 years of their potential life, in some cases people who haven’t been born yet.

• Unfortunately, most users pick the mid-series assuming it to be the most likely outcome and also it avoids the need to do your own projections

• Most developed countries’ mid-range projections have underestimated the improvement in longevity after 65.

• A default “naive” projection assuming the past long-term trends (30 to 50 years) are maintained, might be a more useful anchor projection for most users. Statistics NZ has recently produced such a projection, the 2011 Very Low Mortality projection, that we would recommend forecasters and planners use in place of the Series 5 projections that most people have previously defaulted to.

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1950 1970 1990 2010 2030 2050 20700.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

Ratio of Working Age (15-64) to 65 Plus Population in New Zealand 1950 - 2060

(Projection using SNZ Series 5)

Source: Infometrics from Statistics New Zealand

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Source: NZ Stats•Statistics NZ Series 5 - 1 extra year of life after each decade•FSC “Lancet” Projections – 2 extra years of life after 65 each decade•Recent NZ 1996-2066 Trend (ELL) – 3 extra years of life after 65 each decade

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1950

1960

1970

1980

1990

2000

2010

2020

2030

2040

2050

2060

2070

2080

2090

2100

2110

0.0

500.0

1000.0

1500.0

2000.0

2500.0

3000.0

New Zealand Population Aged 65 & Over under Different Longevity Trends

Historical

SNZ Series 5 (1 in 10)

FSC "Lancet" (2 in 10)

1996-2006 Actual (3 in 10)

SNZ VLM Projection 2012

Source: Infometrics

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

2105

2110

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

New Zealand Superannuation (PAYGO) Costs as % GDP 1970-2100 with age of eligibility at 65 and

FSC "Lancet" Longevity (2 years per decade)

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Expected Lifespan (years)

Year of Entitlement for NZS Aged 65

FSC“Lancet”

Projections

Survey Reported Self-expectation % Gap

Male Female Male Female Male Female 2011 86.1 89.1 86.5 86.3 -0.4% 3.2%2012-2021 87.1 90.0 84.1 83.4 3.4% 7.4%2022-2031 88.9 91.8 81.6 83.3 8.3% 9.3%2032-2041 90.9 93.7 83.6 84.9 8.0% 9.4%2042-2051 93.0 95.7 83.4 84.1 10.3% 12.1%2052-2058 94.9 97.6 85.8 86.0 9.6% 11.9%2059-2061 96.1 98.7 88.0 94.4 8.4% 4.4%

Underestimating LongevityLast year the FSC asked Horizon Research to ask New Zealanders of all ages how long they expected to live past 65. The results below indicate that most people are likely to be underestimating their likely life expectancy past 65. The estimation gap is largest in those age groups where they are most likely to be able to save for retirement. The same research indicated that most people had an understanding of what they would need to be comfortable in retirement but most people could not make a good estimate about how long it would take to double their money from a certain interest rate and keeping the interest in the account to earn interest on interest. Other research undertaken internationally reveals that most people have difficulty understanding what size of retirement savings pot would be needed to fund a level of pension.

Source: FSC Horizon Research Dec 2011

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Source: FSC Lancet Projections and Horizon Research Dec 2011

It is notable that the underestimation of longevity is currently greatest for those furthest away from retirement when saving would be most effective in boosting retirement income.

2011 or earlier

2012-2021

2022-2031

2032-2041

2042-2051

2052-2058

2059-2061

60.0

70.0

80.0

90.0

100.0

110.0

Average Life Expectancy Expectations Gap

(Expectations compared with projections)

FSC "Lancet" - MenFSC "Lancet" - WomenSelf - MenSelf - Women

Year turn 65

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Currently saving enough to retire on a comfortable

incomeTotal

Own dwelling with a

mortgage

Own dwelling

without a mortgage

Renting a dwelling

Flatting/ boarding

In a dwelling owned

by a family trust

Other

Yes 20.0% 18.1% 38.8% 10.5% 21.9% 22.0% 2.5%

No 62.9% 65.5% 43.7% 75.0% 57.4% 58.3% 66.4%

Don’t know 17.2% 16.5% 17.6% 14.4% 20.7% 19.8% 31.2%

Source: FSC Horizon Research Dec 2011

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Are you currently saving enough to retire on a comfortable income?

Australia New Zealand OECD Avg.0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

OECD Retirement Income Replacement Rate in 2008 for Someone on an Average Wage*

2008

Net

Rep

lace

men

t Rat

e

Source: AMP Capital 2011 from Pensions at a Glance OECD 2009*Replacement rates are the percentage of pre-retirement income represented by the retirement income

15

0

20

40

60

80

100

120

-10 0 10 20 30 40 50 60 70 80 90 100 110

Net

rep

lace

men

t rat

e fo

r av

erag

e in

com

e w

ork

er

Percentage of retirement incomes from earnings related (tier 2) schemes

Net replacement rate for average income earner Source: OECD 2011

public schemes

private tier 2 scheme

public& private tier 2 scheme

Dot size proportional to replacement rates for people on 1.5 times average income

AUNZ

IRE

AUT SLVSPN

POR

CAN CHL

CZE

DEN

EST

BEL DEU FRA ITY NOR POL SVK SWE SWZ

GREHUNICE

ISR

JAPKOR

LUX

MEX

NTH

TUR

UK

US

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The Pension Gap with Australia in 2055 Assuming No New Zealand Policy Change

*This table compares the compulsory retirement systems in both countries. Australia has its age pension and its Superannuation Guarantee whereas New Zealand has New Zealand Superannuation and no compulsory retirement savings scheme.**The ratio of Australian and New Zealand incomes assumes an exchange rate of $NZ1 = $A0.85, close to average value since 1990.Source: Coleman (2012)Source: Australian Treasury

New Zealand NZS pension in 2055

Australia pension for someone retiring in 2055 having earned the median income

Ratio(AU/NZ)

Australia pension for someone retiring in 2055 in Australia having earned the average income

Ratio(AU/NZ)

Retirement income

Dollars $NZ 31000 $A60800 2.31* $A69000 2.67**

% per capita GDP

34% 52% 1.50 59% 1.70

Contributions

2011 4.3% 7.2% 1.66

2055 7.4% 9.9% 1.34

Average 2011-2055

6.4% 9.2% 1.44

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Real return Labour Productivity growth rate

SAYGO Pension PAYGO Pension RatioSAYGOPAYGO

Unfavourable conditions for SAYGO (low capital returns, high growth)

3.0% 2.0% 35738 25982 1.38

Average conditions for SAYGO

3.0% 1.0% 32072 16678 1.92

3.0% 1.5% 33804 20828 1.62

3.5% 1.5% 39921 20828 1.92

4.0% 1.5% 47252 20828 2.27

4.0% 2.0% 49638 25982 1.91Favourable conditions for SAYGO (high capital returns, low growth)

4.0% 1.0% 45111 16678 2.70

The relative size of SAYGO and PAYGO pensions when rates of returns and productivity change.*

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Total Return by Asset Class in Australia Over the Past 25 Years to end of 2009

Calendar Year Cash

Australian Fixed

Interest

International Fixed Interest

HedgedListed

PropertyAustralian

SharesInternational

SharesInternational

Shares HedgedAlternative

Assets A$Residential

PropertyDirect

Property

(%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%)

5 year CAGR 5.9 5.7 4.6 -7.5 8.4 -0.2 0.0 3.9 -0.7 7.0 10.1

10 year CAGR 5.6 6.5 6.7 4.0 8.9 -2.9 -1.9 7.4 2.4 13.1 10.8

15 Year CAGR 5.8 7.6 6.7 6.5 10.8 5.5 4.3 9.1 1.1 12.0 10.4

20 Year CAGR 6.6 8.9 7.3 7.7 10.0 5.3 3.7 11.4 -0.2 11.2 7.7

Source GS& PA Research

Asset Class Benchmarks:

Cash UBS Warburg Bank Bill Index (Australian Cash - Source Ibboston prior to 1988)Australian Fixed Interest UBS Warburg Composite Bond Index (All Maturities/All Series) (Australian Fixed Interest - Source Ibboston prior to 1990)International Fixed Interest SSB/Citigroup World Govt. Bond Index - Hedged to A$ (JP Morgan Global Govt Bond Index 2004-2005)Listed Property S&P/ASX 200 Property Trust Accumulation Index (S&P/ASX Property Trust Accumulation Index prior to 1993)Australian Shares S&P/ASX 200 Accumulation Index (S&P/ASX All Ordinaries Accumulation Index prior to 1993)International Shares MSCI World Accumulation Index Gross Div A$International Shares Hedged MSCI World Accumulation Index Gross Div HedgedAlternative Assets HFRI Fund of Fund Composite IndexResidential Property ABS Established House Price Index (Capital return), REIA 3 Bedroom (rental return)Direct Property IPD Property Weight Average Total Accumulation

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* Costs of funding NZS from Tax No Change (Redline) versus from Savings (Green Line) (including the cost of NZS recipients that have already retired) as a percentage of GDP (FSC “Lancet” Longevity)

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

2105

2110

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

What is the Cost of Funding NZS from Savings (SAYGO) versus Taxa-tion (PAYGO)*

NZS (PAYGO) No Change Policy

Tier 1 SAYGO) + Legacy PAYGO NZS

GDP

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* Note: The blue line is funding retirement pensions considerably higher than the NZS pension funded by the red line of costs

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

2105

2110

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Costs as a Percentage of GDP with No Change PAYGO (Current NZS) versus with SAYGO KiwiSaver Plus and PAYGO (NZS) Combined

(FSC "Lancet" Longevity)

Total KiwiSaver Plus and Future Legacy NZS

NZS (PAYGO) No Change Policy

GDP

Perc

enta

ge

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Why Now?• There is still time as we have enough people still

working and therefore able to earn and therefore make the additional savings.

• Savings for retirement is more efficient because of compound interest but like all things good, compound interest takes time.

• Eventually the window of opportunity closes as the costs of making the transition becomes impossible because the combined cost of paying for those already retired out of taxation and the yet to retire out of savings becomes economically and politically difficult.

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Contribution rate needed to achieve same KiwiSaver Plus account balance at age 65/70 for

(Cohort turning 65 in 2061) Median Income  Account balance at 65 Account balance at 70

  Male Female Male Female

KiwiSaver Plus Account Balance if you start at Age 25 on 10% contribution rate: 638,000 420,000 781,000 515,000

 

Starting age Required contribution rate (%)

25 10.00 10.00 10.00 10.00

35 13.84 14.25 13.54 13.90

45 23.60 24.54 21.94 22.64

55 58.64 60.43 46.34 47.12

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Retirement in the 20th Century

Retirement in the 21st Century

Funding retirement incomes in 1955Over 65 population less than 300,000Life expectancy at 65 - 12.8 years for males and 16.9 years for females.Seven working age people support one pensioner.Age pensions cost 3% of GDP when the universal pension was available from 65.

Funding retirement incomes in 2055Over 65 population reaches almost 1.7 million.Life expectancy at 65 – 31.3 years for males and 33.9 years for females.Two working age people support one pensioner.Age pensions will cost 9-10% of GDP if the age of eligibility for NZ Superannuation stays at 65.

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What do people under 45 know and do about retirement• If you saw the Campbell Live programme after we released the

FSC report “Pensions for the Twenty First Century: Retirement Income Security for Younger New Zealanders”, you will know that most people under 45 do not know that the highest NZ Superannuation benefit is only $349 a week or about $18,000 a year to live on. One person interviewed on Campbell Live thought it would be $35,000 a year which interestingly is about the level most New Zealanders said they would need to have a comfortable retirement.

• Historically New Zealanders have not started saving seriously for retirement until they reach 45.

• For most of us that is too late because by waiting that long you need to save 25% rather than 10% of your income to fund a comfortable retirement.

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Actions for those under 45• If you are not in KiwiSaver - join it or your

employer’s compatible programme.

• If you have suspended your contributions - restart them as soon as you can.

• If you are contributing 2% and your employer another 2% (soon to be 3% plus 3%) - when you next have a wage or salary increase move up at least to 4% plus 2% or preferably 8% plus 2% and look forward to a much longer and more comfortable retirement than your grandparents probably enjoyed.

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What does this all mean to Savers, Trustees, Advisors, Fund Managers and GovernmentIf the typical young New Zealander can expect to live 30 to 40 years in retirement then:

• It is likely that savings levels and contribution rates will need to rise considerably to fund additional years in retirement. A 10% contribution rate from 25 is the new black.

• Most retirees will need to invest for capital growth post retirement if their retirement savings are to last the distance including refurbishing their home and maintaining their lifestyle for much longer than for their grandparents retirement.

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Actions for Savers, Trustees, Advisors, Fund Managers and Government• If you have some responsibility for a defined benefit

scheme then it would be prudent to review the scheme in the light of the improvements in post 65 longevity now expected.

• Greater clarification from Government on what younger New Zealanders can reasonably expect from the tax payer in retirement is needed now to help young people plan for a comfortable retirement. We have suggested a cross party select committee on retirement income policy to increase that clarity by creating a broadly supported sustainable policy.

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