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New Zealand’s Savings Health Check

The Problem:

Research just released by Milford Asset Management adds up to a sharp reality check for those New Zealanders looking to enjoy a retirement income better than the ‘No Frills’ lifestyle they could afford living solely on National Super.

It also discloses that many New Zealanders may be off-track for a comfortable retirement and urges the Government to undertake a more formal review of the savings situation in New Zealand. Prioritising measures that will lift our savings rate and see those savings invested more productively.

In an online interview with Ian Fraser this week, Milford Asset Management’s Chief Executive Troy Swann said, “Moving from low returning assets to high returning assets over 25 to 40 years has an enormous impact on people’s ultimate lifestyle. To give you an example, if you’re 25 years old today and you save 5% more of your income and move from a conservative strategy to a growth strategy in terms of where it’s invested, that could be worth over $700,000 more to your retirement.”

“As advisers and investment managers, we have a long-term duty of care to make sure our clients are well placed in their retirement,” says Troy Swann. “The Government also has a duty of care. It’s time for them to adopt a long-term approach so that New Zealanders can plan properly for their retirement.”

“We appreciate that savings is a politically sensitive issue – some people might even call it a ‘third rail issue’ (touch it and you’re dead!). But it’s especially important for the Government to take the lead here and outline what the situation is with NZ Super moving forward. Households need to be able to plan accordingly before it’s too late and the community finds itself in an unhappy place.”

Despite the fact that household assets and wealth have been increasing due to soaring house prices and strong equity markets, New Zealand’s household savings rate has actually been negative over the past several years. This contrasts with positive savings rates of about 4.6% for Australia and 5% for the USA and Europe. This means in aggregate New Zealand households are spending more than they are earning. This means they are drawing on current savings or using debt to fund current spending.

“There’s a deficit on the other side of the ledger, too, as our inadequate savings are failing to keep pace with our spending expectations in retirement” Troy Swann says.

Massey University and Westpac produce a regular survey showing how much one-person and two-person households are spending during retirement. They then group expenditure levels under two headings – a Choices retirement and a No Frills retirement.

Massey finds that a two-person Metro household is spending roughly $57,000 per year for a Choices lifestyle in retirement. Milford has combed through the Massey data and concludes that a true Choices lifestyle would require least $10,000 more per annum. For example, the Massey data only allows for a couple to have one modest meal out each week and it also allows very little for travel, including smaller trips within New Zealand.

“Massey says that if a couple wants to enjoy its version of a Metro Choices lifestyle, a couple needs to have $486,000 (in today’s dollars) at retirement to supplement their NZ Super, says Troy Swann. “Our view at Milford is that to enjoy a truly Choices retirement – what we’re calling a Choices Plus retirement – that couple would need to have about $630,000 (in today’s dollars) at retirement.”

Two further critical assumptions of Milford’s analysis is that a household’s investments will have a real return of 5 per cent per annum during retirement and the household is consuming all their liquid savings in retirement. Any change in these assumptions has a material impact on the savings required. For example, if you invested your retirement savings in term deposits and only received a return around the inflation rate, the lump sum you would need would be more than 40 per cent higher.

Then, there’s the extra downside complication of having to pay off your house if you are not already freehold. Meaning you must add your mortgage repayments on top of your retirement target savings. Statistics NZ data tell us that the median household with a mortgage is paying a little over $400 per week in mortgage payments. Assuming an outstanding loan term of 20 years, this would imply total remaining repayments of $415,000 or principal outstanding of $262,500.

According to Mr Swann, “the takeout from our analysis is that if people have an expectation of something better than a No Frills retirement, they are going to need a substantial amount of savings and those savings will need to have been wisely invested. Although many Kiwis aspire to a higher quality of retirement lifestyle (a Choices retirement), they are off-track to achieving it”.

The Fix:

So, what strategies should New Zealand adopt to get us on-track to the lifestyle we aspire to in retirement?

“As a matter of urgency, New Zealand needs to lift its savings rate. Before he became Finance Minister, Grant Robertson said he wanted to see KiwiSaver minimum contribution rates lifted from 3 per cent to 4.5 per cent. The problem here is that many Kiwis are already very stretched financially and cannot afford to contribute more.

A more effective way to encourage people to save more, Milford considers, would be to incentivise them to do it. For example, allowing people to make tax-deductible contributions, capped at a certain amount each year, to their KiwiSaver account. Whilst still allowing them to contribute over and above the annual cap on a non-tax-deductible basis. Currently the median New Zealander is earning about $49,000 p.a. yet anyone earning over $35,000 p.a. has no tax incentive to save more than 3 per cent to their KiwiSaver account. Australia, the US, the UK and Canada all have stronger forms of tax incentives to encourage extra retirement savings – and all these countries have higher savings rates than New Zealand.”

Making matters worse, the small amount we are saving is being invested too conservatively, Mr Swann points out.

“81% of KiwiSaver members have 10 or more years until retirement, yet just 32 per cent of KiwiSaver money is invested in growth-oriented funds. This is a huge and very dubious misalignment – because growth funds will almost certainly outperform conservative funds over longer time periods.

“For example, the average KiwiSaver default fund, which is roughly 80 per cent invested conservatively in bonds and cash, delivered a return of 5.4 per cent per year over the first 10 years of KiwiSaver, compared to the average KiwiSaver growth fund, which delivered 6.7 per cent per year. Note that this period includes a major market downturn, in the form of the Global Financial Crisis, and such downturns normally favour conservative funds. Project these returns forward and a 25-year-old investor would be more than $200,000 better off at retirement simply by choosing a growth fund over a default fund (adding up to roughly $10,000 extra of annual retirement income). Furthermore, the better performing KiwiSaver growth funds have done much better than the average, with the top 25 per cent of managers delivering a return of 8.5 per cent per year over the first ten years of KiwiSaver.

“Having a conservative fund as the KiwiSaver default fund is akin to giving our community poor investment advice,” says Mr Swann. “And in this case the poor advice is coming from the Government and it’s costing Kiwis hundreds of thousands of dollars in their retirements. A decade on from the start of KiwiSaver, it seems to have proved too hard for default providers to move their clients into growth funds. Clearly, action is now called for from the Government.

“If we take Australia as our yardstick, their Superannuation money is roughly 65 per cent invested in equities. Which means not only are Australians getting wealthier through higher savings, they are also investing their savings in a much smarter way for maximum retirement gains,” Mr Swann said.

“We believe this is the major policy issue for KiwiSaver going forward.”

The final piece of the jigsaw is a Government-sponsored detailed study of individual savings patterns and retirement requirements. This report should include a clear statement on the sustainability of NZ Super. It is important that the public know how much Super they can rely on so they can plan accordingly.

Milford is also advocating for savings-based tax incentives and for the adoption of a more age-based and, therefore, more appropriate approach to the use of Default KiwiSaver funds.

Mr Swann says, “A savings-challenged block of New Zealanders should not continue to be thrown reflexively into conservative funds that will not generate the returns they require to sustain the lifestyle they aspire to in retirement.

“It would be a major step to improving New Zealand’s quality of life if we could turn the current saga of underperformance into one of comfortable retirements funded by effective saving and smart investing. New Zealanders deserve no less.”

See Troy Swann’s full video interview by clicking here.

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