Hawke’s Bay Fin. Planners & Insurance Advisors
Hon Michael Cullen
4 July 2003
Hawke’s Bay Financial Planners and Insurance Advisors Association
Thank you for inviting me to call in to your meeting this afternoon. As the Minister who diversified around $7 billion into the longest bear market in fifty years I presume that you have called me in to offer me some sage advice.
On a more serious note, I would imagine that you and your colleagues are also having to come to terms with the implications of recent trends in world share markets. The big question is whether we are in the middle of a sea change in where small savers put their money.
During my working life, financial planners have faced one major change in the way they went about their business. When I first encountered the insurance company agent the pitch was quite simple: use up whatever you haven’t used up of your $1,200 annual tax exemption, and put it in a policy that my company sells.
Since then, the tax exemption has gone, there are more requirements around transparency and disclosure and the clients have been far less willing to take the only product on offer. Financial planners are less likely to work for a single company and are under more pressure to tailor the product – or more specifically a savings and insurance plan – around the specific needs and life cycle stage of the client.
I am generalising and of course there are exceptions, but I suspect that financial planners still had a basic fallback. When it came to the crunch, the advice was to invest in global equities because over time they had delivered the best returns. Because all markets have their ups and downs, invest for the longer term and do not panic in response to temporary fluctuations. Go into an overseas fund, lock it away, and look at it again when you are 65.
I would be interested to get your views on how well that pitch goes down these days. There is a nervousness in the marketplace about returns on managed funds, and there is still a questioning going on about whether, when and how strongly global equity markets will rebound. Personal financial planning is in a state of flux, and I don’t imagine that we will get a clear picture on where it will settle for some months – or even years – yet.
In the meantime, you have asked me to address some very specific questions that your members have lodged with Vicky Watson, your Secretary. I am sure we will have time at the end to canvass other issues.
I am asked to define the government’s position on estate and death duties, and to comment on whether they are likely to be reintroduced. The issue is not on the agenda and I cannot recall reintroduction of death duties ever being a formal option for consideration in budget discussions during the last four years. Indeed, if anything, the trend is the other way. The recent decision to phase out asset testing on long-term frail care patients has the ultimate effect of protecting inheritances before death as well as not taxing them after death.
I would make an observation that the recent Household Savings Survey carried out by Statistics New Zealand in collaboration with the Retirement Commissioner revealed a surprisingly strong contribution from inheritances to the net assets that New Zealanders own. People seldom inherit when they are young, but if you look at the results for those in the 45 to 65 year age groups, those who had received an inheritance had – on average - over $100,000 more assets than those who had not. I make the observation that inheritance – inter-generational savings in effect – is a surprisingly large part of personal savings behaviour in New Zealand. It is also a fact of life that inheritance will be unevenly distributed, and this explains some part of the very large inequality in the distribution of assets that the survey discovered. The survey showed that the distribution of wealth was twice as unequal as the distribution of income.
The importance of inheritance in the life-cycle savings pattern is probably one factor that would tend to make governments of all political persuasions reluctant to get back into the business of death duties.
My second question asks the government’s view on tax incentives to save for retirement. We haven’t closed the debate on this, but at this stage in the evaluation I would indicate that official advice is that tax incentives are very expensive and may not be all that effective in increasing retirement savings.
They are expensive for three main reasons. Firstly, they apply to all who save, and the government is not only incentivising new savers but paying the money to those who would have saved anyway. Secondly, it is difficult to design tax incentives that cannot be accessed by people who simply shift savings out of current vehicles into tax advantaged forms. Finally, in order to change behaviour, incentives have to be fairly large. The $1,200 a year I mentioned earlier was a lot of money in those days. Multiply a large incentive by something like a million people who might want to use it and you see that tax incentives for savings tend to be counted in the hundreds of millions of dollars.
There is also a bit of concern that they tend to be regressive: they give the biggest advantage to those who have the most money anyway. If lower income groups and young families are not in a position to save, they cannot access the incentives. Finally, there is the question of how effective they are. By lowering government saving to try and leverage more private savings, tax incentives can actually reduce national savings.
This is not to say the tax on savings issue is dead. A big problem is the tax disincentives that apply to forms of savings, and how we deal with that. The budget made a start by aligning the tax on the employer contribution to a superannuation scheme with the marginal tax rate of the worker, but I readily concede that we need to take a harder look at the practicalities of ironing out other disincentives and anomalies that remain in the tax system.
The next question seems to widen out the brief of financial planners a bit, and asks whether there is any plan to ease Fringe Benefit Tax on group medical insurance contributions. The argument is that medical insurance saves the government millions in health costs. The general answer is no. As a matter of principle, we have tended to go for a tax regime that has few exemptions. Comprehensive taxes are much cleaner and more efficient to administer, and there is always argument about why this or that should be exempt from GST, or FBT, or allowed as a deduction against PAYE. In this area I find my Doctor No act is the best defence.
But even on the simple argument of costs and benefits to the government, the case is weak. Removing FBT would exempt all treatments and cost recoveries and not only those that would have taken place in public hospitals had the patient not gone private. It would also give tax relief to those who would have taken out private insurance anyway to ensure more choice over time and place of treatment. It is by no means clear that this would be a fiscal winner.
I can tell you that current plans are to issue a government discussion paper on the rules that govern FBT. Because FBT on health insurance was one of the issues that were raised in submissions on the initial round of consultations, it will be in the discussion document. The focus of the discussion is on simplifying the rules and reducing the associated compliance costs, including determining whether the breadth of benefits covered by FBT remains appropriate. The document is due out later this year.
I have been asked if the government will legislate against products that are promoted as investment products, but pay high up-front commissions to promoters, at a cost to the investor. This is a special sub-set of a later question that asks what the future holds for the regulation of financial planning in New Zealand and about government plans for regulation. I am going to duck these questions for two very good reasons: they are outside my direct area of Ministerial responsibility, and the relevant Minister is scheduled to outline government thinking on the regulatory agenda at your annual association meeting in Rotorua later this month. If I gave you a preview, I am sure your national association would feel that its thunder had been stolen.
One question asks why the government doesn’t allow a similar tax regime for unit trust investments in New Zealand as applies to Australian unit trusts. Australia sees unit trusts as more akin to ordinary trusts and distinct from companies, whereas New Zealand taxes unit trusts under our company tax rules.
This is because economically, a unit trust most resembles a company. There is capital contributed by beneficiaries, a real separation of owners from managers, and mutual investment by unrelated persons. In our view, these factors are not present to the same extent in an ordinary trust.
This leaves the last of the set questions before the free-for-all. It is very specific and asks whether the government will continue to allow the use of loss attributing qualifying companies for negatively geared investments.
The use of LAQCs for negatively geared investments is not on the IRD work programme and at present there is no intention to review the existing rules.
LAQCs are used in a number of mass marketed tax driven schemes, though not in all of those schemes. The recently introduced deferred deduction rule which targets arrangements that result in investors receiving more in tax deductions than the money they invest in the arrangements addresses these schemes without interfering in the legitimate use of LAQCs. It is the inappropriate use of the LAQCs, rather than LAQCs themselves that we need to focus on.
The fact that the use of LAQCs for negatively geared investments is not on the work programme does not mean that the IRD will not carry on observing what is happening in the marketplace and I am sure that they will report to me if they become aware of transactions that give rise to fresh policy concerns.
Savings has been the slumbering giant of the public policy debate during the last decade. During that time the proportion of the workforce that are members of employment based superannuation schemes has slumped from 22.6 per cent to 14.6 per cent. Household debt has increased dramatically, and credit card debt continues go grow apace.
Now the debate on what to do about savings is reviving. The Retirement Commissioner has encouraged a fuller exploration of the information that the Savings Survey gathered. The government has convened the Periodic Review Group that was established under the largely moribund Superannuation Accord and has asked it to make recommendations that focus on employment based superannuation. The PRG is scheduled to report by the end of the year. The Insurance, Investment and Savings Association is holding a savings summit on 23 July, and the next day your own national association has its forum on the theme of facing change.
So change is on the agenda in a number of ways. The investment environment has changed, policy on saving is changing, and there is a change in the profile of the debate about how to improve our national savings record.
This will be an important year for charting the course ahead for the savings industry and all the interests associated with it. With those remarks, please fire away with your questions and your observations.