In his ongoing superannuation series Andrew Coleman points out NZ’s government retirement system can be quite extreme, assuming all people are competent to make their own savings and investment decisions before they retire, with little government help

By Andrew Coleman*

Economic policy sometimes fails to predict how people actually behave. In 1975, New Zealand scrapped its new compulsory saving scheme and replaced it with National Superannuation, a scheme that provided everyone over 60 with the same government pension regardless of the income they earned or the taxes they had paid. It was expected that people who wanted a higher retirement income would save the difference themselves. Policy makers assumed most people would find this straightforward.

Just as this was happening Daniel Kahneman and Amos Tversky, two Israeli psychologists, were pioneering a revolution in economic theory. They researched how people actually made choices, particularly choices that had uncertain outcomes such as savings and investment. Their results caused a shock wave in the economics profession.

Previously, most economists assumed that most people sought out the best information and clear-headedly chose the options that had the best prospects. But this was not the case. Humans, it appeared, often made lousy choices. Our brains are not naturally good at understanding probability. We let irrelevant information bias our judgements. Our choices depend on the ways issues are framed, including whether identical outcomes are framed as wins or losses. People are much more likely to favour a medical intervention which has a 90% success rate than one which has a 10% failure rate, for example.

Together, Kahneman and Tversky kick-started the field of behavioural economics. Kahneman, who died earlier this year, received the 2002 Nobel Economics prize for this work – although this came too late for Tversky, who died in 1996.

Behavioural economics rapidly expanded and explored other issues. One set of issues concerns the difficulties that many people have with short-term self control when trying to achieve long-term goals.

Another set of issues concerns the way people select information sources that confirm their existing views, and ignore information that challenges them. A third set of issues concerns was the way people delay dealing with bad news, because it makes them so uncomfortable, allowing problems to get worse.

We all recognize the times in our lives when we do these things. What we don’t necessarily recognize, however, is how difficult this can make it to adequately save and invest for retirement.

Over the last 40 years, a large number of economic studies have shown that saving and investment is difficult for many people. It is difficult to work out how much we should save; and it is difficult to work out how to invest well. It seems our brains are not wired to calculate investment probabilities, and we often are swayed by recent trends.

Fortunately, many companies offer products that are designed to make saving and investment easier. But not everyone uses these companies, and those that don’t often make saving and investment decisions that are pretty bad. The evidence is too large to summarise in a line, paragraph or even an article, but a particularly readable introduction to behavioural finance is here.

While some economists were surprised to discover that many people find saving and investment difficult, most people were not. Indeed, almost all countries have adopted contributory saving schemes because most people believe they could use some help saving for retirement. They also believe they need help managing their money when they retire. Contributory schemes are designed to help people save and invest while they are working, and to retire worry free when they are older.

This is why in most countries people who pay more in taxes get higher pensions – the pension scheme is seen as a way of helping people save. These schemes are somewhat complicated to operate, as the amount of taxes people pay are monitored and everyone gets a different pension when they retire. But they are consistent with the adage of Richard Thaler, winner of the 2017 Nobel Economics prize: “The lesson of behavioural economics is that people only save if it’s automatic.”

New Zealand Superannuation is much simpler to run as everyone gets the same government pension which is unrelated to the taxes they have paid during their lives. Nonetheless, the simplicity of New Zealand Superannuation is misleading. Since everyone receives the same pension, middle and higher income New Zealanders who want to maintain their living standards in retirement need more private savings than people with similar incomes who live in other countries.

Most middle and higher income people do save privately for their retirement. But this is where New Zealand’s system makes life not so simple. People who want more than a basic pension have to do a lot of financial management themselves to provide additional amounts. This not only exposes them to investment risks – including the risk of fraud – but it assumes people have a level of interest in and competence at money management that many do not have.

Most OECD governments have much less confidence than the New Zealand government that people will be able to save and invest the correct amounts to ensure they have enough money when they retire. The contributory systems or compulsory savings schemes these countries use are designed to make it much simpler to manage saving and investment decisions. As a result, people in most OECD countries have to do far less of their own private financial planning and management to obtain a comfortable living standard in retirement than people in New Zealand.

Middle and higher income New Zealanders have much more need to manage their money and save and invest to ensure they have a comfortable retirement.

KiwSaver is designed to help people save for retirement if they want more than the government pension, but it only helps before age 65. Once you are over 65, all the management responsibility is your own.

In this respect, New Zealand’s government retirement system is quite extreme. It assumes that all people are competent to make their own savings and investment decisions before they retire, with little government help. It also assumes that older New Zealanders can adequately manage their savings after they retire, even though this is quite a difficult problem given the vagaries of how long people live, and whether they get sick or even have dementia.

Managing your investments before and after you retire might be fine if you are an investment banker, a tax accountant or just super rich, but vast amounts of international experience suggests that many people will not find it easy.

Nonetheless, despite this evidence, successive New Zealand governments have adopted the attitude that you’re on your own if you want more than the basic pension. Whether you are 19 or 90, it is considered your responsibility to manage your savings, manage your investments, and manage how much tax you pay. This is a very different approach to countries that have contributory pensions or compulsory saving schemes.

Of course, KiwiSaver does help. Yet it is only a partial solution. First, it is voluntary, so not everyone joins. Secondly, the contribution rates tend to be small, much smaller than the amount of savings done in contributory schemes in similar countries. Thirdly, it does not provide people with options to manage their money when they are old, a major oversight.

Even though some of the insights from behavioural economics have been used to encourage people to use KiwiSaver while they are working, these insights were completely ignored when it comes to spending KiwiSaver balances in retirement.

Given the government requires middle income New Zealanders to rely more on their own savings for additional retirement income than middle income people in other countries, you would think that the government would have made it as simple as possible to save privately for retirement.

Unfortunately, this is not the case. For decades governments have made the simplest saving and investment products – bank deposits or investments in government bonds – the most heavily taxed investments in the country. Bank deposits in New Zealand are so heavily taxed because interest income is not adjusted for inflation before it is taxed. This raises the effective tax on inflation-adjusted interest earnings, causing them to be significantly over taxed. Economists have decried such taxes for more than a century, starting with a 1923 paper by Jacob Viner, and while many countries have adjusted the way they tax retirement savings to minimise this effect, New Zealand has not.

The problems don’t just concern bank deposits. New Zealand taxes income from other classes of investments at some of the highest rates in the OECD – unless, of course, the investment income is in the form of capital gains, which have been mysteriously exempt from tax. Part of the reason why taxes on investment income are so high is because New Zealand does not use social security taxes or compulsory saving contributions to fund the pension.

Moreover, rather than use the standard OECD method of taxing dedicated retirement saving funds such as KiwiSaver accounts, in 1989 the government adopted a particularly distortionary tax regime for retirement savings. This topic is sufficiently complicated that it will be addressed in its own article in a couple of weeks. Suffice to say for now, New Zealand replaced ‘simple’ with something that needs an army of tax accountants and advisors to understand.

It is hardly surprising that New Zealand’s tax system, combined with relatively low pensions for middle-income people, have made rental housing one of the favourite investment choices for people who are saving for retirement. This combination has placed upward pressure on housing markets, raising the housing wealth of baby-boomers – but at the expense of younger generations. Artificially high house prices make life harder for the next generations who want to start families -and this is not just unfair, but unnecessary. New Zealand Superannuation may have reduced income inequality amongst older people, but it has also shifted it elsewhere.

Kahneman and Tversky showed the way people make decisions frequently leads to less than desirable outcomes. They also showed that outcomes can be improved if people recognize and counteract these tendencies. Governments can also make less than desirable decisions. Since the 1970s successive New Zealand governments have chosen taxes that are very different from the taxes adopted in richer, more productive, and more equitable countries elsewhere in the world, and the taxes we have chosen may be at the heart of our seemingly intractable productivity and inequality problems.

The evidence from these countries suggests there may be better types of taxes to fund our government pensions, and less distortionary ways to tax personal retirement income accounts. They are big topics, and the subject of the next few articles.

*This series and an accompanying paper are based on work I started in 2020 with Jeanne-Marie Bonnet while we were both at the University of Otago. I am very grateful for her assistance and insights. All errors remain my own.

(This article is part 7 in the series. Part 1 is here, part 2 is here, part 3 is here, part 4 is here, part 5 is here, and part 6 is here).

**Andrew Coleman is a visiting professor at the Asia School of Business. This article is his personal view of retirement policy in New Zealand, based on academic study.

Coleman is on extended leave from the Reserve Bank of New Zealand, while working overseas. The views expressed in this article do not represent the RBNZ and are unrelated to work conducted at the Bank, which has no responsibility for retirement policy in New Zealand.