Gold-plated superannuation can be a trap.
Nick Smith left Parliament with an unusually generous retirement setup, but for some workers those schemes are a trap, writes Melanie Carroll.
When National Party MP Nick Smith left the corridors of power this month, 31 years after entering them, he departed with an unusually generous retirement scheme.
Under the parliamentary super scheme which closed to new members in 1992, MPs including Smith get an effective 23 per cent employer contribution.
Under the current parliamentary scheme, there is an effective 20 per cent employer contribution.
Compare that with KiwiSaver, in which the matching employer contribution is a maximum of 4 per cent.
‘‘Obviously [Smith’s] entitlement will be large any which way you shape it, and that comes down ultimately to the power of time and compounding contributions,’’ says Blair Vernon, chief executive of AMP Wealth Management New Zealand.
The type of super scheme parliamentarians are in is called a defined benefit scheme, a gold-plated vestige of the past.
There are 82 workplace savings schemes on the Disclose Register, of which about 20 are open to new members. About 50 of those are defined benefit schemes, in which contributors make regular payments to the fund and receive a defined level of income, or lump sum, when they retire.
KiwiSaver is a defined contribution scheme, in which investors contribute but the return is not guaranteed.
Chris Douglas, principal of MyFiduciary, says defined benefit super schemes have progressively been wound down since the 1990s.
‘‘They effectively have just been hideously expensive to run, because people’s life expectancy has increased significantly, and so the cost of running those schemes just became far too expensive to maintain.
‘‘There are still one or two people who are still lucky enough to have them.’’
In many defined benefit pensions, after 40 years of service the pension works out to be two-thirds of the final salary, but in some old pension funds it can be bigger, according to financial planning website, Sorted.
The Government Superannuation Fund, which houses the old parliamentary scheme, dates back to 1948. Its schemes closed to new members in 1992, but they will continue to have a substantial membership for many years.
At June 2020, there was one contributor from Parliament, no judges or solicitor-general, 20 from Corrections, 55 from the Defence Force, 161 from police, and 4275 from the general scheme.
On the receiving end, there are 43,894 annuitants.
In 2020, there was a $7.8 billion shortfall between the market value of the assets and the benefits the fund was liable for.
Vernon says it is ironic that former prime minister Sir Robert Muldoon cancelled the New Zealand Superannuation Scheme in December, 1975, which would have virtually guaranteed the country’s prosperity, while their own super generous scheme continued for decades.
‘‘What’s good for the electorate wasn’t obviously appropriate for the politicians, so they were busy participating and kept the scheme until 1992 and guaranteeing their entitlements, pretty generous arrangement.’’
Sam Stubbs, chief executive of KiwiSaver fund Simplicity, says we would have saved at least $500b by now if the scheme had lived longer than 11 months.
When defined benefit schemes were in their heyday, most employees signed up on day one. On the plus side there was financial certainty, but they were also a golden handcuff – people had to stick around to get the benefit.
A lot of people often describe the last 10 or more years of their time as a sentence because they just have to stay to collect their defined benefit entitlement, ‘‘even if it’s unbearable’’, Vernon says. ‘‘It’s an interesting conundrum. They certainly create loyalty, but ultimately the question is, do they create prisoners.’’ Undeniably, the people in them are in better financial shape than those who are not, or who choose a lump sum on retirement instead of an annuity, or recurring payment, he says.
The key is how long workers contributed, and for some it was from when they were still a teenager until they retired. Simplicity sales director Ian Miller says the Financial Markets Conduct Act was the nail in the coffin for many of the old standalone schemes which had their own investment arm, because of the new financial reporting requirements. But there is still some life in the industry, despite KiwiSaver’s domination of retirement savings.
‘‘They [defined benefit entitlements] certainly create loyalty, but ultimately the question is, do they create prisoners.’’ Blair Vernon Chief executive, AMP Wealth Management New Zealand
‘‘KiwiSaver isn’t always the right place, so, many of these schemes will have a place for many years,’’ Miller says.
‘‘Police, for example, they have the police early retirement fund, and 65 is pretty old to be a constable on the beat, so they have earlier retirement dates.’’
Under the police scheme, recruits and constabulary employees contribute 7.5 per cent of their salary, and the employer puts in 15.2 per cent.
Among the other defined benefit schemes are pension funds specifically for dairy workers, meat workers, university workers, and steel workers.
Vernon says a total contribution in the 10 per cent territory means a ‘‘solid insurance’’ on retirement entitlements.
‘‘Hence why we have such concern at the 3 per cent number that we’re talking about today for KiwiSaver. It’s great, it’s a start, but for many people it’s not enough. You don’t have to have an actuarial degree to figure out that 3 per cent on a voluntary basis when lots of people aren’t putting in any, isn’t going to get you there,’’ Vernon says.
Under KiwiSaver, the minimum contribution rate is 3 per cent of pre-tax pay, but people can put in up to 10 per cent.
Under AMP Wealth’s super scheme, the company contributes 12 per cent and employees put in 3 per cent.
‘‘We just fundamentally believe as an employer that 3 [per cent] plus 3 isn’t good enough. That costs us substantially . . . but that’s the kind of territory where you see staff really starting to realise a different financial outcome in future,’’ Vernon says.
‘‘Contributions beyond the minimum aren’t particularly common in the market, because the employment market’s been driven by cash, pure salary levels.’’
There had been hopes of KiwiSaver incorporating an annuity feature, but it hasn’t happened and Vernon does not expect to see it.