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KiwiSaver – a New Zealand landmark

Mike Woodbury and Emma Harding of Chapman Tripp summarise key features of the KiwiSaver regime, and provide some analysis of the Bill in the latest SuperScoop publication.

Tuesday, March 7th 2006, 9:57AM
KiwiSaver is one of several recent Government initiatives designed to increase the level of savings by New Zealanders and support New Zealanders in retirement. It follows the introduction of the State Sector Retirement Savings Scheme, whereby the Government in its employer capacity offers superannuation benefits to state sector employees, and the establishment of the New Zealand Superannuation Fund, which is aimed at pre-funding the future cost to the Government of the universal New Zealand Superannuation benefit.

KiwiSaver is designed to complement rather than replace New Zealand Superannuation, by encouraging a long-term savings habit for those who want to have more than a basic standard of living in retirement.

Initial high–level details of the KiwiSaver workplace savings scheme regime were announced in Budget 2005. The KiwiSaver Bill, which sets up the KiwiSaver regime and provides further details of how it will operate, was introduced into Parliament on 28 February 2006 and had its first reading on 2 March 2006.

There has been a lot of public commentary on the Bill. This has mostly tended to iterate details without editorialising. We intend selectively highlighting certain material points of interest from a legal and practical perspective.

Key features of KiwiSaver

The KiwiSaver Bill proposes that participation in the KiwiSaver regime will not be compulsory, but that employees aged between 18 and 65 who begin a new job on or after an anticipated commencement date of 1 April 2007 will be automatically enrolled in a KiwiSaver scheme. Employees who are automatically enrolled will have the right to opt out during weeks 2 to 6 after starting their new job. If an employee does not opt out, contributions will be deducted from the first pay received following 11 weeks of the new employee’s employment.

Existing employees, persons who are not employees (such as beneficiaries and the self-employed) and employees under 18 years of age will be able to opt in to the KiwiSaver regime on a voluntary basis.

The Government will make a one-off $1,000 start-up contribution to each saver’s account and will make a contribution towards the annual fees incurred by savers of a flat dollar amount per member per annum (which will also be credited to each saver’s account). The amount of the fees subsidy will be determined following the default providers tender process.

Savers will be able to contribute at either the default rate of 4% or 8% of their employment income, which includes all monetary remuneration received by an employee in that capacity (with very limited exceptions). Employers will be able to make voluntary contributions to KiwiSaver.

In accordance with the aim of minimising compliance costs for employers, savers’ contributions to KiwiSaver will be deducted at source and forwarded to the Inland Revenue Department (IRD) at the same time as PAYE tax. The IRD will hold contributions in a holding account for 3 months from the date of the first contribution being received by the IRD before passing them (with interest, currently at a rate of 5.71% per annum) on to the appropriate KiwiSaver provider.

Savers will be permitted to choose their own KiwiSaver provider. If savers do not choose their own provider, then they will become a member of the preferred KiwiSaver scheme nominated by their employer (if their employer has chosen one, which is voluntary) or they will be allocated to a default scheme by the IRD.

Savers who contribute for an initial one-off period of 12 months will be able to cease KiwiSaver contributions by applying to the IRD for a contribution holiday lasting for a minimum of 3 months and a maximum of 5 years (but with the ability to renew the contribution holiday after the expiry of each 5 year period). If an employee elects a contribution holiday then the IRD will notify the employer to cease deducting contributions on behalf of him or her.

Contributions will be locked in until the age of eligibility for New Zealand Superannuation or five years after the first contribution (whichever is later), with earlier withdrawals permitted only in circumstances of serious financial hardship, permanent emigration or to assist with the purchase of a first home after at least 3 years’ contributory membership.

Employers will be required to advise IRD of a new employee’s details within 3 weeks of that new employee starting a job, as well as providing all new employees with a pack supplied by IRD which contains information about KiwiSaver, default providers and schemes and the opt-out form. The Bill expressly provides that an employer will not be liable as an investment adviser or promoter by merely passing on the pack to its employees.

Existing schemes

The Bill establishes that KiwiSaver schemes will be registered by the Government Actuary under a regime that is separate from, but similar to, that currently operating for registered superannuation schemes. However it is intended that existing registered superannuation schemes can continue to operate as they have done until now.

Essentially, the providers of existing registered superannuation schemes will have three options:

  • convert the whole scheme to a KiwiSaver scheme (this will require the consent of all members of the scheme);
  • establish a KiwiSaver section within the existing scheme (with each member being offered the choice to decide whether to transfer their membership to the KiwiSaver section); or
  • continue operating independently of KiwiSaver.

Additionally employers currently offering superannuation to their employees will be able to apply to the Government Actuary for an exemption from the KiwiSaver automatic enrolment provisions, if their scheme (or, if applicable, two or more schemes considered as a whole as if they were one scheme):

  • is open to all new permanent (including part-time) employees;
  • is portable (i.e. members can transfer their balances to other schemes);
  • has a required minimum employee contribution, combined with a maximum employer contribution, which together are at least 4% of each employee’s gross salary or wages; and
  • where all employer contributions vest in the employee within 5 years of the employee becoming a member of the scheme.

Timeline of key events

A formal call for submissions has yet to be made by the Finance and Expenditure Select Committee, which is to consider the KiwiSaver Bill. However, the public is likely to have an opportunity to have their say about the Bill sometime during the next several months. The Select Committee is scheduled to report back to Parliament in either late August or early September.

The default provider tender process (to appoint schemes to which people will be allocated by the IRD on a random basis, if they do not select a provider of their own and their employers have not chosen a preferred KiwiSaver scheme) will occur in parallel with the Select Committee process. Providers who meet the publicly notified selection criteria will be appointed after the legislation is passed, which is likely to be in October 2006. This should give the superannuation industry and other stakeholders around 6 months to prepare for the anticipated launch of the KiwiSaver regime on 1 April 2007.

The Bill contemplates flexibility in the timing of commencement of certain parts, to allow time for the early set-up of certain aspects of the KiwiSaver regime. Examples given include allowing individual schemes to register as KiwiSaver schemes, exempt employers to be approved and any necessary regulations to be made.

The regulation-making power set out in the Bill also allows the Governor-General to provide for “any transitional or savings matters concerning the coming into force of this Act”.

Commentary on KiwiSaver

Automatic enrolment process

The Bill prescribes that the automatic enrolment rules will apply to all new employees who:

  • meet the New Zealand residency test (this will include overseas citizens personally present in and able to work permanently in New Zealand); and
  • begin either their first job or a new job with a separate payroll (transfers between related employers, or to the buyer of a business purchased as a going concern, will be excluded for this purpose).

The Bill takes a pragmatic approach to the mechanics of automatic enrolment. Notably:

  • employers must give new staff the KiwiSaver information pack prepared by IRD, but need not distribute an investment statement;
  • when an employer notifies IRD of the new employee’s name, IRD number and address, IRD then allocates the employee to a default scheme and sends the employee the investment statement for that scheme (unless the employee has already opted out or chosen his or her own scheme);
  • an employee can opt out or choose another scheme during weeks 2 to 6 after starting the new job, and that opt-out period can be extended to 8 weeks in certain circumstances;
  • an opt-out notified after the 6 or 8 week time limit is treated as an application for a contribution holiday;
  • IRD processes any opt-out forms and advises employers accordingly; and
  • if there is no opt-out, then the employer must commence deductions from the new employee’s next pay after week 11.

Providers’ costs have been limited by requiring default providers only to provide their investment statements to employees specifically allocated to their products (or who request an investment statement directly).

IRD will hold and distribute stacks of investment statements for providers, and distribute them direct to employees (not via employers).

The Bill provides for an employee’s “provisional allocation” to a default KiwiSaver scheme, and for the person to be notified of that fact. “Provisional allocation” becomes binding on that person (and on the KiwiSaver scheme) after the provisional period – see below – has expired.

The default scheme’s investment statement is deemed to have been received in the ordinary course of post. This is an exemption to the general securities law, in order to deal with the effects of automatic enrolment and default allocations.

The Bill prescribes “deemed offer and acceptance” provisions, under which default subscriptions are treated as binding and enforceable in the same manner as contracts freely and voluntarily entered into.

IRD holding account

A key feature of KiwiSaver is a 3 month initial “holding period” after contributions have begun, during which IRD retains those contributions in a holding account. The purpose of this facility is to allow a member additional time to select a scheme and investment risk profile (and seek financial advice if desired). During this period, interest will be added to the member’s balance at the Commissioner of Inland Revenue’s paying rate of the 90 day bill rate less 100 basis points (currently 5.71% per annum). Income tax will be deducted from that interest rate at the tax rate applying in respect of taxable income that is not more than $38,000 for a tax year (currently 19.5%).

For the avoidance of doubt (because money allocated to the holding account is held in cash rather than diversified) the Bill prescribes that the “prudent person” duties in Part II of the Trustee Act 1956 do not apply to the Commissioner in respect of money in the holding account.

The Bill provides that the Commissioner and a provider may agree on a minimum balance that must be accumulated before a person’s contributions are passed on to the provider’s scheme. This will mean that in some cases the Commissioner holds a person’s contributions for the longer of 3 months or until they are of sufficient value to be accepted by the KiwiSaver provider.

The application of a flat (and in many cases concessionary) proxy rate of income tax is a welcome feature of the holding account mechanism.

Default investment funds

The Bill requires that when a person is allocated to a default provider and does not then make an active investment choice, his or her contributions are to be invested according to a “conservative” investment strategy (with, impliedly, a low risk of a negative return in any given year).

The commentary to the Bill makes clear that a “conservative” fund need not be comprised exclusively of cash.

Because a conservative investment strategy can typically be expected to produce lower long-term returns than a balanced strategy and may not therefore accord with the “prudent person” duty prescribed for trustees in Part II of the Trustee Act 1956, the Bill prescribes that a person’s allocation to a default investment option is to be treated for the purposes of that Act as a binding direction to the trustee of the relevant KiwiSaver scheme.

Employer-preferred schemes

The Bill prescribes a hierarchy of options for employees to be allocated to a KiwiSaver scheme:

  • by choosing their preferred KiwiSaver scheme; or
  • if they do not so choose, but their employer has chosen a preferred KiwiSaver scheme, by being allocated to that scheme; or
  • in any other case, by the person being allocated to a default KiwiSaver scheme nominated by the Commissioner of Inland Revenue.

When an employer chooses a preferred KiwiSaver scheme (by notice to IRD) it must then supply an investment statement for that scheme to every new employee, and others who choose to opt in to that scheme, together with the IRD’s information pack.

The facility for an employer to effectively choose its own “default” scheme should provide business opportunities to KiwiSaver providers who do not qualify as default providers at employee level.

An important (if merely clarificatory) aspect of the Bill is that an employer will not become a promoter of a KiwiSaver scheme, for Securities legislation purposes, by reason only of either complying with its obligations with respect to an employee’s participation in a default KiwiSaver scheme or choosing a KiwiSaver scheme as the employer’s preferred scheme.

Contribution holidays

The initial 12-month minimum contributions period for a new KiwiSaver scheme member is subject to a facility enabling persons to apply to IRD to cease contributions in cases of significant financial hardship.

When invoked, a contribution holiday must apply for a minimum period of 3 months, unless the employer agrees to a shorter period of suspension.

IRD will remind employers to restart contributions for employees when contribution holidays end.

If a contribution holiday is not actively renewed after the maximum contribution holiday period of 5 years, then contributions will automatically resume. However, when contributions resume in that manner, there appears to be no minimum period before which the employee can take another contribution holiday.

As an aside, much of the public commentary about the standard KiwiSaver contribution rate of an after-tax 4% of taxable employment income concerns its possible inadequacy for retirement saving purposes. Perhaps for that reason, the Bill provides that either or both of the prescribed 4% and 8% contribution rates may be changed by regulation.

Regulatory streamlining

The Bill gives employers and providers, and trustees of existing schemes, some compliance relief in areas that might otherwise have given rise to very material concerns.

The following are not treated as the giving of “investment advice” for the purposes of the Investment Advisors (Disclosure) Act 1996:

  • supplying a KiwiSaver information pack; or
  • giving a factual description to another person of the features of a KiwiSaver scheme or schemes (such as information about admission as a member or termination of membership); or
  • giving a factual description of the features of a KiwiSaver scheme in the course of promoting the benefits of retirement savings in general; or
  • acting only as an intermediary who transmits information about a KiwiSaver scheme; or
  • otherwise exercising or performing a function, duty or power under the Act.

While merely clarificatory, these provisions should go some way towards assuaging employer concerns.

A default scheme provider is exempted from the requirement in the Financial Transactions Reporting Act 1996 to verify the identity of a default subscriber (unless that person starts making voluntary payments) so long as the provider makes reasonable efforts to identify the person when he or she becomes a new member.

KiwiSaver scheme providers will be exempt from the existing requirement in the Superannuation Schemes Act 1989 to state in an annual report “whether all the contributions required to be made to the scheme in accordance with the terms of the trust deed have been made”. The Bill acknowledges that compliance with that requirement is impracticable in the KiwiSaver context, and instead requires only that the trustee of a KiwiSaver scheme state that it has applied contributions received in respect of each member in accordance with the trust deed.

The Bill proposes that a KiwiSaver scheme provider need not distribute annual reports to the holder of an “inactive account”. This is defined as an account in respect of which no contribution has been received for at least two years.

Certain additional annual reporting requirements apply to KiwiSaver schemes (and to “KiwiSaver sections” within schemes, which must report separately) but KiwiSaver annual reporting requirements otherwise largely mirror those prescribed in the Superannuation Schemes Act 1989.

The Bill provides that a KiwiSaver scheme must, for the purposes of any other enactment, be treated as a registered superannuation scheme. This is important in the context of preserving a KiwiSaver scheme’s entitlement to (for example) a prospectus exemption or other compliance relief under the Securities legislation which is expressed as only being available to registered superannuation schemes.

The void and voidable allotments provisions in the Securities legislation are modified in the KiwiSaver context. Essentially, when a subscription for KiwiSaver scheme membership is void or voidable (for example due to non-receipt of an investment statement) the affected person’s interest is allocated to another KiwiSaver scheme.

The Bill allows for bulk transfers to a replacement scheme (without having to elicit transferring members’ consents) when a KiwiSaver schme is wound up.

The “Questions and Answers” document accompanying the Bill states that:

    “For KiwiSaver schemes which are not default schemes, the decision on whether to become a qualifying collective investment vehicle will be left up to individual trustees”.

This is vital. Any requirement to apply “pass-through” of investment income at higher earners’ marginal income tax rates would likely be untenable for a number of existing scheme providers.

Some potential regulatory problem areas

The Bill prescribes that the fees charged for membership of a KiwiSaver scheme must be “not unreasonable”. Fees are exhaustibly defined for this purpose. Whether or not a fee is unreasonable is a matter for the Government Actuary to determine, in a manner that appears potentially subjective. In the New Zealand environment, where fees in this context are relatively modest – who says competition doesn’t work? – these provisions seem unnecessary.

The Bill contemplates allowing early withdrawals in cases of “serious financial hardship”. That term is non-exhaustively defined in the Bill and the definition itself begs several questions (notably what is meant by an inability to meet minimum living expenses according to “normal community standards”).

We think that there will likely be a high incidence of hardship-based claims under KiwiSaver, necessitating fact-based enquiries and giving rise to cost and complexity.

The Bill contemplates that providers will administer hardship-based claims, and we think this role may be both expensive and fraught with dispute risk. A central agency will administer housing withdrawals and in our view the Bill could usefully adopt a similar approach for hardship-based claims (if only in the interests of consistency and avoiding a “moral hazard” for providers).

We query the absence from the early withdrawal criteria of any provision for early withdrawals on the grounds of total and permanent disablement or (at the very least) medically certified terminal illness.

Existing schemes – conversion

The Bill allows trustees to put forward proposals “converting” an existing scheme to a KiwiSaver scheme. Of necessity (given the requisite lock-in of members’ balances under the KiwiSaver rules) this can only occur with unanimous member consents. Nothing else would be tenable.

For that reason alone, we think it unlikely that this “whole scheme” conversion mechanism will ever be invoked.

A more practicable conversion mechanism is the Bill’s provision for trustees to establish a KiwiSaver scheme (in practical terms a “KiwiSaver section”) within an existing scheme. Enabling provisions will allow the requisite trust deed amendments to be made without giving rise to a member consents issue. Once established, the KiwiSaver section will become a section of the existing superannuation scheme, but must be treated as a separate KiwiSaver scheme for the purpose of administering the Act. Members of the existing scheme can begin contributing to the KiwiSaver section (thereby becoming KiwiSavers, entitled to the full range of contribution and fee subsidies) and can fully or partially transfer their existing interests to that section.

The Bill allows a scheme with a “KiwiSaver section” to be regarded for administrative purposes as a scheme governed by one trust deed with the same trustees.

Because conversion is necessarily a member-level decision, we think that an elective right for an existing member to join or transfer to a KiwiSaver section will be the only practicable conversion mechanism under the KiwiSaver Act.

The Bill allows full and “partial” conversion mechanisms to be proposed to members and the Government Actuary in the alternative.

Employer exemptions

Employers will be exempt from automatic enrolment requirements if they provide access to one or more superannuation schemes that meet certain criteria. The exemption mechanism is intended to help ensure that KiwiSaver does not encourage “good employer schemes” to wind up.

The proposed exemption criteria have been materially relaxed since they were first announced on Budget Day 2005. However, they remain problematic (and will be unworkable for many schemes unless further amended) for a range of reasons. These include, among others:

  • the minimum 4% contribution requirement currently being expressed (as for KiwiSaver schemes) as a percentage of salary or wages and all other employment-related allowances – this is a conceptual departure from the usual approach to calculating “superable salary”, whereby the figure used for that purpose is generally gross base salary;
  • the 4% minimum contribution requirement does not appear to cover schemes which operate on an unallocated funding basis or which (more particularly) have reserves or a surplus which enables an employer contribution holiday; and
  • the trust deed of the relevant scheme must provide for any employer contributions to vest completely within 5 years of a member joining, which would disqualify many schemes with longer vesting periods and seems wrong in principle – at the very least, it would appear conceptually preferable to prescribe that employer contribution amounts must vest within five years only to the extent that they are required to count towards the 4% minimum.

We expect that the employer exemption criteria will be a “hot button” issue for KiwiSaver, given those and other problem areas and the Government’s repeatedly stated – and doubtless genuine – aim of ensuring that existing schemes can continue to operate as they have done until now.

General observations

Although whether or not to call for public submissions on the KiwiSaver Bill will technically be at the Select Committee’s discretion, we have no doubt that public submissions will be sought and that the final shape of the KiwiSaver Bill will be heavily influenced by those submissions and the Select Committee’s report–back to Parliament. Officials, in particular, have impressed all involved with their open-mindedness and very genuine desire to ensure the Bill “works” and does materially more good than harm.

As the regulatory impact statement appended to the Bill observes, the financial sector will benefit from increased demand for its products if KiwiSaver increases the numbers of people saving, or aggregate savings. However:

  • it may change the structure of the financial sector as people switch the form of their savings;
  • a result is that the long-term savings market may become more consolidated and less competitive; and
  • to the extent that existing schemes wind up – and that is inevitable to some extent – funds may flow out of the financial sector altogether.

That said, we think there are grounds for cautious optimism that KiwiSaver can be made to deliver on its promise of simple explanations, hassle-free administration, low fees and a sufficient array of attractive approved products.

One thing is certain – a New Zealand-wide system of automatic enrolment in savings schemes, with a voluntary opt-out provision, will be a truly fascinating experiment in behavioural finance.

SuperScoop is published by Chapman Tripp, email

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