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A group of financial consultants has sent an open letter to the Financial Markets Authority (FMA) and the Reserve Bank of New Zealand (RBNZ) proposing a 10-point Programme to address these inequities.
Over 400,000 KiwiSavers who have invested in default funds have missed out an estimated $1 billion over the last six years. This includes an estimated $70 million in overpaid taxes. Meantime, $1.5 billion of their funds are invested in securities issued by Australian-owned banks and insurance companies.
The sufferers
Default funds are principally operated by banks and an insurance company.
These companies benefit when cash and bond securities are held by themselves or in each other. Their gain comes at the expense of KiwiSaver investors who effectively receive lower returns than they ought to be getting from a retirement investment. These poor returns are suffered primarily by New Zealanders least equipped to make considered investment decisions and provide for their retirement.
A group of independent financial advisers, who have no involvement with default KiwiSaver funds, are calling for immediate and substantial changes in the way default KiwiSaver funds operate.
Ten-Point Programme
They ask the Government, the RBNZ and the FMA to urgently undertake the following ten point programme:
- Change all the default fund options to balanced, not conservative fund types
- Ensure IRD provides default fund managers correct member tax rates for all default members
- Progressively remove all members still in a default fund after 12 months by switching them out
- Establish a white labelled Government balanced fund into which all longer-term default members are switched
- Stop new default member flows to any default fund provider who does not adequately meet specified engagement and switch out rates for default members
- Instruct the white labelled Government balanced fund to minimise investments in Australian-owned bank securities
- Require default fund providers to keep default KiwiSaver funds separate from other funds, to not use the word “default” in the name of any other fund they operate and to switch “active choice” members out of their default fund
- Investigate KiwiSaver fund managers that have significant conflicts of interest in security selection or in the way they determine what fund types to recommend to members
- Require default fund managers to refund management fees charged in relation to placing and keeping investments in their own issued securities
- Require explicit identification and on-going disclosure of such conflicts to fund members
John Cliffe of Cliffe Consulting Company said that the problems with default KiwiSaver funds are systemic and long-standing.
“They are well understood, yet little of real substance has been done to resolve them by those involved, including the banks and insurance companies, the Financial Markets Authority, the Reserve Bank of New Zealand or successive Governments,” he said, speaking on behalf of the Group.
Three main issues
Using publicly available data the group has, for the first time, quantified how default KiwiSavers are missing out. Default KiwiSaver funds total around $4.6 billion, with approximately $1.5 billion of this invested in cash or short term bonds. The three main issues which have contributed to the default members missing out are (a) the appropriate
conservative default fund type setting (b) the failure of default fund managers to switch default members out to better funds at an appropriate rate and (c) over-taxation of a large number of New Zealanders in the default funds.
The Wrong Fund
There are three basic types of investment funds: conservative, balanced and growth. KiwiSaver assets are designed for retirement funding, specifically retirement income maximisation, a long-term purpose where a balanced (or growth) investment strategy is much more appropriate. A conservative strategy is generally incompatible with the overall purpose of KiwiSaver, so that it effectively penalises long-term investors.
Yet the default funds are all conservative.
The problem has been evident almost from the commencement of KiwiSaver.
However, when new contracts for default suppliers were let in 2014 the conservative default fund model was retained. The decisions to keep default funds conservative rather than balanced has resulted in default members missing out on approximately $830 million over the six years ended 31 March 2018, roughly $2.7 million every week.
“Default funds were designed as a ‘temporary holding place’ for new KiwiSavers from which they could be switched to a more appropriate fund. Yet, for many default fund members, the switch has never taken place. Default fund managers have performed poorly in this regard,” Mr Cliffe said.
Over the last six years, approximately 460,000 KiwiSavers have switched out of default funds. Yet, the numbers in default schemes have only marginally reduced, as new members have offset those switching out. In 2012, there were 447,274 members in default schemes. As at March 31, 2017 at least 444,486 KiwiSavers were in default funds. The value of assets in default funds continues to grow, from $2.92 billion in 2012 to $4.58 billion in 2017.
Over-Taxation
Many of the lowest income earning KiwiSaver members are paying tax at the highest possible rate of 28%, when they should have been taxed at 10.5% or 17.5%.
The Inland Revenue Department (IRD) supplies default KiwiSaver funds with default member account details but not the member’s tax rate, so, unless a fund successfully contacts members and gets their tax rate, it is required to deduct tax at 28%, the maximum rate.
This problem is likely to have affected the majority of those who have been enrolled in a default KiwiSaver fund. For six years ended 2018 this amounts to an estimated $70 million of excess tax.
As this Portfolio Investment Entity (PIE) tax is a final tax, any overpayment is unrecoverable.
Australian-owned banks benefit
The real winners have been Australian owned banks, which have been able to invest the default funds in their own and each other’s securities.
As at March 2018, this amounted to 31% of the ASB’s default fund, 30% of ANZ, 31% of BNZ, 27% of Westpac and 34% of AMP.
If a balanced fund option for default funds was implemented, the exposure to Australian-owned bank securities would decrease by approximately $1 billion.
The banks charge KiwiSaver members management fees for investing their funds in this way.
“The FMA, Government Ministers and others responsible for overseeing KiwiSaver have frequently asserted that better financial literacy education of default investors is required along with better fund manager performance in switching out default members to solve the problem,” says Mr Cliffe. “After a decade of failure with this approach it is time to take action.”
(Tables from source documents)
Key Facts:
Over 400,000 KiwiSavers who have invested in default funds have missed out an estimated $1 billion over the last six years
They have overpaid an estimated $100 million in taxes
Over $800 million of their funds are invested in securities issued by Australian-owned banks and insurance companies
