Pension Reforms

Title	National Pensions Framework

Institution	Government of Ireland
Topics	Pension reform
	Pension scheme design
	State Pension Age
	Behavioural economics

Date Published	2010
Date posted on PR	12 Jul 2010

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PensionReforms’ summary and comments

The Irish government started its look at the future cost of pensions in 2007. See here for a summary of the 2007 ‘Green Paper’ and here for a local commentary on those proposals.

In summary, the Irish government proposes more radical reform than PensionReforms expected but quite a bit of that seems misdirected. The government is rightly concerned about the future affordability of current pension commitments (a projected “increase in public spending on pensions from 5½ percent of gross domestic product to almost 15 percent”) but then seems to think that partly shifting the pension burden from public to private provision somehow makes pensions more affordable.

Ireland faces the usual collection of affordability issues faced by most countries – “a tripling of the number of persons older than age 65 ... and a decline in the number of workers supporting each pensioner (from nearly 6 to less than 2).”

Here are the main changes recommended:

The State Pension Age will rise from 66 to 67 in 2021, to age 68 in 2028 and a current supplementary “transition pension, payable from age 65 to 66 for individuals not in paid employment, will be abolished in 2014.”
A new, national auto-enrolment, opt-out Defined Contribution scheme, similar to the UK’s new Personal Pension Accounts, will start in 2014.
Tax relief on contributions to occupational retirement saving schemes will be simplified and reduced. However, employer contributions and the scheme’s investment income will remain tax-exempt.
The state’s occupational schemes for its own employees will change for new hires from a Defined Benefit calculated in relation to pay near retirement to one based on career-average earnings.

The government says it wants to increase ‘pension coverage’ from the current 54% (early 2008). Here are the main suggestions for the new auto-enrolment ‘supplementary pension plan’ that will be administered by the government:

It will be Defined Contribution and will, “if it would be prudent given the economic conditions prevailing”, start in 2014.
Employees aged 22 or older will be automatically enrolled on starting work.
They can opt out but only after three months; they will be re-enrolled after two years.
Contributions will be locked in after six months.

Although opting out will again be possible after two years, the government will give a one-time bonus to those who contribute to the new plan for more than 5 years without a break.
Employees must contribute at least 4% of qualifying earnings (between unstated bands).
Employers must contribute 2% of qualifying earnings.
There will be a standard tax break on the total contributions of 33% (equivalent to another 2% of qualifying earnings) but possibly paid to the scheme rather than reducing other tax.
Employers that sponsor Defined Contribution schemes with higher contributions, or that offer Defined Benefits, will not need to auto-enrol employees.
The state will deliver the saving options from providers chosen by ‘competitive tender’ so that members will choose from a “range of funds (including a low risk default option)”. Other taxpayers will probably be relieved to hear there will be no government guarantee on the returns.

The proposals with respect to tax subsidies on employees’ contributions to Tier 3 occupational schemes would slightly improve the current regressivity by allowing a flat rate of 33% rather than the current range from 20% to 41%. It is intended to extend tax relief at a single rate of 33% to all pension contributions. However, maintaining tax exemptions for employer contributions and tax exempt investment income will undo much of that improvement.

The government proposes ‘improving’ the regulation of private pension schemes. It will also simplify the way the Tier 1 pension is calculated so that it will be based on qualifying years of contributions (rather than average lifetime contributions paid) and offer new ‘credits for homemakers’.

PensionReforms has a number of issues with the recommendations. If the government is concerned about the future cost of pensions:

Increasing the State Pension Age will reduce costs (there was no real evidence-based support for this proposal other than a comment that “people are living longer and healthier lives”);
Levelling the tax breaks for private provision will increase costs for the lower paid members and reduce them for the higher paid;
The new auto-enrolment ‘supplementary pension plan’ will increase the cost of pensions because many more will be members of tax-subsidised schemes than now;
The shift from ‘final pay’ to ‘career-average’ pay-based benefits for its own new employees will probably reduce employees’ total remuneration and so cut costs.

PensionReforms suggests that the combination may, on balance, reduce pension costs to taxpayers but probably not by enough to satisfy the government’s concerns. Whether the new arrangements improve the Irish economy’s future capacity to support more pensioners is an entirely different matter. Fewer workers with more retirees means that the Irish economy must grow, perhaps by more than it has grown in recent years. The crucial significance of this received not a single mention in the report so there was no explanation as to how precisely the proposed pension framework will encourage Ireland to grow more. It may increase future retirement income (at the expense, it must be noted, of today’s incomes) but, unless the economy grows to support those higher future claims, the retirees’ increased incomes will come, presumably, at the expense of other groups in the economy.

The government thinks “there are several reasons people are not saving for retirement” but offers no evidence that they are in fact ‘under saving’ (a completely different issue); nor any that the proposals will fix that and that people won’t simply reduce other savings to compensate for the proposed ‘supplementary pension plan’. PensionReforms thinks that would be a rational response. There is also the likely reaction from employers that will probably stop existing more generous schemes in favour of using the national scheme. The new scheme will also significantly change the funds management industry, leading to aggregation in favour of the government’s ‘chosen few’. That probably won’t be an improvement and it’s not obvious why the government might want to encourage that.

PensionReforms notes that Ireland has one of the highest pensioner poverty rates in the developed world at 31% according to the OECD – see here and at 29% according to the EU here. Even the government’s own number (cited in the report) is that “consistent poverty for older people has fallen from 3.9 per cent to 1.4 per cent while the proportion of older people at risk of poverty has fallen from 27 per cent to just over 11 per cent” in the five years to 2009. Presumably, the government thinks that tripping citizens into the new ‘supplementary pension plan’ will eventually fix that. That may eventually be the case but PensionReforms wonders how that might help currently poor pensioners.

PensionReforms suggests that the report is light on detail and skips quickly over the mechanics of the new national savings scheme. How generous, for example, will an employer’s Defined Benefit scheme have to be before the employer is exempted the auto-enrolment arrangements? And why wouldn’t the employer then avoid offering membership of its own scheme? Employees who can’t afford the 4% for even two months might prefer that. Also, what about the self-employed? Presumably, they will be exempt and so their numbers will grow. This kind of crucial detail will seemingly emerge over the next four years during the implementation phase.

Clearly the Irish government has significant current fiscal constraints and the effect of the changes proposed in the report will be to push out the implementation of what will be more costly arrangements to taxpayers and employees in combination. However, PensionReforms thinks the Irish government should instead concentrate on the things it can change (like getting rid of acknowledged old-age poverty) and leave citizens and their employers to decide what else to do about retirement incomes – and there is no need to pay them to do that through tax incentives either.

If the Irish government is really worried about finding sufficient money to pay for the cost of a decent universal Tier 1 in the face of an ageing population, removing costly tax breaks given to “supplementary pensions” (about €2.9 billion or about 1.9% of GDP in 2006 according to the 2007 Green Paper) should do it. (File size 1.28 GB; 68 pp) 386