IRELAND - Green paper proposals to reduce or eliminate tax incentives for pensions and divert the money into a higher state pension are "fundamentally unsound", according to the Irish actuarial consultancy Life Strategies.

Analysis by the firm, commissioned by the Irish Association of Pension Funds (IAPF), claimed the estimates of savings made from reducing or abolishing tax incentives put forward in the government's Green Paper on Pensions - which closed to consultation on May 31 2008 - were in some cases "overstated".

Life Strategies pointed out while it broadly agreed there would be €1.9bn in savings by abolishing tax relief on pension contributions, it said the estimate of €1.2bn resulting from imposing tax on pension fund investment earnings was "overstated" and claimed its calculations using more "realistic" assumptions is more than €300m lower.

In addition, the report argued diverting the full cost of existing pension tax relief towards pillar one pensions provision would make the Irish system a Taxed, Taxed, Exempt (TTE) model, instead of the existing Exempt, Exempt, Taxed (EET) model - which is advocated by the EU Commission as the "most desirable" system.

The analysis also highlighted a "fundamental flaw" in the plan to divert the saved money towards a higher state pension, as it claimed the proposals should be examined in terms of long-term sustainability and not just the current year cost.

It warned that an increase to the state pension may be cost neutral in the current year but would give rise to a substantial increase in costs as the demographics of the Irish population change.

The report stated the cost of the state pension is projected to increase considerably by 2050 - from approximately 3% of GNP to 10% - even before any changes in the actual level of the state pension are considered.

In comparison, Life Strategies research suggested the net cost to the Irish Exchequer of supporting the supplementary pension system through tax relief would remain stable at "close to its current level".

The report stated spending an additional €2bn on state pensions in the current year - based on the assumption this is a reasonable estimate of the savings from abolishing tax relief - would increase the level of the state pension from the existing 34% of average earnings to 50% at no additional current year cost.

However, the analysis pointed out projections show although this strategy is cost-neutral in the current year, it would "result in a substantial worsening of the overall budgetary position as the population ages" with an additional cost of 2% of GNP by 2050, "thus exacerbating the sustainability issues" already identified in the green paper.

Michael Culligan, director at Life Strategies, said: "Analysis in this area has been overly simplistic to date and the suggestion that reduced tax relief on pensions contributions could fund a higher State pension does not stand up to proper economic scrutiny once you look beyond year one."

Patrick Burke, chairman of the IAPF, also commented: "It should not be forgotten that the so-called cost of tax relief is really tax deferred rather than tax foregone and any serious analysis must quantify this point, taking into consideration Irish demographics."
In addition, the study analysed the 'net effective rate' of tax relief on pension contributions compared to the 'headline rate', and suggested for high earners the net effective rate of relief is lower than the headline rate, reflecting the fact that tax will be paid on the pension in retirement.

"We find the current system gives the highest benefit to those earning just above the average industrial wage and that the benefit falls as one moves up the earnings scale and/or as one increases the level of pension contributions. This is a little remarked but desirable feature of the current system," added Culligan.
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