Ireland: Comparative easing
The government’s 2013 budget appears to have taken on board pensions industry concerns over tax relief on pension contributions and the pensions levy, writes Christine Senior
The Irish pensions industry breathed a sigh of relief with the announcement of the budget for 2013. Its worst fears were not realised on the loss of tax relief on pensions, and there is even some cause for optimism. There are two reasons for this – the threat of withdrawal of tax relief on pension contributions at the marginal rate has been lifted, and the hated pensions levy on assets will definitely disappear in 2014.
The introduction of a cap on pensions tax relief of €60,000 was widely predicted. In the wake of Ireland’s bailout in 2010, it was evident that this would face a cut. The original suggestion of limiting tax relief to the standard rate would have had a punitive effect on saving for pensions, all the more painful in a country where the higher tax rate of 41% kicks in on salaries of around €33,000, affecting a large swathe of middle income earners.
The government elected in 2011 was known to be sympathetic to the €60,000 cap, an alternative suggested by the pensions industry. The Irish Association of Pension Funds (IAPF) had calculated that the cap would affect around 27,000 pension savers, compared with 555,000 who would have suffered had the marginal rate relief been abolished.
Jerry Moriarty, CEO of the IAPF, says: “If the government was going to make changes we felt that this was the right change to make. It has the least amount of impact on the system as a whole. I don’t think people can argue that €60,000 isn’t an unreasonable amount of money to have in retirement. It’s what the government will incentivise you to have in retirement; if you want to have more outside that you can go off and do it yourself.”
It came as something of a surprise that the change will not take effect until 2014, but that allows some time to sort out the implementation issues, particularly how to bring the impact on both defined benefit (DB) and defined contribution (DC) schemes into line. Tax relief is currently limited by a lifetime cap of €2.3m on the capital value of all pension savings. For DC schemes it is applied to the total value of the fund, while for DB schemes the calculation is more complicated. It involves multiplying the value of the pension by 20 and adding the value of any lump sum paid on retirement. With no lump sum, that equates to a pension of €115,000 per annum.
But some claim that using this multiplier of 20 would be unfair on DC scheme members. Multiplying €60,000 by 20 would give a fund of €1.2m, but at current annuity rates that would fall far short of the amount needed to fund a pension of €60,000 with indexation and a spouse’s pension.
Michael Madden, a partner in the retirement business at Mercer in Dublin, says a multiplier of 25 or 30 might be fairer, but might not suit the government. “If they use a factor of 30 it would give a €1.8m fund value to buy a pension of €60,000 per annum. That is not far from the current €2.3m limit. Perhaps it wouldn’t represent enough of a saving as far as the government is concerned in tax relievable pension funds.”
ESB group pensions manager, Marie Collins, highlights another implementation issue – ensuring fairness between the public and private sector.
“Members of certain legacy state schemes would have no access to a state pension, but a private-sector worker would have a state pension of €12,000 plus a cap of €60,000,” she notes. “That will have to be looked at to ensure there is fairness across the board. I think negotiations will be challenging but nothing will be insurmountable.”
Confirmation of the end of the pensions levy of 0.6% of accumulated assets in 2014 was particularly welcome. Although it had been imposed for only four years when first introduced, there was some scepticism that a cash-strapped government might be tempted to extend it.
Madden had not expected it to continue. “People seem to accept the government increasing income tax more readily than if they dip into your capital,” he says. “I think the government was surprised at the backlash they got from the ordinary man on the street against the pension levy.”
Collins, though, is a strong believer that the levy should end now, and not in 2014. “Given the perilous state of pension funds I think the levy should be stopped immediately,” she argues. “It’s a significant drain on funds that are under water. It was a raid. I understand why the government did it – they need money and it was one of the easiest ways for them to get money. But people’s confidence has collapsed in relation to saving for retirement. We can’t have it both ways in society. We are trying to encourage people to save but at any particular time the state can come in and impose a super levy and change the rules.”
The news that pension savers would be given limited access to their additional voluntary contributions (AVC) savings came as a surprise. The government had previously seemed immune to lobbying for such a move. With the country in such dire economic straits, temporary access to these pension savings seems to offer some respite to many people weighed down by debt. People will be permitted to take out up to one third of their AVC savings for a limited period of three years, but will have to repay the tax relief already granted.
Frank O’Dwyer, chief executive of the Irish Association of Investment Managers, thinks that allowing access could be useful in encouraging people to save for retirement. “The change seems equitable and sensible,” he says.
“It’s difficult enough to incentivise people to provide for retirement. There is a credible argument that says it enhances the environment for encouraging people to save if they can actually withdraw some of their retirement pot in times of financial stress.”
But some fear banks might put pressure on people struggling with debt. Eoin Fahy, chief economist at asset manager Kleinwort Benson, says: “We have a huge negative-equity problem here, and there is a worry that if people owe money to banks the banks will say ‘now you can take 30% out of your AVC fund and pay off your debt’. There is some concern around that.”
In the longer term, auto-enrolment is expected sooner or later in Ireland. Pensions coverage is only around 50%, with a target to raise it to at least 70%. But it is widely acknowledged that the time is not right. Any new burden on hard-pressed employers in the form of contributions to employees’ pension funds would cause an outcry. Employees, too, would balk at a further drain on income.
When auto-enrolment is back on the agenda, it is likely that tax relief will be replaced by equivalent sums being deposited in employees’ pension accounts, with the contribution from the state equal to a 33% tax – a figure between standard and marginal rate of tax – giving an enhanced incentive to save to basic-rate tax payers. The proposals will be implemented “when financial conditions permit”, according to the government.
Philip Shier, senior actuary at Aon Hewitt, says: “There’s no expectation that financial conditions will permit auto-enrolment any time soon. Employers certainly would be unhappy with any proposal to require them to make extra contributions, particularly employers in sectors where traditionally there hasn’t been pensions coverage. Business is having very difficult times and anything perceived to hamper growth or perceived to be a tax on employment is not going to be at all popular. I think we are probably looking four or five years out before auto-enrolment happens, and any associated tax changes.”