Ireland: Short private pensions reprieve
Stephen Lalor and Amanda James on radical changes to public and private sector pensions
This was the most feared Budget for decades. The economic crisis allowed for no alternative to some draconian fiscal measures. Dire warnings were rife about the possible axing of tax advantages of occupational pensions.
In fact, 9 December 2009 came and went without private pension plans being touched.
True, the Budget did make significant reductions to public employees' pay and to social welfare benefits, the main cuts being:
No reduction for retired public employees; Plans to break the link between pensions and public employees' pay increases; Reduction in social welfare disability, unemployment and other benefits of approximately 4% across the board; Social welfare pensions not reduced (this time at least).
This produces overall reductions in salaries ranging from 5% to just under 8% for employees earning up to €125,000. Salaries above this level will be adjusted in line with the recommendations of the Review Body on Higher Remuneration in the Public Sector. This will mean reductions of 8% on salaries of up to €165,000, 12% on salaries of up to €200,000, 15% on salaries of €200,000 or more and 20% in the case of the Taoiseach.
A later amendment mitigated these cuts for some of the most senior civil servants by taking account of the loss of bonuses (which had happened earlier in the year), meaning that for this echelon most of the reduction will not affect pension entitlements:
While the Budget had its almost inevitable impact on public service pensions, and pay, other changes that had been widely expected were not included. The main issues of concern were:
In addition, specific changes to public sector pensions have been included in the 2010 Budget and pension benefits for all new public servants will be based on career-average earnings rather than a final salary. The minimum retirement age will increase to 66 and will be linked to any future increase in the state retirement age.
However, the finance minister warned that the favourable tax treatment of pensions was to be revisited soon. He mentioned two specific areas:
Reduction of tax relief on contributions. At present individuals get tax relief on their contributions to approved pension plans, up to certain age-related limits. The effect of the tax relief depends on the individual's marginal tax rate, with higher-paid people paying the top rate of income tax (41%) getting a proportionately higher tax saving than the lower paid who are on the standard rate (20%). Pension contributions also reduce a person's liability to Pay Related Social Insurance (PRSI).
The Revised Programme for Government agreed between the coalition partners in October contained a commitment to introduce a single rate of tax relief, 33%, on pension contributions. Such a change would benefit people on the lower tax rate but would be to the disadvantage of those who can now get relief at their marginal rate of 41%. There is a point at which contributing to a pension would be uneconomical, when the tax benefit would be 33% of the contributions but the tax take on the resulting pension would be 41%.
Taxation of retirement lump sums. Under the current tax regime an employee can receive a lump sum of up to one and a half times annual remuneration on retirement free of tax. For self-employed pensions and Personal Retirement Savings Accounts (PRSAs) the tax-free amount is one quarter of the value of the available fund.
The Commission on Taxation has recommended that the tax-free element should be limited to €200,000, with any excess over this amount being subject to income tax at the standard rate (currently 20%).
National Pensions Framework
The minister said that these measures would be considered in the context of the National Pensions Framework to be published shortly by the Department of Social and Family Affairs. The Framework is likely to be quite different from the previous Green Paper on pensions published by the government in 2007.
Other aspects of private pensions likely to come within the Framework debate are suggestions made in the 2009 Report of the Commission on Taxation, which include the following:
Limit on maximum fund. In 2005 a lifetime limit to the value of an individual's pension fund was introduced. This started at €5m, with a surtax to apply to any excess. Because the limit was indexed the threshold is now a little above €5.4m. The Commission recommends that the limit be reviewed downwards (in line with the reduction in maximum salary for contribution purposes last year) and the most likely new figure would seem to be €3m.
No consideration is given in the report to what would happen to people who had already exceeded €3m in fund value. We would speculate that their current fund value, at the cut-off date, would be deemed to be their personal fund threshold, with surtax to apply only in excess of this amount, which was what happened with people above the original fund limit in 2005.
Replacing tax relief on contributions with government matching contributions. As an alternative to tax relief, an individual's contribution would attract a matching contribution by the government. The government would contribute €1 for every €1.60 contributed by an individual to a self-employed or company pension plan, or to a PRSA. This is equivalent to tax relief of 38.4% to all contributors, regardless of level of earnings or tax band.
As an incentive to those who have so far made no private pension provision, it is proposed that for the first five years the government match would be on a one-for-one basis. It is not clear what form it will take. The Commission might have envisaged the payment of actual money into people's retirement accounts. However, with the government now badly strapped for cash, there may be the temptation to implement the new regime and to provide the matching contribution by way of gilts or other debt instrument.
The Commission also recommends that the current age-related limits on pension contributions should continue, although it is not clear if this limit would apply to the individual's contributions only, or to the combined contribution and government match.
SSIA accounts. In 2001 the government launched a Special Savings Incentive Account (SSIA), which involved a subsidy paid into a savings account, provided the individual maintained monthly contributions for a five-year period. This proved highly popular, and the Commission recommends a similar type of incentive for retirement savings. The details, as sketched in the report, would be a €1 government contribution for every €2 saved in the retirement account, up to a maximum individual contribution of €2,200 per annum, or a €1,100 government subsidy.
Funds would be locked away for retirement, but could be drawn down early in special circumstances (serious illness, purchase of principal residence), although the government contribution would be forfeited.
The incentive would not be available to members of defined benefit pension plans.
There would be a range of investment options, with explanations as to the risk characteristics of each, and a suitable default fund.
Soft mandatory pensions. Under this proposal, employers would be obliged to enrol employees in a pension plan or a PRSA. The employee would have the right to opt out subsequently, but it is hoped that many will remain, once they are already enrolled. The minimum level of employer and/employee contribution is left to the government to consider. This, of course, is the crux of any pension system, and having automatic enrolment is meaningful only if a realistic minimum is set.
The Commission also leaves it to the government to consider how such soft-mandatory pensions would be invested.
Extension of Approved Retirement Fund options. An Approved Retirement Fund (ARF) is a means by which a person may draw down or continue to invest funds after retirement and avoid having to purchase an annuity at the point of retirement. The Commission recommends that the ARF option be extended on the same terms to all defined contribution assets, thus freeing up a lot of DC funds that would otherwise be destined only for annuity purchase.
Timing. While the minister for finance said that the National Pensions Framework was due to be published "shortly", the minister for social and family affairs has said that it will take a "few months". It is to be hoped that the framework will lead to a debate among the concerned parties, so there should be time for careful consideration of all the consequences of the potential changes. The minister for social and family affairs also said that there would be a lead-in time for reforms of up to four years.
On the other hand, fiscal changes, such as taxation of all or part of retirement lumps sums or a reduction in the maximum pension fund could be achieved at the stroke of a pen, so we may not get the same lead-in time for these measures.
Private pension plans have had a reprieve in terms of their tax treatment, but this might prove short-lived if the proposed changes to tax relief and lump sums on retirement are implemented quickly. In an environment where the state should be encouraging private pension provision, it would be counter-productive to reduce the incentives for saving. We would hope that the government will take these considerations into account when looking at possible reforms.
Amanda James is legal adviser, employee benefits and investments division, and Stephen Lalor is consultant at Willis in Dublin