Jerry Moriarty reviews the direction of Irish pension tax policy, the funding standard, sovereign annuities and wind-up plans
The end of 2012 finally brought some certainty to pensions policy in Ireland. While there is still a lot of detail to be worked through, the government has at least clarified the direction it will be taking on several policy issues.
The first of these is tax incentives. Ireland operates the exempt, exempt, taxed (EET) system, where contributions are tax-exempt (although they are no longer exempt from social insurance), investment returns are tax-exempt and pensions paid are taxed as income in retirement.
Tax relief on contributions is currently granted at an individual’s marginal rate of tax, and the total cost of tax incentives was estimated at €2.5bn in 2008. The government set out in 2010 to reduce this by €940m annually by 2014, and identified that a reduction in tax relief to an individual’s standard rate would achieve this.
However, the government did recognise that this change could have a significant long-term impact on pension provision and agreed to consult with key stakeholders on alternatives.
A change in government in early 2011 brought a new policy commitment to limit tax incentives to pensions up to €60,000 per annum. With two policy options on the table, there has been considerable uncertainty for the last two years as to what would happen.
Changes already made in the last two budgets, plus a general fall in pension savings, have resulted in savings for the government of €527m already.
The budget was delivered to parliament on 5 December 2012 and the minister for finance, Michael Noonan, announced that he would not be changing the marginal rate of tax relief but would introduce the €60,000 cap on pensions from 1 January 2014. “The government wishes to encourage as many citizens as possible to continue to invest in pension schemes,” he said.
While there are many implementation issues to be finalised this year, the government’s intentions are clear, which should help to restore confidence.
The minister also said that the levy on pension fund assets, introduced in 2011, will not be renewed when it ceases in 2014. The levy is 0.6% of assets and in 2012 amounted to €477m. By the time the levy does cease in 2014 about €2bn will have been paid from pension assets. The effect of the levy has been a straight deduction from defined contribution (DC) funds and, in an increasing number of cases, a reduction in defined benefits (DB), including reductions to pensions in payment. So, while the levy has caused and will continue to cause problems, the fact that the government has confirmed it will end in two years is welcome.
The minister also announced that people who have additional voluntary contributions will be allowed to withdraw up to 30% of their fund subject to tax at their marginal rate. This initiative had been suggested mainly to assist people who might be struggling with debt but have significant pension assets that they could not access until retirement. Again the details of how this will work in practice are not available and it will be interesting to see what the take-up is.
The other main area of focus in 2012 was the funding standard for DB schemes. The requirement for schemes that do not meet the funding standard to submit funding proposals to the regulator, the Pensions Board, had effectively been on hold. This was due to the impact of the financial crisis on both schemes and sponsors.
The funding standard in Ireland assumes a scheme is winding up and buying out its liabilities, and is therefore relatively stringent. In June, the Pensions Board announced that the requirements were being reinstated and published new guidelines. Funding proposals were required to be submitted, for most schemes, by 31 December 2012. This date was extended to June 2013.
Among the new requirements was the ability to use sovereign annuities to satisfy requirements to provide benefits. A sovereign annuity is a particular annuity product backed by EU sovereign bonds but which allows the annuity provider to cease or reduce the annuity in the event of a default or restructure on those bonds.
Existing Irish annuities are mostly backed by German Bunds and the contraction in Bund yields has greatly increased the cost of annuities and DB liabilities. Sovereign annuities, which at present seem likely to be backed by Irish sovereign bonds, have the potential to provide annuities at a lower cost, which can reduce a scheme’s liabilities. However, they are more risky, so it remains to be seen how trustees will use them. The continuing fall in Irish bond yields also reduces the benefit that can be gained.
Risk sharing in DB schemes has also been under scrutiny. When a DB scheme winds up, the priority order in the Pensions Act determines how the assets are distributed.
The first benefits that must be secured are those of pensioners, which must be secured by annuity purchase. Only the current level of pension has to be secured, which means future increases can be excluded. Following this, the benefits of active and deferred members can be secured on a transfer value basis. Any remaining assets can then be used to provide for future increases for pensioners.
As 70-80% of schemes are failing to meet the funding standard, this means many active and deferred members would not receive their full entitlement on wind up and, in extreme cases, might not receive any benefits.
The minister for social protection, Joan Burton, has recently confirmed that the government intends to change the priority order to ensure a fairer distribution of assets in such a situation. It is likely that pensioners will have a core level of benefit secured as an initial priority. This would help address the situation where very large pensions receive full protection but someone about to retire could lose everything.
The government also asked the OECD to examine the Irish pension system with a view to making recommendations for the long-term future. Their report is due in the first quarter of 2013.
Burton has made it known that she expects auto-enrolment to form a key element of the long-term solution. While this would be difficult to implement in the current economic circumstances Ireland is facing, it would only take a few years to put the infrastructure in place to deliver this and it may be that the economic environment is more favourable in the future.
Jerry Moriarty is CEO of the Irish Association of Pension Funds