Reviewing the national review
The National Pensions Review was published by government on mid last month. The main reason why the government requested the Pensions Board to carry out this review was to recommend ways to achieve its stated target of having at least 70% of those in the workplace age 30 and over in some type of private pension scheme to supplement the state pension. As important a target is the level of retirement income that people will be provided with. Pension from the state provides an income of 34% of average industrial wage. This leaves quite a gap to be filled if people wish to maintain their standard of living after retirement.
Another reason for the review was to consider how to sustain social welfare pensions. Ireland is facing the challenge of an ageing population and improved longevity.
Also, some action has previously been taken by setting up the National Pensions Reserve Fund in 2001. The objective of this fund is to meet some of the cost of social welfare pensions and pension of public service employees from the year 2025. Previously a pure pay as you go system operated. The annual contribution from the state to the fund is 1% of GNP. The fund is invested on a commercial basis.
The review shows a significant increase in the expected cost of social welfare pensions, from 3% of GNP currently, to 10.1% of GNP in 2056. Currently 4.3 people are at work per person over age 65. This ratio is expected to reduce to 1.4 by 2056.
There are many possible solutions to this issue, some more difficult than others and none of them easy. Although the government does not wish to increase the state retirement age currently, a recommendation of the review that we believe is likely to be implemented is the option to defer receiving state pension beyond age 65. The specific proposal is to increase state pension by one third if deferred from age 65 to age 70. With the trend of people living longer, healthy lives, the wider availability of more flexible working arrangements, and the desire of many employers to retain experienced people, we expect that this option could have broad appeal.
A mandatory pension system was considered as part of the National Pensions Review and the minister responsible for pensions has expressed keen interest in this topic. This could take the form of compulsory savings from employees and compulsory contributions from employers. This concept received much press attention last year, including a very negative response from employers, who would regard it as another tax on employment.
We believe it would also be unpopular with the general public who would regard it as an extra tax on income. A mandatory system would be particularly unpopular with young, lower paid people who experience many demands on their earnings, including high property prices and high child care costs. We believe that the options of simplifying the pension system and making pensions more attractive should first be exhausted before mandatory pension are implemented.
The minister has mentioned the possibility of what he calls a “soft” mandatory system. This could include a provision whereby employees are automatically included in a pension scheme (where one exists) unless they opt out.
The minister stated that he requires further analysis of options in relation to mandatory pensions. We expect that it will be impossible to achieve consensus on this issue and don’t expect to see mandatory pensions implemented in the short-term.
A key challenge in achieving the aim of increasing pension coverage is to make pensions simpler. One recommendation of the review is e1 for e1 matching of pension contributions. This would operate by the state paying e1 to a person’s pension fund for each e1 the person contributes. We believe this is an innovative way of making pensions more appealing to younger people and to the lower paid. Our firm had recommended this change in its submission to the Pensions Board.
This recommendation draws from the experience of the national savings scheme implemented in 2001. This was designed to encourage a savings culture. The state paid 25 cents for every e1 paid over a period of five years. The maximum monthly contribution permitted from any individual was e254. This savings scheme had huge appeal and will mature in 2006 and 2007. The Pensions Board clearly believes that lessons can be learned from this experience in setting pensions policy. We believe that the key attraction of this scheme was its simplicity and it relatively short term of five years.
We believe that matching will have greater appeal than the current system of tax relief. The proposed new system is not only more transparent but is also very generous. Currently, tax relief of 44% for a top rate tax payer equates to a 78 cents top up per e1 paid in, so even top rate tax payers would benefit significantly under the proposal. The proposal would be beneficial to the lower rate and nil rate tax payers, who currently have little or no incentive to save for retirement. Tax relief of 26% for a lower rate tax payer equates to a 35 cent top up per e1 paid in.
However, we are disappointed that the recommendation of e1 for e1 matching applies only for PRSAs. PRSAs are a relatively new type of product introduced by the Pensions Board in order to increase pension coverage by providing a simple vehicle for pension savings. PRSAs have not been as successful as the Pensions Board hoped. If e1 for e1 matching is introduced, we Mercer recommends that it is introduced for all types of pension schemes, instead of favouring just Peronal Saving Retirement Accounts (PSRA)s. Otherwise, there could be a move away from occupational pension schemes to PSRAs, for no good reason other than an anomaly in legislation.
A related proposal is to give higher rate tax relief on pension contributions to everybody regardless of their marginal rate of income tax and to all types of pension schemes. We believe that this could be a forerunner to the type of matching system suggested. It would give a valuable incentive to the lower paid and those not in employment to save for retirement, the very group most in need of pension provision.
The pensions board also recommends giving people the option of cashing in up to 30% of their pension fund before age 45. This withdrawal would be tax-free and would reduce the tax-free lump sum that could be drawn at retirement. We welcome this proposal and expect it would have wide appeal. The very long-term nature of pension savings is a key deterrent to younger people and a key reason why other forms of saving are often preferred, despite the generous tax relief on pension contributions. Again, we are concerned that the Pensions Board makes this recommendation for PSRAs only and see no reason why the same option should not be available to members of occupational pension schemes.
There is wide recognition by government that we must take action to address the low take up of pensions. There is also recognition that we have the luxury of time due to a young population and must take advantage of that by planning now for the future. The National Pensions Review recommendations pave the way for a pension system that could provide a model for Europe. Sustaining momentum by policy makers and engaging in thorough analysis and costing to ensure a robust system for the long-term will be crucial for success.
Joyce Brennan is a senior consultant and actuary with Mercer in Dublin