By Niall O’Callaghan – Partner and Head of DC, Mercer Ireland
Sunday Business Post, 19 October 2014
After a challenging decade, 2014 seems set to be a good year for pensions. Overall asset performance has been strong. There has also been stability in fiscal policy and regulation. Furthermore, this week’s Budget brought the belated but very welcome announcement from Minister Noonan of the abolition of the pension levy after 2015.
Taking a step back and looking at the wider macroeconomic picture, however, it is clear that we are not yet out of the woods. National debt is still over €200bn, and 2015 expenditure is expected to exceed income by €6.5bn. This, coupled with demographic trends, calls into question the sustainability of the state pension. Despite recent steps to manage costs by increasing the State Pension Age to 66 from 2014 (with further increases up to age 68 by 2028), it is likely that the cost of sustaining the current system will remain a significant challenge.
Mercer, the Irish Association of Pension Funds (IAPF), the Irish Association of Investment Managers, PublicPolicy.ie and the Irish Brokers Association recently facilitated Ireland’s inaugural participation in the Melbourne Mercer Global Pension Index (MMGPI). The MMGPI is a major comparative study of more than 25 countries’ retirement systems. The study will be launched at the IAPF Annual Benefits Conference on Wednesday. The findings in relation to the sustainability of the Irish State pension system should provide a meaningful basis for policy direction in this critical area.
By 2050, there are expected to be just two workers for every person in retirement compared with five workers per pensioner today. The OECD Review of the Irish Pension System strongly recommends increasing private pension provision to address this future gap.
Despite tax benefits, private pension coverage in Ireland has always remained well under 50%. Defined benefit (DB) plans, that seek to provide lifetime pensions linked to pay and service, were once the norm. In recent years they have been replaced by defined contribution (DC) plans that offer a more flexible personal retirement savings approach. DC is now the predominant pension system in the private sector for newer employees and, increasingly, for some or all of the retirement provision of their longer-serving colleagues.
Thankfully, the majority of DB plans have now returned to some level of financial stability, with over 50% now meeting the Minimum Funding Standard. DB plans do, however, remain under considerable pressure. The flip side of the strong performance in bond markets, the unprecedented collapse of bond yields, has caused an upsurge in the valuation of DB pension liabilities. DB plans must focus on effective management of the risks they face to ensure sustainability.
While future private sector pension provision will mainly be about DC arrangements, these also face significant challenges, primarily due to their complexity. Depending on the type of DC plan and when it was set up, there are varying rules around tax treatment and the form of benefits that can be taken. As such, layers of legacy issues cause confusion and undermine peoples’ engagement with these plans.
For instance, there is a less favourable tax treatment of Personal Retirement Savings Accounts (PRSAs), intended as the “consumer friendly” pension solution when they were introduced 12 years ago. Whereas employer contributions to a PRSA incur the Universal Social Charge (USC), those to an occupational pension plan are exempt. An employee earning €50,000 pa whose employer contributes 5% of salary will face a €175 USC tax if this contribution is made to a PRSA rather than to an occupational pension scheme. Budget 2015’s increase in the USC rate to 8% for those earning over €70,044 will compound this inequality. Other examples of areas in need of reform abound across the DC system. Unless these are addressed it seems certain that a legacy of complication and confusion will continue to limit public engagement with DC pension saving.
Responding to the OECD’s recommendation for an increase in pension coverage levels, Minister Burton announced that a roadmap for a comprehensive occupational pension scheme would be launched in 2014/2015. This is to be called MySaver and will be available for those without pension provision. MySaver is likely to be an auto-enrolment or soft mandatory system that will automatically include employees without pension coverage unless they opt out.
If it is to succeed in improving coverage and addressing pensions adequacy, it is crucial that the system is both simple to understand and transparent for members. Lessons should also be learned from the UK, where contribution rules in their auto-enrolment system have generally been regarded as overly complex.
Even more importantly, MySaver should not simply be layered on top of the existing system. There are currently nine different types of DC arrangements, all with their own requirements. This complexity increases costs, reduces understanding and acts as a barrier to individuals saving for retirement. PRSAs, which were originally intended to address coverage and adequacy, were simply thrown into the mix of existing arrangements and have not achieved what was intended.
There is now an opportunity for the government to reform the pension rules and put in place a world-class auto-enrolment system. An understanding that members will always need guidance on the options available to them reflecting their personal circumstances must be central to any reforms. Auto-enrolment is not a panacea and cannot substitute for enabling savers to make more informed decisions. The UK has recognised that a critical ‘advice gap’ exists in its most recent pension reforms and now mandates that independent financial advice be made available to all members approaching retirement. This should be a prominent feature of our own reformed DC system.
In summary, after a difficult decade the pension system is in a better place. However, the challenge of improving coverage, adequacy and sustainability remains. The abolition of the pension levy is a very welcome first step in reform. Now we need to work on simplifying the system. Only then should an auto-enrolment system be introduced allowing everyone to save for their future with confidence.