Irish Mail on Sunday, January 27, 2008
There are almost a million workers in Ireland facing retirement with nothing more to live on than their social welfare pensions. Should they be forced into pension schemes or simply encouraged to save? Thatâ€™s a question that has been exercising the mind of welfare minister, Martin Cullen in recent months. It was one of a range of issues, raised in a discussion paper on pensions published by the Government last year. They are currently the subject of ongoing consultations with the social partners and the pensions industry.
Mr Cullen has promised to unveil policy initiatives before the summer.
Itâ€™s time to do something. Our population is ageing and, while the recent influx of immigrants may have slowed the process, it is being forecast that by 2031 there will only be 3.3 workers for everyone over 65 compared to 5.6 now.
Itâ€™ possible to make an argument in favour of letting the problem sort itself out by adopting a pay-as-you-go approach and encouraging people to retire later, but it hasnâ€™t got much support up to this. The conventional wisdom is that we need to get more people to put more money aside for their retirement.
That has been official government policy for some time.
Employers are against any form of compulsion and, while he hasnâ€™t said so, thatâ€™s likely to be Mr Cullenâ€™s preference too. But the current turmoil on the worldâ€™s stock markets has greatly enhanced the case for compulsion. It has graphically illustrated the fact that investment values can go down as well as up thereby making voluntary saving much harder to encourage even with greater incentives.
Irish pension fund values fell by about 3% on average during 2007 and have fallen by a further 10% so far this year. Slightly differing figures are given by different analysis but those are about the orders of magnitude. Actually the performance is not as bad as it seems. You need to take a longer term view.
Pension fund values rose by about 13% in 2006 so, in short, fund values are back about where they were two years ago at the beginning of 2006. But values had jumped by over 20% during 2005 and by 10% during 2004. Even taking account of the current sharp down-turn, the average pension fund has achieved an annual growth rate of 6% plus over the past three years.
Itâ€™s not massive but it is a positive return. The fact is that pension fund investments have given good returns over the longer term. Put tax relief into the mix and the returns are brilliant. So good, indeed, that those many self-employed individuals who invested heavily in pension funds last October are still showing gains despite the sharp stock market downturn.
Assuming tax relief at 41%, every â‚¬100 invested only cost them â‚¬59. It will take a 41% drop in the value of the pension fund investment before they suffer a real loss. Those who only get tax relief at the standard rate of 20% are more vulnerable, of course. And thatâ€™s part of the problem.
Most of those million or so workers who are not in pension schemes are only paying tax at the standard rate. The tax relief on pension contributions is less attractive for them than for those able to claim at the top rate.
Martin Cullen may be able to do something about that. He has been pushing the notion of an SSIA-type incentive on the grounds that an easily understand top-up is more attractive than a less transparent tax-relief. But he would need to do more than to simply repackage the current tax relief.
Tax relief at 20% is equivalent to the one-for-four top-up that was paid on SSIAs but tax-relief at 41% is the same as a top-up of â‚¬1 for every â‚¬1.4 contributed. Take â‚¬100 through your pay packet and you end up with â‚¬59 after tax. Put it into a pension schemes and the full â‚¬100 goes in. The Exchequer has effectively topped up your â‚¬59 with another â‚¬41.
That incentive needs to be marketed better but making it more transparent would also highlight the inequity. It would be difficult for Mr Cullen to introduce an alternative top-up without removing the current bias in favour of the higher paid. And would it encourage more saving? Itâ€™s doubtful.
These incentives have existed for decades, as has the Governmentâ€™s desire to extend pension coverage. Yet little or no progress has been made. The truth is that no matter how well the carrot is repackaged or even improved, it will not be enough to encourage significant numbers of low paid workers to save for their retirement.
Thatâ€™s been evident for a long time but the facts are ignored. Some employers such as Tesco have had relatively low take-up of voluntary contributory pension schemes which offer very attractive top-ups for workers who opt to join. Not only does the worker get tax relief on his or her contributions but also benefits from a company top-up contribution.
What Mr Cullen and the employers have in mind, is nothing more than that type of plan. It may be packaged differently but it wouldnâ€™t be any more successful in encouraging people to save.
It has become very clear that the only way to extend pension coverage is by compulsion. The easiest, cheapest and most effective solution would be to simply extend PRSI. The collection system is in place and operated by all employers, while the existing National Pension Fund is an ideal investment vehicle. Thatâ€™s the approach that should be advocated by the trade unions but private sector pensions has never been one of their strong points.