Pension Tension (by Gerry Hassett, Irish Life)

There’s only three certainties in life – death, taxes, and the Pensions time bomb!

We all know about death and taxes so let’s focus on the pensions time-bomb. There are some things about this we know to be absolutely certain;

1. Ireland may be a young country today, but its getting older. There’s 6 of us working for every 1 in retirement today, but by 2050 that ratio will shrink to 2 to 1
2. We’re also living longer. If you’re lucky enough to be alive at age 65, my actuarial colleagues tell me you’re likely to live for a further 16 to 20 years
3. The state pension is a valuable benefit, but for most people it’s not enough to live on. Someone earning €60,000 a year can expect a drop in income in retirement of up to 80% if they rely solely on the state pension. And with the pressure on public finances, it’s inevitable that the State pension will erode in real terms, as indeed the age at which it is received has already been extended.

Clearly, these three factors combine to create a major funding challenge for Ireland Inc. into the future. However, proper long-term planning in our public policy can make this challenge manageable. That’s if we start planning today, and encouraging people to plan for themselves to reduce the burden on the state has to be part of the solution.

Planning for the time-bomb

Quite properly, the Government today is obsessed with the €15bn fiscal adjustment that’s required between now and 2014. However, there’s a real risk that in solving today’s problem we create an even bigger one for the future.

Many of us believe that the seeds of Ireland’s demise were actually sown long before the crash in the prime years of the Celtic Tiger, around 2000 and 2001, when we began to spend money we simply didn’t have.

I genuinely believe we are making the same mistakes today in the area of pensions. Every single policy measure of recent years has been negative, and it’s created a crisis of confidence in pensions. Recent Irish Life customer research indicates that almost one quarter of our customers are considering either reducing or suspending payments in the next 12 months, which also bears out our experience of the past 12 motnhs.

What an appalling vista it would be, if the youth of Ireland who inherited negative equity from the generation before them, were themselves condemned to poverty in retirement.

In the excesses of the Celtic Tiger we had people borrowing money they couldn’t afford to invest in dreams that could never be realised.

Pension customers are different and should be supported. Even in the teeth of recession they are prepared to put something aside today so they can enjoy their retirement and not become a burden on the state.

Supporting middle Ireland

For the workers of middle Ireland – 85% of our customers earn less than €70,000 – retirement planning is a noble cause. I believe it is in society’s interest to support these people today in their honest endeavour and their hopes and dreams for the future.

Unfortunately, these middle income workers don’t feel valued today. In a recent Irish Life survey, 70% of middle income workers said they did not believe that the Government was actively trying to encourage people to save for their retirement.

The current Programme for Government sets an objective of rebuilding a broken society. In its introduction it quotes Albert Einstein

‘Learn from yesterday, live for today, and hope for tomorrow’

That’s why I’m calling on Government today to give clarity to the workers of middle Ireland that it will continue to support them in planning for their retirement and allow them to hope for their futures.

Paying our share

Of course, the reality is that every section of society has to make a contribution in a time of national crisis. I fully accept that. The plain fact is that the pensions community is being asked to fund about €1bn of the total €15bn fiscal adjustment. That’s a significant adjustment in anyone’s language.

We’ve signed up for this and we’re working with Government to see how we can deliver. However, in addition to this €1bn annual saving, we then had the recent Pensions Levy from which a further €1.8bn contribution is expected over next four years.

The Pensions levy has had such a devastating impact, not just because of the €1.8bn reduction of all our pension funds, but because it has undermined any remaining confidence in retirement planning. Pensions generally – public and private – are long term contracts of trust and it’s incredibly difficult to repair such a breach of trust. It’s the latest in a long line of negative signals that being sensible today is not valued by the state.

Now, I’ve heard many commentators suggest that the Levy was actually originally suggested by the industry, and I’m glad to set the record straight here. The idea of a levy has been around for over 20 years. For example, the Pensions Board is currently funded via a similar levy. It is true that some in the industry, suggested a lower % levy as an alternative to a change in tax relief.

However, the Government has introduced the Levy – not as an alternative as was suggested but as an additional measure with no commitment to retain tax relief at the marginal rate. Effectively, it’s a ‘double whammy’ and completely at odds with what was originally intended.

But that’s history and we need to deal with today.

The simple fact is this. The chronic lack of confidence in future incentives for retirement planning is contributing to a record level of workers stopping paying into their pensions. In turn, this is generating surplus flows to the exchequer over and above those projected in the €15bn National Recovery Plan.

A recent analysis carried out by Milliman Actuarial Consultants has indicated that even if the Government did nothing else in the area of Pensions, it would achieve over 90% of the savings required in 2011 and 2012 in relation to the €940m goal. And that’s before we even consider the levy.

It’s a very significant conclusion so I’ll repeat it – even if the Government introduces no new pension initiatives in the budget it will achieve over 90% of the savings required for 2011 and 2012.

Now, whilst this is good news for the exchequer in the short-term, it’s bad news for us all in the longer term. The Government is relying on workers stopping their pensions and thus increasing tax revenues. That’s going to store up even bigger problems for the Exchequer in the future.

Reducing pension tax relief is a bad idea

The recent National Pension Framework recommends reducing pension tax relief to a hybrid rate of 33%. I believe that would be a retrograde step. I think it would be very difficult for most financial planners to recommend to their customers to lock money away for 20 or 30 years at say 33% relief, when they could be taxed at 41% (or more) in retirement.

There are simply more attractive short-term savings options available and professional advisers would be bound to recommend them. This would not be in the long-term interests of the State and would inevitably impose an increasing burden on the first pillar which is the state pension.

Yes, tax relief at the marginal rate is an attractive incentive, but you need an attractive incentive if you are expected to put your money way for 20 or 30 years. We need to be honest here, when discussing tax relief too many commentators think about Michael Fingleton’s €27m pension pot, rather than the 85% of pension customers who earn €70,000 p.a. or less. These days the marginal tax rate kicks in at €32,800 so reducing tax relief will undoubtedly hit the middle income worker.

So, I would urge the Government to give a commitment to retaining relief at the marginal rate for middle-income workers.

I also agree that we need to do more for lower paid workers and women who have less opportunity to build a pension pot given the more stop / start nature of their working career. We need to be innovative here, and I think some of the ideas contained in the National Pensions Framework can provide the solution.

Equity in pensions

We need to ensure that the scarce reliefs are widely available, and not the domain of the few. The State cannot continue to support wealth management type incentives in the current climate and the various measures of recent budgets have quite rightly closed off these loop-holes. However, it’s vital that middle-income workers continue to be given every incentive to plan for their retirement.

We need equity between defined contribution members and defined benefit members. Now, I meet pension trustees every week and I am very sympathetic to the concerns of defined benefit schemes. The recent decision by the trustees of the Tara Mines scheme to cut benefits in retirement by 10% is a devastating blow to the workers involved and is perhaps only a pre-cursor of things to come, particularly once Trustees come to grips with the down-stream impact of the recent Levy.

However, the simple fact is that most defined contribution schemes are equally under-funded. The under-performance of various markets over the past decade and continued low interest rates have left most defined contribution holders significantly under-funded. Most of the public debate centres on defined benefit, but I believe that the needs of defined contribution workers also needs to be addressed.

The other area of equity is between the private sector and the public sector.

Now as we know, public sector pensions are funded on a ‘pay as you go’ basis. This represents its very own ‘pensions time-bomb’. A recent review by the Department of Finance indicated that pensions in payment to public servants has grown by around 70% since 2006 from €1.4bn to €2.4bn.
Pensions in payment now represent 16% of the entire public sector wage bill, and there are now 2.5 active public servants for every one in retirement. Within a couple of decades, there’s likely to be more public servants in retirement than working, and serious reform is required here if another fiscal black-hole is to be avoided.

The average retirement income to public servants is €22,500 (not including the social welfare pension). This equates to a fund of approximately €700,000 which is about five times more than the average fund of €150,000 for the private sector worker in a defined contribution scheme.

Now, the Programme for Government proposes a maximum limit of €60,000 p.a. on any public sector pension. And if we are going to have equity between the public and private sectors, then I’m assuming the Government is also proposing a €60,000 limit for the private sector.

However, where pension practitioners do have a problem here is around the basis in which this income is converted into a notional lump sum for defined contribution workers. The current factor of 20 times is nowhere near the market rate. Most of us in this room would love to provide an income in retirement using such a factor, but it’s simply not possible.

A recent independent study conducted for PIBA concluded that for a public servant retiring at age 60, the relevant factor is between 30 to 40 times. That indicates that the current maximum fund threshold of €2.3m may be not far off the mark as to what’s required.

We’re passionate about pensions in Irish Life. For generations, we’ve helped over 1 million middle-income
workers plan for a peaceful retirement.

It greatly saddens me that confidence in the future of retirement planning is so low right now. I think it’s in the interests of every one in society that we build collective hope in our shared future. That’s why its vital the Government commits to support middle Ireland to plan for their retirement.

You see, the fundamentals of retirement planning have changed. It’s no longer about what age we can retire at, it’s more than ever about what income we can afford to retire at.

The pensions time bomb | The Irish Life Blog: discusses the pension crisis on Morning Ireland