Spotlight

Prepare for a new era in workplace pensions

Oct 01, 2018
The consultation on the automatic enrolment retirement savings system has begun, but what does the Government’s strawman proposal recommend?

BY JOE CREEGAN

The long-awaited strawman on automatic enrolment (AE) to retirement savings has been launched, two decades after it was first mooted.

The background to its introduction is stark; recent statistics issued by the Central Statistics Office suggest that as little as one-third of employees outside the public sector have no pension coverage. This statistic ignores the potentially bigger issue around the adequacy of contributions being made, something I will come back to later.

Worryingly, this statistic has worsened since 2008 when 54% of all employees were contributing to a personal pension or a pension plan sponsored by the employer. This figure includes public servants and the most recent corresponding figure is down to 47%. Ironically, AE in not new to Ireland as, in the past, it was not unusual for employers to make it compulsory for new employees to join the company’s pension scheme. This was more typical in the world of defined benefit schemes, where benefits are calculated with reference to final salary. However, the public sector aside, defined benefit schemes have mostly been replaced by defined contribution schemes.

In such schemes, the benefits are determined by the contributions made and the investment return achieved. With the move to defined contribution schemes, the joining of the pension scheme has also become voluntary. During the recession, many employees faced with pay cuts and increased income tax chose – unsurprisingly – to sacrifice future income needs to protect current income. As a result, we now have a cohort of workers that have lost a decade during which they should have being saving for retirement. When you examine the detail in the proposed strawman, this cohort will unfortunately have to wait another decade before it gets close to making adequate contributions towards retirement.

The detail

Looking more closely at the detail of the consultation document issued on 22 August 2018, the proposal is to commence contributions in 2022 with an initial contribution of 1% from the employer and 1% from the employee and a contribution from the government of 0.33% in lieu of tax relief. This would be payable on gross annual earnings to a maximum of €75,000, which gives an effective tax break of 25% to all taxpayers. It remains to be seen how contributions in excess of €4,500 (6% of €75,000) will be treated for tax purposes and, indeed, how existing pension arrangements will operate going forward – many of which currently attract income tax relief at the marginal rate. Over time, contributions will be required to increase to 6% from the employer, 6% from the employee and 2% from the government in 2027. This would be close to an appropriate contribution level for an adequate income in retirement.

The concept of increasing the contribution over five years is a sensible one and is similar to the ‘Save More Tomorrow’ concept in the US where employees divert salary increases each year towards pension funding. Over the last 10 years, this concept would not have worked in Ireland. Indeed, any attempt over the last 10 years to introduce AE might have been interpreted by hard-pressed taxpayers as just another tax, not unlike USC.

On that note, the messaging around AE will be crucial. The public will need to understand that the appropriate level of contribution is the 14% arising in 2027 and that the initial contribution is simply a mechanism to phase in a more appropriate level of contribution. The fact that the Government proposes to appoint up to four external providers will counter any suggestion that this is “just another tax”.

Another point of debate will be the capping of charges at 0.5% of assets under management on the assumption that the automatic enrolling of employees will reduce distribution costs. While the proposed ‘central processing authority’ will introduce cost efficiencies, it is important to ensure that employees have access to appropriate advice on their investment decisions and the adequacy of contributions being made.

In relation to investment returns, this will continue to be the most important decision for employees – especially in light of the fact that these returns will continue to grow tax-free. In fact, over time and with the right investment strategy, this tax break will provide a greater benefit from the Exchequer than the 0.33% (increasing to 2%) of salary. As Figure 1 demonstrates, the investment returns far outweigh the cumulative contributions made over time.

figure-1-pensions

Communication and engagement

It is important to recognise that AE is not the same as compulsion and many employees may opt out at every opportunity. Engagement with the pension scheme therefore becomes even more important if scheme members are to truly appreciate the benefits of long-term savings. Specifically, we need:

  • To ensure that members are contributing at the right level as early as possible in order to maximise the contributions made and, more importantly, the investment return on these contributions. There is nothing to stop people starting contributions now, and indeed at a higher rate than proposed under AE;
  • To ensure that members make the right investment decisions. For example, a low-risk approach might not be appropriate for someone with a long time horizon to retirement; and
  • To help members understand the conversion from savings to retirement. This is particularly important where, after retirement, members retain responsibility for investment decision-making under approved retirement funds rather than purchasing an annuity with the retirement fund.
It is therefore important that communication and engagement with scheme members, at the very least, addresses these three elements sufficiently. Furthermore, the introduction of AE will bring a younger cohort into retirement funding and we will need to reconsider how we communicate with this group, perhaps with better use of technology, to build trust and highlight the importance of long-term thinking.

The AE consultation process will run until 4 November 2018 and while the initiative is positive, there will be many issues to be resolved before the system can be rolled out in 2022. In the meantime, and before AE becomes mandatory, we all need to do more to encourage our employees to join the company pension scheme and get the immediate benefit of the employer contribution and tax relief. For those employers without a sponsored pension scheme, why wait to be forced to introduce a scheme in 2022?

Joe Creegan is Head of Corporate Life and Pensions at Zurich Life.