A pensions solution for a disengaged population

Jun 01, 2018
Is auto-enrolment the answer to Ireland’s mounting private pension crisis?

Ireland’s private pension crisis is not new. In fact, it has been well documented as an issue for several years now. The reality is that almost 60% of private workers in Ireland have made no provision at all for their retirement. Instead, many will rely on the State pension in retirement and this currently stands at around €12,000 per annum. This is in or around the current minimum wage and for a lot of people, will mean living on the poverty line.

Why does the pension crisis keep raising its head from time to time? In the last few years, Ireland’s demographic has changed. With improved living standards and access to better healthcare, people are living longer. Today, there are just over five workers for every retiree in Ireland and by 2055, it is expected that this will decrease to just over two workers for each retiree. Less tax-paying workers combined with more retirees and low levels of retirement savings will put enormous pressure on the State’s pension system.

The response to the crisis thus far has been fairly routine and ordinary: experts tell us that we should put more aside for our retirement. People hear the message, but in many instances few choose to act.

Reasons for non-provision

According to a study by the Central Statistics Office (CSO) in 2015, 39% of respondents cited affordability as the top reason for not providing for their pension. The majority of these respondents were in low skilled and lower paid jobs. 22% said they just never got around to organising a pension and fewer than 5% cited a poor understanding of pensions as the reason for non-provision.

When workers hear the word pension, some think of it as an issue to address in the distant future when they are older. We do not tend to imagine ourselves becoming old and therefore, do not make a connection between the current day and the need for retirement planning.

The Government’s road-map

In response to the crisis, a Roadmap for Pensions Reform 2018-2023 was released by the Government in March of this year. This plan includes six strands of measures to help modernise the pension system in Ireland. Among the proposals is reform of the State pension and the report suggests moving towards a total contributions approach, a restructure of public sector pensions, and measures to support the sustainability of defined benefit schemes.

What stands out is the planned introduction of an auto-enrolment savings scheme. Not for the first time, the Government has stated its desire for employees without private pensions to be automatically enrolled in a workplace retirement scheme from 2022 onwards. Interestingly, Ireland is one of the only OECD countries without a mandatory earnings-related scheme to complement the State pension.

How does auto-enrolment work?

Auto-enrolment works by enrolling all employees into a pension scheme without compelling them to remain in it. Employees can opt out if they choose to do so. It differs to the compulsory system in Australia where enrolment is mandatory and there is no option to opt out.

Under the terms of the Government’s roadmap, a public consultation is expected to take place later this year but some details on how auto-enrolment could work were provided by the Government. The highlights are:
  • All employees over 23 years of age with an income of at least €20,000 will be automatically enrolled;
  • Anyone who earns a lower amount, or is self-employed, can opt in;
  • Workers who are already enrolled in a private pension scheme can also opt in;
  • Workers, employers and the State will make contributions to the scheme. The exact ratio of these contributions has not been confirmed but the proposals suggest that employers may be asked to match employee contributions on a euro for euro basis, with the State contributing on a 1:3 basis. For example, if a worker contributes 6%, the employer will match the contribution with 6% and the State will make a 2% contribution, bringing the total amount paid in to 14%. Any contributions made by the State will replace rather than augment the current tax relief provisions for pension contributions;
  • Retirement benefits accrued under the system will become payable when the recipient’s State pension becomes payable; and
  • Workers with pre-existing personal or occupational pension arrangements will be able to retain those arrangements.

Does auto-enrolment really work?

At the moment, starting a pension in Ireland requires an active decision to do so. The attraction of auto-enrolment is that if an employee does nothing, a portion of their pay will automatically go into a pension fund. Auto-enrolment also relies on behavioural inertia; the system trusts that some people will not get around to opting out of a pension scheme and will simply stay invested.

Evidence from the UK

The UK introduced auto-enrolment in October 2012 and the perception among many people there is that it has worked in terms of getting private workers to enrol in a pension. Figures from March this year showed that almost 10 million people have enrolled in pension schemes and over one million employers have undertaken their duties to facilitate and provide auto-enrolment. Around 80% of workers in the UK are therefore enrolled in some form of pension scheme, an increase from 55% prior to 2012, and auto-enrolment is cited as the main reason for this increase.

The UK system automatically enrols workers aged 22 years or over and earning more than £10,000 per year into a pension scheme. Employers, employees and the Government all contribute in the form of tax relief. Contributions started at a low threshold, with the employer and employee both contributing a minimum of 1%. From 6 April 2018, however, these rates increased to 2% for employers and 3% for employees and will increase again to 3% and 5% respectively from 6 April 2019.

The UK scheme was introduced on a staggered basis. The largest firms were engaged first, and they were followed by medium-sized companies with small firms engaged from 2018. To ensure that the new rules are adhered to, the UK introduced a workplace pension scheme called National Employment Savings Trust (NEST) while in the future, mandatory measures will be introduced to support auto-enrolment for employers who may not have a pension structure in place. Employers do not have to use NEST, however. They can choose to use an alternative pension scheme provided it complies with the rules for auto-enrolment.

At 8% on average, opt-out rates in the UK are lower than expected with automatic re-enrolment after three years for those who do opt-out.

In terms of administration for employers, the Pensions Regulator in the UK has said that over 80% of employers are supportive of auto-enrolment and find it easier to manage than they first anticipated. On average, it takes roughly one hour per month to administer the scheme. However, the administrative cost for employers in Ireland – who may not have had any such cost before – is an important consideration.

Making auto-enrolment a success

Auto-enrolment is seen by many as a success in the UK but if the scheme is to be successful in Ireland, solid commitment to the Government’s roadmap is needed. In the UK, the Turner Commission was established in 2002 to evaluate the pension landscape in the UK. One of the recommendations set out in a report published by the Commission in 2005 was auto-enrolment. While the UK government decided to adopt the proposals in the Turner report in 2006, it took a further six years for auto-enrolment to get up and running. The Irish Government’s roadmap gives a four-year timeline and a public consultation needs to take place in the meantime.

Chartered Accountants Ireland surveyed its members earlier this year on the subject of auto-enrolment and found that over 90% were in favour of such a scheme. To make auto-enrolment a success, people will need to buy into the idea of contributing to their pensions and understand the future benefits of doing so. Workers must be aware that they are enrolled in a pension. It may well be the case in Ireland that people feel distanced from their pension. Under auto-enrolment, the relationship isn’t between the pension provider and the worker; it is between the pension provider and the employer. In a sense, the employer works as an agent for the employee and the employee ends up having very little visibility over their own pension. One way to solve this conundrum and ensure that people stay enrolled could be to show pension contributions on payslips, or enable and encourage employees to look at their pension funds through an online portal.

Ireland is a nation of savers. During the recession and subsequent boom, many people saved. Perhaps some thought could be given to branding auto-enrolment as a form of saving for later in life, with consideration given to enabling access to small pots in advance of retirement age. In New Zealand, for example, the Kiwi Saver is quasi-form of auto-enrolment which applies to new workers only. The scheme allows early withdrawals if the saver is moving abroad, buying a first home or suffering financial hardship. In Ireland, one of the only ways for workers to access a pension ahead of retirement is ill health. For many of those suffering financial hardship and/or unable to afford a house, having money locked away in a pension fund that they are unable to use is a difficult pill to swallow. These people may look to save in a deposit account, invest in a property, or spend the money that would otherwise have been earmarked for a pension.

In the UK, one of the issues with auto-enrolment is where workers have more than one job. Combining the individual revenue streams may bring an individual into the auto-enrolment net but because they don’t individually meet the threshold, such employees fall between the cracks. In Ireland, there may be merit in considering a nil threshold entry level to combat this issue.

Managing expectations

The expectations of those who contribute the minimum amount to their pension scheme must be managed carefully to avoid disappointment on retirement. They may believe that they will have a large pension pot at retirement age when in reality, contributions of 2% to 4% aren’t going to result in a massive retirement fund at the end of the day – particularly when workers enrol for the first time in their late 30s and 40s.

Conclusion

The auto-enrolment concept has been around for a few years, but solid commitment to the Government’s roadmap is required to finally address the growing pension crisis among private sector workers. At the end of the day, very few people are likely to regret having a pension pot on retirement.

Cróna Brady is a Manager in Public Policy & Tax at Chartered Accountants Ireland.