A simple solution to our pension problem

Sep 06, 2020
Originally posted on Business Post 6 September 2020.

One of the many unpleasant side-effects of the coronavirus pandemic is that it has pushed pre-existing problems which still need to be solved into the background.

Key issues in the February general election campaign have been dwarfed by the scale of the Covid-19 crisis. The pensions conundrum, specifically whether the retirement age should remain at 66, is a key example.

Last week, the government promoted the reduction in the standard rate of Vat from 23 per cent to 21 per cent. The cost to the exchequer will be some €450 million. Coincidentally, this is the same amount that it would cost to retain the retirement age at 66 rather than increase it to 67 next year.

In February, some politicians baulked at that kind of money being spent. Now, as can be seen from the August exchequer returns, €450 million is a relatively minor component of the cost of the national coronavirus response. Should we now also be spending this kind of money on managing future pensions provision?

The pensions challenge is fundamentally one of demographics. At present, broadly speaking, for every retiree there are five people in the workforce, earning and paying taxes to support their pensions and welfare. That proportion will drop over the coming years. Low birth rates in a shifting demographic prejudice our capacity to pay state pensions in the future.

State pensions are managed on a pay-as-you-go method, rather than out of an accumulated pension fund. The state pension is provided out of the social insurance fund which in turn is funded by PRSI contributions. It is topped up from general taxation from time to time whenever there is a shortfall. In 2018, more than 70 per cent of the social insurance fund went in pension payments.

The state contributory pension is particularly good value for the lower paid, because the benefits are not tied to how much PRSI has been paid in cash terms, but to how many times PRSI was paid over the working career. The state contributory old age pension is worth just over €1,000 a month irrespective of how much PRSI was paid in over the years.

This, of course, is only possible because of support from the exchequer. Over the last two decades, the state pension has increased substantially and is now a vital component of any retirement planning, as only about one in three workers in the private sector makes contributions to pension schemes.

There is currently a proposal to improve the level of private pension savings by introducing a process called auto-enrolment. The idea behind this is that all employees will be put into a contributing pension scheme whenever they start a new job with an opportunity to opt out, rather than relying on people’s prudence by opting in as is currently the case. Even for those who have opted in, and even allowing for the tax relief on pension contributions, private sector workers have a retirement savings mountain to climb.

As a rule of thumb, it costs about €30 of pension savings to buy €1 worth of an annuity on retirement in the current market. This means that a person who spent their career in the private sector literally has to retire as a millionaire to secure an annual private pension on retirement which could compare with the average wage. It is no longer obligatory to spend all of a pension pot on an annuity, but as we all are living longer, more money is needed to ensure a comfortable retirement.

Auto enrolment, if it is ever implemented, will be helpful for many people, but other techniques to help individuals provide for retirement are necessary. It is already possible for people to choose to make voluntary PRSI contributions to avail of contributory old age pension benefits. Perhaps we should now consider extending these choices. Rather than establish a whole new auto-enrolment system, there may be merit instead in offering enhanced state pension entitlements to workers who choose to make additional PRSI contributions over the course of their working lives.

The social insurance fund, which is already under threat from the current economic crisis, could use higher contributions now. There will be a payback for what in effect would be a different form of government borrowing, but that payback would go directly to the benefit of Irish workers in their future retirement.

Pandemics don’t come cheap. The costs of providing education, healthcare and senior care will remain higher than before the coronavirus happened, and long after a vaccine against this scourge has been delivered. A higher PRSI contribution option, rewarded by a better future state pension, would be a step in the painful process to which we must likely become accustomed in the future – paying more taxes.

There will be life after the pandemic. We need to look at ways to ensure that there is also life after retirement.

Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland.