On Wednesday, 13th September 2023, Social Justice Ireland presented at the Pensions Policy Research Group seminar on the Commission on Taxation and Welfare (COTW): approach and proposals for pensions (Chapter 8 of the COTW Report). This article reflects that presentation on alternative approaches.
While the COTW Report does quite a good job outlining some of the issues with private pensions and the tax regime that goes with them, it doesn’t go so far as critiquing Auto Enrolment plans.
Social Justice Ireland would suggest Auto Enrolment:
- Represents poor value for money.
- Is not the most efficient way to provide retirees with a socially acceptable standard of living.
- Has little to no financial benefit for the State in the short to medium term.
- Could result in financially vulnerable people missing out on qualifying for means-tested benefits in retirement;
- Can only reduce the "financial burden" of pensions on the State if the long-term plan is to reduce the value of the State Pension over time and force people to rely on their private savings.
Typical arguments in favour of Auto Enrolment
The argument in favour of Auto Enrolment revolves around the need to encourage people to save for their retirement, while the arguments most often cited as to why we would want try to incentivise pension savings usually revolve around two strands:
- To ensure a reasonable continuation in the standard of living of people once they retire, reducing people’s reliance on the State in retirement;
- The need to reduce the long-term financial burden on the State.
Maintaining Living Standards
Maintaining living standards in retirement sounds like a fine and noble policy idea. In 1998 the Pensions Board’s National Pensions Policy Initiative set a target that pensions from all sources, whether State or private, would replace half an individual's pre-retirement income. 50 per cent is an arbitrary enough target, and appears to be based on an assumption that an individual would have no accommodation costs.
How feasible is this?
A 2014 study by Micheál Collins and Gerry Hughes found if you used the median contribution to a private pension as an example, contributing to a pension plan for 40 years will provide a retirement income of about €5,200. Combined with the State Pension at the time, this gave a replacement rate in 2014 of 37.5 per cent for the median pension contributor. So the middle contributor should be expected to achieve about 3 quarters of that target of 50 per cent.
Is this shortfall a problem?
Excellent research by TILDA suggests that replacement rates were not associated with quality of life retirement. They found that it is actual income in retirement that most affects quality of life. This would suggest that policies aimed at achieving a certain level of replacement of pre-retirement income should not be given as much priority as policies aiming to achieve a minimum income floor for retirees.
And that minimum floor is something that the State Pension is best positioned to provide.
Given that the purpose of a country’s pension system is to allow older people to retire from work with dignity, it would make sense that the vast majority of resources within the system be allocated to:
- providing a flat-rate pension, universally available to everyone over the State Retirement Age,
- and maintaining that pension at a level to achieve a socially acceptable standard of living.
Reducing the Burden on the State
The other reason often cited as a need for Auto Enrolment is the need to reduce the financial burden on the State. It is also a regularly cited argument for using tax incentives to increase private pension savings. Usually on the basis of:
- The number of older people is increasing.
- The ratio of workers to pensioners is going to decrease significantly in the coming decades.
- As a result, the cost of paying the State Pension to those past the State Retirement Age will become unsustainable.
- Automatic Enrolment is part of the strategy for reducing this burden on the state and is the best way to ensure people save for their retirement.
But it’s not going to work that way
One of the features of the Irish State Pension is its connectivity to the labour market. Either you qualify for a State Pension in Ireland on the basis of your labour market history and social insurance history, usually over several decades, or you qualify based on a means test that shows that you don’t have the financial means to provide for yourself.
In theory, encouraging people to save for retirement will help reduce their reliance on the State and therefore the financial burden to the exchequer of paying these pensions will be reduced. However, saving for a pension at any kind of decent level is really expensive. As a rough rule of thumb, every €25 saved will buy a pension of about €1 a year for a man aged 66. And that’ll be a flat pension which will not increase, even though the cost of living will certainly increase over time.
People who can afford to save sufficient amounts of money over a long period of time to buy themselves a decent pension are almost always in the labour force for several decades, so are almost always the same people who will qualify for a full Contributory State Pension based on their PRSI history. They will also by then have received probably tens thousands of euros in tax relief, or Auto Enrolment top-ups, over many years.
This is purportedly with a view to saving the State money when they reach retirement, but it is unclear how that will save the State anything. The fact that people have saved a medium or large sized pension pot, and so can afford a decent annuity, will not reduce any cost to the State. On the contrary, these same people will now likely qualify for a full State Pension in addition to their private pension, assuming the qualification criteria for the State Pension does not change drastically in the meantime.
These individuals will be reasonably well off, and certainly much better off in retirement than had they not saved for a pension:
- they will have their State Pension (Contributory) – currently about €13,800 per annum – and
- whatever money they are receiving from their private pension, which was effectively subsidised by other taxpayers through the very generous system of tax relief.
But let's be clear this has saved the State nothing.
Means-tested state pensions
How about those who receive a means-tested pension; the Non-Contributory State Pension?
By definition, they have not qualified for the Contributory Pension because of insufficient PRSI payments, nor have they got the necessary financial means to achieve a decent standard of living in retirement. Given that they have insufficient PRSI contributions, it’s safe to assume that their connectivity to the labour market in their lives has not been strong. So they won’t have been in a position to avail of the current tax-based incentives or to join pension schemes as part of Auto Enrolment.
Again, there is no saving here for the State, as these people still need income in retirement.
There may be situations where they can contribute sporadically to auto enrolment schemes. But research would suggest that people with precarious links to the labour market tend to be in low paid employment, and so are prime candidates to opt out of pensions because they can’t afford them, while what little money they might be able to save may actually be counted against them when applying for a means-tested pension when they retire.
In that case, there would be a saving to the State, but it would be a very small one and may come at a cost to the living standards of some of Ireland's poorest.
Pension tax reliefs are inequitable
More than 70 per cent of the relief granted to pension contributions goes to the top 20 per cent of earners and that the cost of all pension-related tax reliefs and exemptions runs into the billions of euros every year. Auto Enrolment will see this increase this by hundreds of millions of euros each year - possibly as much as an extra €740 million, according to the COTW Report.
Social Justice Ireland has been pointing out for years that State incentives to save in private pension schemes are an expensive way to subsidise retirement savings for the better off in society, with little or no financial benefit to the State. Auto Enrolment may change the profile of who gets what, but it still won’t provide everyone in the state with a satisfactory income in retirement. So the arguments in favour of Automatic Enrolment do not stand up.
There is little to no fiscal benefit to the exchequer in either the short or the long term, unless the eventual aim is to slowly erode the value of the State Pension over time and force people to rely on their private pension savings - something that should be strongly opposed.
A better use of the resources would be to direct them towards funding a flat-rate universal pension payment from the State that would ensure that older people can retire with enough income to live life with dignity and without the prospect of poverty in their retirement.
Social Justice Ireland published a very substantial study of a universal pension in 2019, outlining a design for one that would achieve some of the most significant aims of any pension system. At the time of the report, we estimated that with a few reforms to the private pension tax relief structure, as well as an increase in Employer PRSI of 0.5%, and we know that there are plans for Employer PRSI to increase in the near future anyway, our proposals for the expansion of coverage to those not currently receiving a state pension would be achievable for a net positive on the state finances in the short term.
As the population continues to age, additional funding would be needed, but that is the case regardless of whether a universal pension is implemented or not. Demographic challenges require additional revenue streams to be found by government.
Using €740 million, which has been estimated as the eventual additional annual cost of the supports for Auto Enrolment, to further boost private pension savings is money that could be far better used expanding coverage to those who do not have any state coverage, including many carers and people who have fallen between the stools in the eligibility calculations, or have a level of state pension that is insufficient to cover the basics.