POLITICIANS cannot resist expediency. Urgent takes precedence over important. Years of demographic analysis, a Green Paper in 2007 and the launch of the National Pension Framework in March of last year set out our looming dilemma of unfunded pension obligations. By 2050 the ratio of workers to retirees will be 1.8: 1. Currently that ratio is 5.6: 1.
The cost of maintaining the elderly is set to increase from 5.5% to 15% of GDP in four decades.
A series of body blows have hit future pension provision. Charlie McCreevy’s best innovation was establishment of the National Pension Reserve Fund. It’s estimated the current actuarial cost of public sector pension liabilities is equivalent to €108bn. The Special Report on Public Service Pensions in 2009 highlighted that annualised pension payments would rise from €2.4bn currently to €14.7bn over 40 years. Extra life expectancy is the principal culprit. Respective likely lifetime for current retirees is 81 years for men and 84 years for women.
These costs are to be met out of current expenditure in annual budgets. We’ve bet more than €20bn of this kitty on bailing out banks. The cupboard is bare.
Simultaneously, investment values in private sector retirement funds have taken a bath. Ireland’s national fund managers’ performance places them at the bottom of the international OECD league since 2008. Over the decade funds have under-performed inflation. Over reliance on property and Irish equities, being the principal reasons for failure. Three-quarters of all private pension funds carry severe deficits.
Against this backdrop, tax concessions on pension contributions have become a political football. Wealthy individuals amassed mega pension pots with full marginal tax relief at 41%. Approved Retirement Funds (ARF) facilitated tax effective inheritance plans and minimised liabilities. The FF/Green Government proposed to reduce pension contribution tax relief to 20%, thereby removing the biggest single incentive towards providing for your own retirement. The ceiling on personal pension pots is to be reduced from €2.3m to €1m in the Programme for Government.
The pensions industry sought to avert reduction of tax relief by advocating an alternative levy of 0.5% on assets. They made a rod with which to beat themselves. FG and Labour couldn’t resist a four year levy of 0.6% on these assets to raise €470m per annum — total of €1.9bn by 2014. Together these circumstances mean our pension provision is encountering a perfect storm that undermines the entire rational for personal retirement provision.
The Irish Association of Pension Funds (IAPF) is taking legal advice. Areas of challenge relate to the levy being a retrospective claw back of previous tax relief. Terms and conditions of most Personal Retirement Savings Accounts (PRSAs) and annuity schemes require contributors to commit to long-term payment plans. This levy may breach a key taxation principle of being retrospective in effect. The other contention is contravention of individual property rights. The weakness in these arguments is the fact that from 1980 to 1988 a similar levy previously applied. Incidentally, the law prohibits trustees from extracting assets from funds, yet government is allowed to make a smash and grab raid.
Cumulative effect of the four-year levy has been estimated by IFG to an equivalent 21% loss on total funds over a 40 year performance period. This calculation brought the pension sector’s own fee structure into sharp focus. Their deductions extract between 0.3% to 1.5% in administration costs. Entry and redemption fees on PRSAs can amount to 5%. A research paper by Aidan Mahon of WIT estimates industry charges can absorb up to 26% of contributions over their lifetime. Smaller occupational pension schemes bear a disproportionate cost per pension. Understandably there have been calls for the industry to absorb the levy or reduce their cost base.
Winners and losers? Gold medal victors are public servants who are completely exempt from the levy, with no capital fund to attack. Their 7% pension levy has full marginal tax relief and costs 3.5% of salary. Public service pensions are worth a 20% salary increment over private sector peers. Average weekly pay in the public sector is €912 versus an equivalent €624 per week elsewhere. Biggest losers are employees in semi-state companies. Trustees in companies like Coillte, CIE and the ESB have been addressing enormous pension deficits. Benefit cuts and significantly increased contributions from employees and employers have been agreed.
One semi-state boss says the impact of the new levy will be to extract €8m per year from their retirement fund, while trustees have just obtained agreement for a 30% cut in pension entitlements, only yielding €5m in annual savings. For the 750,000 in a pension scheme the average annual cost will be €500 per year (x4 years = €2,000). Using the Government’s arithmetic, €78bn of assets are effected. Victims beneath the radar? 750,000 workers with zero pension provision. They comprise 46% of Irish adults in the workforce over 30 years who only anticipate the state’s old age pension. The final tipping points for private pension administration are new regulations of funding standards. Trustees must urgently reduce the time period to rectify deficits. Similar capital requirements will be needed for defined benefit pension schemes as currently apply for financing commercial insurance companies. This may lead to precipitous action by trustees to wind up defined benefit schemes as the targets are unattainable.
DUE to changing governments and conflicting agendas (eg prudential provisions, taxation policies, budgetary requirements etc) there is no joined up thinking for pensioners. We are going to have to work until we drop. Garret FitzGerald’s sad passing and the royal visit obscured publication of the Finance Bill last Friday. This stamp duty is to be enacted shortly with 0.3% to be paid immediately on market values on either May 19 or January 1 this year and each January thereafter. The Government could have obtained €500m to fund the jobs initiative out of €51bn of public expenditure savings. This initial fiscal tug of war between tax hikes and spending reductions represents a portent of this coalition being a high tax and spend administration.
Pensions industry alternatives such as a public infrastructure investment fund of €4bn or a once off capital contribution are non-runners. A VAT rebate could offset one-quarter of the levy. The real victims are Celtic Cubs, whose future is mortgaged with a national debt beyond €200bn. They’re enslaved paying for houses that may not recover purchase prices. Their pensions are eroded by poor returns, direct levies and less tax incentives. Pension policy reminds us of fishermen — seeking to catch fish to the point of diminishing breeding stocks. European regulations should provide centralised directives to prevent short-term pragmatism prevailing over rights of the next generation.
Finally, the Government should innovate personal pension architecture. Each citizen could be entitled to a diverse range within a singular personal plan, including the option of a nominated deposit account, exempt from DIRT, over their working lifetime. This would maximise individual investment discretion and reduce excessive administration charges.
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