Our politicians win on the double when they get their pensions

Giving out about the pay and perks of politicians is something of a national sport. But forget the drama about Bertie, Brian or Enda being paid more in annual salary than their French or British counterparts. This is small beer. The real issue is pensions.

The top-line figures are striking. Enda Kenny is to get an annual pension of an estimated €126,000 and an up-front lump sum of €378,000 when he retires as a TD. Huge annual contributions would be needed to get these kind of benefits from a defined-contribution (DC) scheme, the type now typical in the private sector.

It would require a pension pot of at least €4 million and arguably €5 million plus in a DC scheme to pay for the level of annual pension payment which the retiring Taoiseach will enjoy. Given the way tax is levied, building up this kind of pension pot in the private sector would be effectively impossible for all but the highest of high-rollers.

But the pension game also favours higher-paid politicians and public servants – and the dwindling number of private-sector employees on defined-benefit (DB) schemes – in another way. The tax regime – including changes introduced in the 2013 budget – mean the retiring taoiseach or minister or senior public servant, as well as getting a gold-plated payment, is getting a very generous overall tax deal. They are winning on the double.

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There are two overlapping issues here. One is the general pension regime in the public sector. It is something which must be considered as part of the pay talks now getting under way. Longer-established civil servants – in particular – still benefit from pensions linked to their final salary, as well as the big perk of generous retirement lump sums equivalent to 1.5 times salary, which for most will be tax free.

Sweet tax deal

But the benefits available to the lower- and middle-ranking public servants are modest, compared with their higher-level counterparts, including the political class. They get their generous annual pension and the big lump sum, too. But they also get a sweet tax deal, which puts them at a significant advantage to most in the private sector.

Pensions are complicated. And pension tax is even more complicated. But the bottom line is simple. Restrictions were put in place after 2005 to limit the build-up of big pension pots as a way of avoiding tax for high rollers. But the way the rules work is skewed hugely in favour of DB schemes – the kind common in the public sector. Reform is now coming, but only in a way which will very gradually reduce the gap between the different kinds of pension schemes over many years.

To clamp down on big pension pots, a restriction was introduced on the amount people could build up before becoming exposed to a big tax bill on retirement. This limit is now €2 million – and the tax take is penal enough on amounts above this level.

This is easy enough to calculate when someone has their own pension pot, typically built up for employees via a DC scheme. However, for retiring politicians, public servants and others on DB schemes, an assumption has to be made about the value of their pension pot. DB schemes operate by promising a certain amount of income on retirement. Individuals do not build up their own pots of money. Instead they build up entitlements. And so some way is needed to translate these entitlements into a notional “ pension pot” for tax purposes.

And this is where the rules are tilted in their favour. Broadly, the value of the pension pot is calculated at 20 times the value of the annual pension which the person will get, with the retirement lump sum then added in. The rules were changed so that a different regime applies for pension benefits accrued after 2014, but this is not going to make much of a different to anyone retiring now, as they will have built up the vast bulk of their entitlements in earlier years.

Pension pot

So for tax purposes, the Taoiseach’s “pension pot” from his time as Minister, TD and Taoiseach would be calculated as being about €2.9 million. The Taoiseach would be expected to pay tax on the amount of the lump sum over €200,000 and on the value of the pension pot over €2 million, though exactly how much depends on a range of factors.

However, here is the key point. To fund the level of annual pension payment which the Taoiseach will get would require an actual pension pot of at least €4 million and - depending on the assumptions made about annual increases and other factors possibly in excess of €5 million. On this kind of pot, a much higher level of tax would accrue – an up-front tax charge of €80,000 - €100,000 for a start, plus further income tax and PRSI as money is drawn down. Effectively saving this level of pension pot would be near impossible.

The bottom line is that retiring senior politicians and public servants not only have generous pension arrangements in terms of the cash they are entitled to, they also get very favourable tax treatment. No doubt this has “encouraged” many senior civil servants to retire in the last few years, as the government sought to cut numbers.

The inequity in in this pension tax issue was highlighted in a report done by consultants Merriman for the Department of Finance a few years ago, but the way chosen to deal with it was not the one they favoured. Instead officialdom decided on a glacial-pace closing of this tax advantage, which will protect those retiring for some years to come.

For most in the private sector, DB-type pensions have either been wound up or schemes are closed to new contributions. In the public sector, newer entrants are hit by less favourable rules. But the old guard is still cashing in – or, should I say, cashing out.