ANALYSIS:The Government is moving on pensions – but is it going far enough?
THE GERMAN chancellor Otto Von Bismarck is credited with the introduction of pensions in 1889. However, it is less widely known that Germany initially set the retirement age at 70 and did not lower it to 65 until 1916 by which time Bismarck was long dead.
Yesterday, Mary Hanafin reminded us that Ireland introduced the Old Age Pension 100 years ago – at a time when life expectancy was 50, and you got your pension at 70.
The pension reforms now proposed will no doubt be controversial but the first question that arises is do they go far enough, given that the current life expectancy for men is 76 and women 81? The Government proposes to push out the retirement age to 68 – they could have gone for 70 at least.
They also missed an opportunity to link the retirement age to life expectancy as Finland, France, Germany and Portugal have done.
It has long since been clear that something had to be done about pensions given our ageing society. Back in 2000, Charlie McCreevy set up the National Pensions Reserve Fund to fund a quarter of State pension liabilities after 2025. However, we were fairly laid back as the Celtic Tiger was still prowling and we believed we had a window of opportunity of about 20 years given that our population was younger than most.
The crisis has effectively removed our comparative advantage so needs must even if the circumstances are anything but opportune.
Now, a soft mandatory scheme is proposed from 2014 with the ability to opt out. Experience elsewhere shows that this is likely to lead to a big increase in coverage – the old 70 per cent target will likely be exceeded.
This will be controversial with both employers and the pensions industry. Employers will face extra costs of between 1 and 1.75 per cent of the wage bill for a good portion of those 50 per cent of employees who do not now have cover.
Some employers, particularly those making large contributions, may be tempted to close down existing schemes and move to the new one which is likely to be less expensive. This could be the biggest problem with the proposed framework – as yet we do not know enough about it to judge just how big a threat this may be.
The pensions industry is also likely to be unhappy. The new contributions will be collected via the PRSI system – hopefully by then integrated into income tax – and farmed out to private sector fund managers on terms that may be less attractive than they are used to. Many will immediately think of the PRSAs which failed because of their cumbersome fee structure.
Then there is the question of the viability of the whole thing. Frankly, the assumptions used regarding investment returns and so on look optimistic. The examples given show illustrative pensions (combined with social welfare) ranging from 75 per cent to 22 per cent on a range of salaries from €20,000 to €100,000 but the reality may be less and the risk lies with the contributor, not the employer or the Government.
The tax proposals mirror those in the renewed programme for Government, viz, an SSIA-type approach with effective 33 per cent relief instead of relief at the marginal rates as at present. This makes pensioning less attractive for higher earners who lose out while those on the standard rate gain. It’s a case of getting the maximum bang for your buck – the total tax relief, €3 billion, remains unchanged. It is also worth noting that 80 per cent of the over-65s pay income tax at the standard rate. Minister for Finance Brian Lenihan would not be drawn on when these new tax arrangements would become effective though it will be after 2011. The Government has decided to accept the Commission on Taxation proposal that the first €200,000 of any lump sum will remain tax free. This will come as a relief to many who are nearing retirement age.
There is little on what to do about existing occupational schemes in deficit as, in reality, there is not much that Government can do to help them. The somewhat tentative proposal here is a model which would effectively turn them into a hybrid of defined-benefit and defined-contribution schemes albeit with some clawbacks. In effect, this recognises what is happening anyway.
The public sector pension reform already signalled in the budget will be implemented in 2010. This involves later retirement and career-average pension but much has still to be decided including whether public pensions will be linked to the CPI instead of earnings. On budget day, the Minister told us that this alone would lower the cost of public sector pensions by €21 billion. Sometimes you wish they would just get on with it.
Pat McArdle is Irish Timeseconomic analyst