Pensions Law Blog 27th October 2011
TIME TO GO DOWN UNDER?
Social Protection Minister Joan Burton’s speech yesterday to the Irish Association of Pension Funds finally cast some light on the Government’s pension strategy, which so far has been restricted to the introduction of the hugely unpopular pension levy.
In her speech, Minister Burton stated that:
- the minimum funding standard is to be reintroduced before the end of December 2011,
- sovereign annuities will be introduced,
- auto-enrolment will not be introduced before 2014,
- a cap on benefits may be introduced as an alternative to a reduction in tax relief, and
- an expert group will be set up to examine pensions going forward.
The return of the minimum funding standard, whilst long heralded, effectively signals the end of the line for many defined benefit schemes. In a credit-starved market, employers simply cannot commit to meeting the increased cost of funding a deficit that might run into hundreds of millions of euro in larger schemes, even if that period is extended to the early 2020s.
Therefore, unless they are obliged by the terms of a pension scheme’s trust deed to make up the deficit, employers are likely to exercise their right to wind the scheme up and walk away, replacing it with a standard defined contribution scheme or personal retirement savings accounts (PRSAs).
Where a scheme winds up in deficit, the big losers tend to be those members who have not yet reached retirement – whether still employed by that employer or not. Pensioners (other than their guaranteed increases) and member’s AVCs are ahead of them in the queue.
Whilst the introduction of sovereign annuities may redress this balance somewhat – the higher interest rates meaning a subsequent reduction in liabilities - the sting in the tail is that sovereign annuities are performance-related, meaning that pensions could be reduced in poor economic circumstances. Thus there is an additional burden on trustees to strike a balance between reducing liabilities (and thus improving a scheme’s deficit position) and risking the exposure of pensioners to lower benefits.
The Minister’s suggestion that benefits may be capped (perhaps to €60,000 per annum) as an alternative to a reduction in the current top-rate of tax relief (41%) will be welcomed by higher earners, who are much more likely to be contributing to pensions. However, it is hard to see how a further reduction in the maximum pension is likely to incentivise the 50% plus in the private sector who do not currently contribute to pension schemes to commence doing so.
The announcement that auto-enrolment will not commence prior to 2014 (indeed if it ever commences at all) and that a new expert group is to be formed suggests that many of the conclusions reached by the National Pensions Framework, published last year, are to be looked at again.
If the expert group is to achieve anything then two things must happen. Firstly, the group must be made up of representatives from all areas of the pension industry: consumers, actuaries, consultants, administrators and lawyers, as well as government and regulatory representatives. The recent cool reception from the public and the media to the Keane Report on mortgages (where the commission comprised only civil servants and two bank representatives) shows the danger of being remote from one’s target audience.
Secondly and most importantly of all, the group must be given the scope to consider and recommend all options in relation to pension reform. In this regard, serious consideration must be given to a mandatory pension system such as that used in Australia.
In the Australian system, the employee and the employer make mandatory contributions to a chosen superannuation fund. Contributions of the employer and investment return on all contributions are assessable to income tax at a concessionary rate, as are the benefits paid on retirement or death.
While not imperfect, the mandatory system results in a much greater engagement amongst savers with regard to their retirement. Another benefit is the €1 trillion in funds under management, which has been described as the “ballast” of the Australian economy[1], helping the country to emerge from the global financial crisis in a far better state than many other developed countries.
The system began through social partnership talks between the Australian Government and the trade unions. The PPF talks in Ireland afforded a similar opportunity here but the chance was missed repeatedly. The National Pensions Framework opted for an auto-enrolment system that would have seen members required to remain in a scheme for three months before being allowed to opt out – clearly in the hope that inertia/engagement would see people remain in the scheme.
However, the economic downturn means that employees are already reducing their contributions to defined contribution schemes and it is probable that many, if not the majority, of members of an auto-enrolment scheme would simply opt out when able to do so. The Government, by postponing the auto-enrolment scheme, seems to be indicating that they do not want to put hard-pressed employers to the expense of paying contributions in respect of an initiative that could ultimately prove fruitless.
The expert group should therefore seriously consider a mandatory pension scheme. If economic conditions mean that such a scheme cannot start before, say, 2014 then so be it. But our population is starting to age and the can cannot be kicked down the road much further.
Contact: James McConville, Partner
Pensions Law Blog 18th April 2011