Poor publicity about pension schemes and the investment complexities involved mean that few people are saving enough to fund a decent retirement
This article was first published in the May 2017 Ireland edition of Accounting and Business magazine.
Ireland’s ageing population and a financially unsustainable pension system highlight an urgent need for the country to undertake pensions reform.
People today can expect to live longer than previous generations. The Central Statistics Office projects that by 2046, life expectancy will be 85.1 years for men and 88.5 for women, and that there will be just two people of working age for every pensioner (compared to five for every pensioner in 2011).
Already, state pensions (encompassing both the contributory pension and the means-tested pension) account for 35% of total social welfare expenditure in the country. Over €7bn will be spent on pensions this year, and the numbers in receipt of state pensions are increasing by around 17,000 annually, which amounts to around an extra €1bn every five years.
A 2013 review of the Irish pensions system by the Organisation for Economic Co-operation and Development (OECD) recommended the expansion of private pensions coverage and suggested various options to do this. Four years on, though, less than half (47%) of Irish workers have a private pension, while the proportion of workers who expect the state pension to be their main source of income rose from 26% in the fourth quarter of 2009 to 36% in the same period of 2015.
Private pension coverage is lowest among the youngest workers. This is worrying because younger people may be less likely than previous generations to become home owners, and the state pension will not provide adequate income for individuals who are still paying rent in retirement.
Coverage is also low among the self-employed (30%). PwC’s Munro O’Dwyer says: ‘The self-employed category is interesting. First, the ability of the self-employed to make pension contributions is quite restricted versus an employed person due to limits on the percentages that can be contributed and the salary that can be used to determine the contributions. Second, many self-employed contributions to pension arrangements tend to be through single-premium contributions year on year, and the charges that apply can often lack clarity.’
Just over a quarter of self-employed people say they have no intention of ever retiring.
Affordability, complexity, poor communication, concerns about performance and fees, the closing of defined benefit pension schemes and the impact of the pensions levy are among the factors cited as contributing to low public confidence in pensions.
‘There does need to be a change in the general public’s understanding of and perception pensions,’ says O’Dwyer. ‘Pensions timebomb, rip-off pension charges, pensions black hole – these are the soundbites that have made the headlines. The reality is that pension arrangements for many people offer a low-cost, highly tax-effective means to save for the long term. Positive and well-structured pension planning can create significant savings to support people through into their retirement. All that said, though, the headlines exist because of poor practice by some in the industry, and this will continue to undermine public confidence.’
The Universal Retirement Savings Group, established in 2015 and chaired by the Department of Social Protection, has been examining options for a new supplementary pensions model. ‘All the evidence indicates that introducing a new system will involve numerous policy, legislative, administrative and technical changes,’ Leo Varadkar, minister for social protection, told a Pensions Authority conference in March.
The new system, which is likely to be a mandatory auto-enrolment defined contribution system, would be phased in, with the first new members potentially being enrolled four years from now if consensus can be achieved.
However, not everyone thinks that auto-enrolment is a good idea. The Small Firms Association, for example, says that credible alternatives are available and should be pursued. Linda Barry, the association’s assistant director, says: ‘These include encouraging supplementary voluntary pension provision, providing an adequate state pension, reviewing public service pensions, and increasing the numbers at work in Ireland. In the context of Brexit and the changing global economy, there is a need for a relentless focus on competitiveness in Irish businesses. This is not the time for government to be piling additional costs onto businesses, such as pension auto-enrolment.’
Others say that the pace of change is too slow. ‘After three years of talking, the planned auto-enrolment pension solution is moving too slowly,’ said Jim Foley, chairman of the Irish Association of Pension Funds (IAPF), at the association’s annual dinner in February. ‘If defined benefit is the past and defined contribution is the present, then I believe auto-enrolment is the future. We firmly believe that, if executed correctly, it will clearly address the coverage issue. However, if there is not a “decent contribution”, then the adequacy problem will not be solved. In fact, auto-enrolment without a decent contribution may well be worse than not having a pension at all, as it may give members a false sense of security in having a pension, when, in fact, the proceeds will not sustain them in retirement.’
As a step towards delivering a universal retirement savings system, the Pensions Authority wants to reform and simplify the existing private pensions landscape, including rationalising the number of schemes (currently more than 160,000). It says that the administration, governance, communication and oversight of pension schemes need improvement, that the investment choices offered to defined contribution scheme members are in many cases too complex, and that default strategies are not always appropriate. It is also worried about the risk management of investments in defined benefit schemes.
In a consultation document published last July, the Pensions Authority outlined its proposals for higher standards for trustees of occupational schemes, an authorisation process for new occupational schemes, closer supervision of pension scheme management, better information for members including more transparent information about charges, and rationalisation of the number of pensions savings vehicles – for example, through greater use of master trusts.
Whether the proposals ultimately benefit pension scheme members will depend on how they are implemented, says O’Dwyer. ‘The Pensions Authority consultation process has the ambition of improving outcomes and increasing public confidence and understanding,’ he explains. ‘There is also a broad theme around the simplification of pension savings vehicles. These objectives are to be welcomed. However, similar objectives were attached to the introduction of personal retirement savings accounts [PRSAs] in 2002, and the legislative and regulatory rules surrounding PRSAs arguably achieved the opposite aim. If PRSAs are the future vehicle, then there is limited potential for member outcomes to be improved unless there is significant reform of the PRSA system.
‘More widely, there are themes emerging around the professionalism of trustees and the introduction of master trusts. There is the potential for these developments to be positive for pension savers, but this does depend on how any changes are implemented.’
The consultation closed in October and the feedback has been sent to the Department of Social Protection.
Meanwhile, defined benefit pension schemes remain in the spotlight. The number of active schemes fell from just over 1,200 at the end of 2006 to under 500 last year, while the number of active members fell from 270,000 to 126,000. Members of many surviving schemes have seen their benefits reduced while employers have had to increase their contributions.
Late last year, defined benefit schemes made headlines when proposals by Independent News & Media to stop contributing to its company pension scheme angered workers and attracted political interest. Three separate private members’ bills aimed at protecting workers where defined benefit schemes are being wound up have since been introduced in the Dáil and a government bill is expected shortly.
The Pensions (Amendment) (No 2) Bill, introduced by Fianna Fáil and currently at committee stage, would make it illegal for a solvent company to wind up a pension scheme without the consent of the Pensions Authority. A government bill aimed at strengthening the powers of the Pensions Authority and preventing solvent employers from ceasing contributions to their schemes ‘without lengthy minimum notice periods and engagement with stakeholders’ was set to be published in April. If enacted, the Social Welfare and Pensions Bill will require employers to provide information regularly to trustees to allow them to plan for the future viability of schemes.
Separately, the continuing increase in the valuation of the liabilities of defined benefit pension schemes as a result of being tied to historically low interest rates is a big issue for pension scheme trustees, according to the IAPF. The Pensions Authority has been asked to develop proposals to address difficulties in the operation of the funding standard, including examining how pension liabilities are valued, the strength of the employer covenant, and extended funding periods.
‘The defined benefit pension regime does need to be overhauled,’ O’Dwyer says. ‘The regime is designed to protect member benefits, but it is having the opposite effect now, as it is creating a pressure to compress funding plans over an excessively short period, which is undermining employer support for the funding of defined benefit arrangements. Debt on the employer [making the employer financially responsible for any deficit in its company pension scheme], if properly implemented, would address this issue and would lead to more appropriate funding arrangements which would help employers, while also delivering increased member security.’
Public sector pensions are also under a spotlight at present with Paschal Donohoe, minister for public expenditure and reform, indicating that the cost and value of these pensions will be a ‘critical component’ of the work of the Public Sector Pay Commission. The state’s total accrued liability for public service occupational pensions is currently estimated at €98bn (unchanged since December 2012).
Other pension-related changes under consideration at present include reform of the state pension, abolition of a compulsory retirement age, and the IORP II directive, which applies to institutions for occupational retirement provision.
The qualifying age for the contributory and non-contributory state pensions (currently 66 years) will rise to 67 from 2021 and 68 from 2028, and there are plans to replace the ‘averaging rule’ used to calculate entitlement to contributory pensions with a ‘total contributions approach’. There are also plans to allow individuals to defer their state pension while recent changes to the pay-related social insurance (PRSI) system will make it easier for people to make voluntary contributions.
Groups representing older people welcomed the Employment Equality (Abolition of Mandatory Retirement Age) Bill 2016, introduced by Sinn Féin last year and currently before the select committee on justice and equality. O’Dwyer, however, warns businesses to consider the potential impact of this legislation on their workforce. ‘Employers need to ensure that their pension arrangements support their long-term business objectives,’ he says. ‘For example, businesses need to consider whether their staff will be in a financial position to exit the workforce, and the potential knock-on impact on the promotional prospects for younger employees.’
Also on the agenda this year is the transposition of the IORP II directive into Irish law. The directive aims to improve the way pension funds are governed, make it easier for them to conduct cross-border business, and provide clear information to pension scheme members and beneficiaries.
While there is no shortage of plans, proposals and bills, past experience shows that pensions reform progresses slowly.
O’Dwyer says: ‘Given the long-term nature of pension savings, there should be a political consensus around the future direction for pensions – state pensions, public sector and private sector pensions. What we see at the moment is the political system having a significant impact on the pension reform agenda, including creating an inertia around any change. The five-year electoral cycle will always be a challenge to proper long-term pension planning and pension reform.’
Daisy Downes, journalist
"The reality is that pension arrangements for many people offer a low-cost, highly tax-effective means to save for the long term"