The Minister for Finance took many by surprise when he announced plans in his last Budget to increase the pensions options open to the self-employed.

Mr McCreevy took another significant step on pensions yesterday with the announcement that the State would set aside funds to deal with its pension costs in the future.

"I have long argued for a major sea-change in the attitude both of individuals and the State to pension planning," Mr McCreevy said yesterday.

"I did something regarding individuals and personal pensions in the last budget. I am now doing it for the State."

Under the proposals, some 1 per cent of GNP will be put aside annually to help meet pension liabilities in the future while most of the proceeds from the Telecom Eireann flotation will bolster the fund.

The State spends roughly £2.5 billion (€3.18 billion) a year to pay for public service pensions, State pensions and other pensions such as those paid to widows and invalids. These are unfunded - they are not provided for in advance but paid for on a continuing basis out of the money the State takes in from taxes.

But as the demographic profile of the State changes - and the population gets older - there will be fewer and fewer working taxpayers to foot the pensions bill for a growing number of those who qualify.

In addition, because the civil service expanded rapidly throughout the 1970s, the numbers of public service pensioners are set to rise appreciably in the next two decades. Finally, the need for health services increases as the proportion of older people in the population rises - all of which means higher costs for the State.

A report on budget strategy and ageing, drawn up for Government, points out that the cost to the Exchequer of broadly maintaining the current level of pension and health service provision will rise by about 1 per cent of GNP over the next decade. It will exceed 5 per cent of GNP by 2030 and will cost the Exchequer 7 per cent of GNP more than in 1999 by 2056.

Even putting aside the planned amount will only meet around one-third of the extra costs in the decades ahead, the report warns. If Exchequer costs were to be spread evenly over the period to the middle of the next century, some 3.5 per cent of GNP would have to be set aside annually, beginning this year.

But Mr McCreevy says that at least the current commitment to put aside 1 per cent is a start. He also says that future governments, although they will not have the power to take money out of the fund or to renege on the annual contribution, could increase the portion of GNP they set aside.

Mr McCreevy also dismissed criticism that the present generation would be paying twice for pensions. "We are enjoying exceptional economic times at the moment. If we don't do it now, we are never going to do it."

The Government has not yet decided when to begin drawing down money from the new fund but the Minister would like to see it accumulate - for a period of 15 years or more - before the Government began to use it as a normal fund.