The Government’s plan for pension auto-enrolment is flawed - there is a better way

The Government has published draft heads of a bill for a national auto-enrolment pension scheme. The goal is that the scheme will deliver badly needed improvements in Ireland’s very low pension coverage rates; only one in three private sector workers has an occupational pension.

However the plans need to change. An alternative approach would give members higher benefit expectations for two-thirds the cost and provide better inflation protection in retirement.

Employees not already in a pension scheme providing reasonable benefits will be automatically enrolled in the scheme – unless they opt out. Employers will have to match employees’ contributions.

Contributions are set to start low, at 1.5 per cent (on earnings up to €80,000 a year), and to increase every three years, reaching 6 per cent from employees and employers from year ten onwards. The State will contribute one-third of employees’ contributions, reaching 2 per cent by year ten. The State’s contribution will be in lieu of tax relief: unlike normal pension schemes, employees will not be able to claim tax relief on contributions.

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The employee’s contributions, together with those of their employer (or employers if they move jobs) and the State, will be invested in an individual account in the member’s name, to which investment returns will be credited. The full account can be accessed on retirement or on death or serious illness.

The proposed 14 per cent contribution (6 per cent employee, 6 per cent employer, 2 per cent state) is what officials estimates is the amount required for an ‘”pension” for someone on an average wage, who contributes for their entire working life and is entitled to a State flat-rate pension. The contribution estimate requires assumptions to be made for what happens after retirement as well as before.

Incredibly, the Bill completely ignores what happens after retirement. It stipulates that employees will have to withdraw their pension savings at retirement. They then buy either a life annuity or an Approved Retirement Fund (ARF) from a private sector provider. This causes a number of woeful inefficiencies, which are factored into the 14 per cent contribution estimate.

First, pension accounts have their highest earning power close to retirement, when account values are at their highest: the investment return in a single year for a member close to retirement could exceed total returns in the first ten years of membership. Therefore, it is vital to structure the scheme to get the best possible returns at that time. Instead, it is proposed to have members’ money in cash and low-yielding assets at retirement.

Second, employees enjoy the protections afforded by the scheme’s directors’ fiduciary responsibility to look after members’ interests, to ensure that investments are appropriate to their age and risk-taking ability, that investment managers can be trusted to deliver, that charges are kept to a minimum, that members get good value for money.

When workers are ejected from the scheme at retirement, those protections disappear. Retired employees will have to look after themselves as best they can, at retirement and, more importantly, in later life, when they are at their most vulnerable.

To make matters worse, the 2018 plans for automatically enrolled pensions, on which the Bill is based, proposed an upper limit on charges that could be levied post-retirement. The charge cap has now been dropped. There will be no constraints on what private sector providers can charge. Retired workers will also lose the bulk buying power they enjoyed as members. They will be charged much more for investment management and account administration.

By taking this approach, the Irish Government is following the UK’s lead. There, some critics claim that lobbying by pension consultants, brokers, financial advisers, and other vested interests caused government to drop plans to add a pension payment facility to its auto-enrolment scheme. The UK government’s decision left private sector players with an open goal when workers’ pension pots mature.

There is a better way. Members should remain in the auto-enrolment scheme post-retirement, drawing from their accounts as needed to secure a regular income in retirement.

This would allow retired workers to continue to benefit from the directors’ duty to look after their interests. They would also continue to benefit from the scheme’s bulk buying power.

By pooling retired members’ investments with those of active employees and utilising the opportunity, unique to auto-enrolment, to smooth the ups and downs of stock market fluctuations, retired members could expect to earn high and stable investment returns. They would not have to pay for investment advice, either directly through fees or indirectly through commission to intermediaries.

This combination of measures would ensure more than 50 per cent better value to members, on average. The required contribution for an adequate pension would fall from 6 per cent to 3.9 per cent from employees and employers, and from 2 per cent to 1.3 per cent from the State. The total required contribution would fall from 14 per cent to 9.1 per cent – and expect to deliver higher benefits to members.

Colm Fagan, a retired actuary, is a Past President of the Society of Actuaries in Ireland