OPINION:Around 800,000 ordinary workers, not the super wealthy, would be hardest hit by any move to reduce tax relief on pensions, writes PATRICK BURKE
WITH THE emergency budget approaching, the issue of pension tax relief has come under the spotlight. The Irish Association of Pension Funds (IAPF) has serious concerns that the Government could destroy private pension provision if it were to reduce pension incentivisation in the budget.
A common but misinformed view is that the majority of the Government’s “spend” on the incentivisation of pensions goes to the “super-wealthy”. Even the most cursory examination of the system shows, however, that there are over 800,000 ordinary taxpayers benefiting from the system whose prospects for retirement would be shattered by radical adjustments. The vast majority of these are clearly not the “super-wealthy” but individual taxpayers who either have had the foresight to set up a pension or are working for an employer who is providing for their retirement.
Recent media reports have highlighted the existence of legacy arrangements (providing excessive benefits) which are causing untold damage to the integrity of the system. The State needs to focus on tackling these loopholes rather than undermining the incentivisation of pension savings.
As the State’s dependency ratio moves from over five workers per pensioner in 2006 to one and half workers per pensioner by 2053 we have no alternative but to ensure that we continue to incentivise pension provision.
At current levels the State pension of just under €12,000 a year will not provide a satisfactory income replacement in retirement for most workers. Supplementary private pensions will be essential for most taxpayers to ensure a reasonable quality of life. Proposals that the current system should be interfered with now to address our short-term financial difficulties are short-sighted at best and reckless at worst.
Tax relief is given on pension contributions to provide an incentive for individuals to save for the long term and reduce the burden on the State. Even with the existing system it is difficult to encourage individuals to save for something that they cannot access for up to 40 years. Any changes are likely to make a difficult task impossible.
The IAPF welcomes steps taken to curb the extent to which the “super-wealthy” can avail of pension tax reliefs. Such steps effectively serve to cap private sector pension benefits at the levels available for those in the public sector bringing fairness and balance to the system.
These steps do not (and should not) impact on ordinary PAYE workers. Changing the system of tax relief, for example by applying it at standard rate or taxing lump sums payable on retirement, would impact on these workers and would damage efforts to get workers to save more for retirement.
Most of the individuals who avail of tax relief on contributions at the higher rate do so because they earn over €36,400 a year, the level at which workers become higher-rate taxpayers. Clearly, this is not an abuse of the system by higher-paid earners. Changes in the marginal rate of relief for contributions would also amount to an effective double whammy for public sector workers – most would see a 35 per cent increase in the take-home effect of the recently introduced pensions levy.
It is essential to remember that pensions provided from these savings are subject to tax when they fall into payment thus ensuring that tax relief granted on contributions is ultimately recovered on pensions in payment (with more tax being taken from those with higher pensions).
In 2006, the State collected €320 million in tax from pensions in payment and this is expected to increase as the number of pensioners increase. Independent actuarial research has shown that, taking into account the tax likely to be paid in retirement, middle- income earners on €45,000 a year benefit most from the current system of tax relief and would be the category of workers most adversely affected by the changes recently suggested. Hardly the super-rich.
The Government’s Green Paper on Pensions analysed the “cost” of reliefs in the taxation system as of 2006 and came up with a sum of €2.9 billion. That analysis is now out of date and includes both double counting and invalid assumptions. For example, the biggest element of the cost (estimated by the Government to be €1.2 billion) was the calculation of the tax forgone by exempting from tax the investment income and gains of pension funds’ assets.
Even if a tax on investment return was feasible it would immediately remove about €1 billion from defined benefit pension schemes at a time when over 90 per cent of these are in deficit. Accounting for this on a long-term basis would increase those deficits by €20 billion! We only need to look at the damage caused to the pensions of millions of ordinary taxpayers when a very small element of such proposals was adopted in the UK.
Speculation that the Government would look to tax the lump sums payable on retirement fails to recognise the implications of such a tax. In the first place a 10 per cent tax on such payments is unlikely to improve exchequer returns by anything much more than €30 million a year assuming no behavioural changes.
However, behavioural changes are inevitable other than in the public sector where the tax would be automatic as lump sums on retirement are effectively a compulsory part of the package.
In the private sector lump sum payments on retirement are voluntary and, if taxed, many would instead choose to take the benefit by way of increased pension. Furthermore, for those able to take severance rather than retirement, many would choose to take severance payments on a tax-efficient basis which is currently neutralised by the lump sum payment on retirement. As such, savings in the order of €30 million are unreliable at best.
IAPF understands the Government’s current need to explore all opportunities for additional finance. Changing the system of tax relief for employees and employers would seriously threaten the future of private pensions in Ireland. As a result, it would not have the desired effect in raising revenue and would store up serious problems for current and future generations of retirees and taxpayers.
The Commission on Taxation has already been tasked with considering how best the tax system can encourage long-term savings to meet the needs of retirement. The Government’s response to the Green Paper process is still awaited. It is important to consider pensions in the long-term framework and any action taken now could seriously undermine the work in these areas.
At this time, more than any other, pension provision in Ireland needs support and does not need action that could destroy it completely.
Patrick Burke is chairman of the Irish Association of Pension Funds