Defusing the pensions time bomb

The most recent census produced possibly the most startling and frightening statistic to date in relation to private pensions coverage in this country. More than three quarters (76 per cent) of the people who answered the question said they would be solely reliant on the State pension in retirement. That means that just 24 per cent, including all public-sector workers, have any form of pension arrangement outside of their State pension entitlement of €12,391.60 a year.

The Government is clearly aware of the need to address this situation and in his speech to IBEC in September, Taoiseach Leo Varadkar said: “Another priority is to ensure that more people in work make provision for decent pensions when they retire. This issue has been long-fingered for too long, and now that the economy is recovering strongly we must act decisively, and we will publish a five-year roadmap for pension reform before the end of the year. This will include introduction of an auto-enrolment pension scheme for private-sector workers, two-thirds of whom currently have no occupational pension to supplement their State pension. I anticipate the first payments being made into those new individually held funds by 2021.”

That’s encouraging stuff but we have been here before with auto-enrolment having been under discussion for many years. Indeed, shortly before he took over as Minister for Social Protection in 2016, the then minister Varadkar said: “A majority of our citizens will rely solely on the State pension in retirement. For some, it will be enough to maintain their standard of living into old age. But for many, it will not. That’s why I view the development of a universal retirement saving system for people without supplementary pensions as an essential objective.”

Unusually for pensions, auto-enrolment is a fairly straightforward concept. It works by automating enrolment of individuals into pensions schemes from the moment they enter a workplace. In some cases, scheme members have the right to opt out after a period – this is known as soft compulsion – while in others the arrangement remains mandatory for like.

Contribution rates vary from country to country but the norm is to start low, for both employer and employee, and ramp up over the years as people get more accustomed to paying in. A number of countries, including Australia and New Zealand, have established successful auto-enrolment schemes over the years and these have resulted in significant rises in coverage.

The issue of inadequate supplementary pension coverage has been debated for decades in this country and the concept of auto-enrolment has been under discussion since at least 2007, which saw the publication of the Government Pensions Green Paper.

That was followed in 2010 by the National Pensions Framework, which set out “the Government’s intentions for radical and wide-scale reform of the Irish pension system”. In 2014, the commitment to introducing some form of universal scheme was restated, with auto-enrolment the preferred option. This has been followed by an Interdepartmental Working Group, which also looked at the issue.

The situation has continued to deteriorate while these deliberations have been taking place. According to the CSO Quarterly National Household Survey, overall supplementary pension coverage nationally was 51 per cent in 2009 but had fallen to 46 per cent in 2015. The figures for younger age groups are even more disturbing, with coverage for 25-34 year olds standing at 36 per cent and a quite alarming 14 per cent for the 20-24-year-old cohort.

The latest statistic from the census is even worse.

Dramatic improvement

On a brighter note, the UK faced much the same problem until it introduced auto-enrolment in 2012 and it has seen quite a dramatic improvement since then. When the scheme was introduced in 2012, coverage stood at 47 per cent. By the end of 2016, it had risen to 66 per cent. This was quite a dramatic improvement achieved during a period when the UK was going through a period of severe austerity policies and stagnant wage growth.

“Auto-enrolment is a very effective means of boosting coverage,” says Alistair Byrne, head of European defined contribution investment strategy with State Street Global Advisors. “It raised private-sector coverage in the UK by 30 per cent in just three or four years. It’s very effective.”

He notes there was quite a high degree of scepticism in relation to the UK scheme when it was first introduced, with many commentators predicting that most members would opt out from the soft-compulsory system at the earliest opportunity. “The scepticism was not well-founded and there was no real push back against the scheme,” Byrne says. “The debate now is whether there will be more opt-outs when the contributions rate increases to 4 per cent.”

That may be an acid test. The UK scheme starts with a 2 per cent contribution rate, of which at least 1 per cent must be paid for by employers, and rises eventually to a minimum of 8 per cent with at least 3 per cent being paid by employers. The fear is that rising rates for employees will trigger more opt-outs.

“I don’t think it will lead to a meaningful increase,” says Byrne. “I think a scheme like this could work in Ireland.”

Peter Feighan, financial planning consultant with Davy, agrees. “Pension coverage is a burning issue and the Census statistic is very frightening,” he says. “Auto-enrolment will help but the devil will be in the detail.”

These details include the level of competition between schemes, the ability to opt out, mobility between schemes and other issues. “The contributions level will also be important, particularly if it starts low,” Feighan adds. “If it starts at 1 per cent or 2 per cent, will it increase over time? When will the increases be phased in? Contributions have to be at a level to deliver a meaningful pension.”

He is encouraged by the current Minister for Social Protection’s response to that speech. “Regina Doherty has started to fill in some of the details in terms of percentage contributions and so on and it’s the first time we’ve had that. It appears that she is looking at mandatory enrolment along with the ability to opt out like the UK. That scheme has been hugely successful and added 1 million new savers in the last year alone.”

The impact on younger people is particularly important. “Auto-enrolment will put people into pension schemes at a younger age. The hope is that once they are in they will stick with it and accumulate a retirement savings over a longer period of time.”

HR consultancy firm Mercer's defined contribution and financial wellness leader Mairéad O'Mahony also finds cause for some optimism. "It was great to hear the Taoiseach follow through on the statements he was making as part of his campaign for the Fine Gael leadership," she says. "What he announced is that there will be a roadmap for a way forward, with the first contributions in 2021 but that still puts us 10 years behind the UK. It is great that it is being done but it is going to be a major challenge for the Government. It is going to be a beast of a project to implement. What is the contribution rate? Who's going to manage it?"

The prize is worth it though. “The UK scheme has created six million new savers and opt-out rates have only been around 8 or 9 per cent. There is a lot of behavioural psychology behind these things. Once people are in they tend to stay in. Auto-enrolment is absolutely the right way to go.”

Brian Kingston of Investec says that auto-enrolment will help but also believes that some attention could be paid to the way the tax relief is offered. "The tax relief is very valuable. If you are paying tax at the marginal rate it only costs you €60 to save €100. But the relief is not fully appreciated by many people. Irish people were very enthusiastic about the SSIA scheme where the State topped up savings directly. Maybe consideration could be given to a direct top-up contribution to the pension rather than tax relief for members of auto-enrolment schemes."

Such an arrangement might see an employee contribute 4 per cent of their salary, an employer matching that contribution and the State chipping in with 2 per cent. Each year, the State and employer contributions to the savings pot would be clearly visible, making the overall scheme that much more attractive.

Alistair Byrne supports that approach. “Tax relief is poorly understood by the majority of the population,” he says. “A top-up will seem more attractive to people. It is economically the same but has a nice simple message and I think it would be a good way to go forward.”

As the UK has shown, the situation is not beyond redemption, but having discussed and debated the issue for 10 years now, the Government might care to set a more ambitious target than 2021 for the solution to be in place.