Pensions are back in the news once again, with a focus on some of the State’s less than consistent thinking.
It always amazes me that the one way of getting pensions into the headlines and on to the radar of most ordinary people is to mention the State pension. Getting similar focus on occupational or workplace pensions that will form a critical part of the retirement income of so many people is a remarkably uphill battle.
This is going to become all the more relevant as the Government belatedly moves to introduce auto-enrolment – mandatory workplace pensions – hopefully later this year.
In that context a new report on Britain’s experience with auto-enrolment, published this week, is timely, offering both affirmation of some of the Irish approach and advice that might helpfully be addressed before we go any further in the process.
Published by the Resolution Foundation, an independent think-tank focused on improving the living standards of those on low-to-middle incomes along with Abrdn’s financial fairness trust, which funds research to improve living standards and personal finances for people on low to middle incomes in the UK, the report focuses on the low level of savings overall among British households – something which is also a feature in Ireland.
First the good news.
Twelve years after the introduction of auto-enrolment in the UK, it has transformed the pension savings landscape. Back in 2012, just 47 per cent of UK employees had a pension outside the State pension; now the figure is 79 per cent.
As the report says, that is an extraordinary policy achievement and one that suggests Ireland should be getting auto-enrolment up and running as soon as possible as we look to address similarly poor occupational pension coverage in the private sector here.
But, the report argues, the amount people are saving is too low. Even with auto-enrolment, it calculates that 39 per cent of individuals over the age of 22 will not hit what it sees as the target rate – pension income of at least two-thirds of after tax pre-retirement income. In the UK context, it says that is 13 million people who are not likely to have adequate income in retirement even with auto-enrolment.
It suggests contributions to the UK scheme should rise from their current level of 8 per cent of wages – 3 per cent from the employer and 5 per cent from the worker – to 12 per cent, with both parties paying 6 per cent.
That suggests the proposed Irish scheme is likely to be much more effective in delivering adequate pension income. Although the Irish scheme is starting slowly (when it starts at all) with contributions of just 3.5 per cent – 1.5 per cent from each of the worker and the employer and 0/5 of a percentage point from the State, those contributions will rise to 6 per cent from the employee, another 6 per cent from the employer and 2 per cent from the State, giving a total investment of 14 per cent of wages.
So we are getting some things right. But not everything.
A legislative change last year allows the UK government reduce the age at which you can be automatically enrolled into a UK pension scheme, from 22 to 18. The Resolution Foundation report says the UK should use that power and trigger the new, lower starting age. Ireland’s planned scheme has a lower entry point of age 23 and, beyond mimicking the UK scheme and no one appears to have come up with a very good reason for it being set at that level.
Setting it at 18 would make more sense.
The report also calls for elimination of the lower earnings limit in the British scheme.
In the UK, you need to earn £10,000 (€11,700) to be automatically enrolled in the scheme. However, an employee under that level can request to join the scheme. The employer cannot refuse but here is where is gets tricky. If the employee earns above the very modest level of £6,240 a year and wants to join the scheme, the employer must contribute at least 3 per cent of pay; if you earn below that level, they do not have to contribute anything.
The new UK legislation would allow the Government make employers pay the 3 per cent minimum on any income and the Resolution Foundation report argues that it should do so.
The Irish scheme has currently set a lower earnings limit of €20,000 for auto-enrolment, a figure that has also been questioned, and the UK report suggests this limit mightneed to be reconsidered.
One of the big concerns raised about the Irish plan is that people in tight personal financial circumstances will be reluctant to lock their savings into a pension scheme and mayopt out as soon as they can, undermining the effort to plan for retirement. The Resolution report has sobering information in that regard, but also innovative thinking.
It notes that when UK contribution rates jumped from 2 per cent to 8 per cent, for every £1 reduction in take-home pay due to higher pension contributions, employees reduced their consumption by 34p, with the rest of the contribution funded through either lower liquid saving or higher debt.
In other words, pension contributions ate into other personal savings or, for some, saw them go into debt to meet the cost. That’s clearly a concern especially with so many families in Ireland struggle to make ends meet.
But the report comes up with two features that might make the scheme more attractive to thepeople it is trying to help.
First, as part of its encouragement to raise contribution levels to 12 per cent, it says an amount equal to two percentage points of income should be placed in what it quaintly calls a “sidecar” account within the pension scheme to serve as a rainy-day fund. There would be an upper limit on this of £1,000 and it could be used by the employee without restriction to manage minor calls on their personal finances as they arise.
Anything about the £1,000 limit would roll over into the pension fund and it would only attract tax relief at that point.
Of course, €1,000 or whatever would not get you far in Ireland if you got landed with large unexpected bills for medical treatment, redundancy or something going awry in your home. For this, Resolution has a second proposal.
To cushion people from what it calls “large, infrequent shocks”, they should be allowed to borrow £15,000 or 20 per cent of their pension fund – whichever is the lesser – but those borrowings would come with conditions. The sum would need to be repaid, with interest to account for lost capital growth as a result of the cash being taken from the pension pot, from subsequent earnings.
This addresses the concern of those who fear they might need access to locked in savings without the risk of tax incentivised retirement savings being regularly ransacked with impunity.
Given how long-delayed the introduction of auto-enrolment in Ireland has been, we actually do have the time to incorporate the lessons from the UK experience before we roll out the scheme here.
Much of the Resolution report proposals make sense and there seems little point in Ireland waiting another 12 years to learn those same lessons.
- You can contact us at OnTheMoney@irishtimes.com with personal finance questions you would like to see us address. If you missed last week’s newsletter, you can read it here.
