Area man pleads with state to continue to give tax reliefs to ‘save’ private pensions in order to prevent ‘reliance’ on… er.. the state…

An entertaining read in the Irish Times recently, a cri-de-couer as it were from a representative of the private pensions industry. For… we read that:

THIS MONTH it was the “Bord Snip Nua” report. Next month we will see the report of the Commission on Taxation. Together they will form the backdrop for Government discussions and public debate in advance of a very, very difficult budget.

There is pressure – justified in many cases – to curtail various tax reliefs and allowances and the Commission on Taxation will undoubtedly have views on many of these. One change that should be resisted is the reduction of tax relief on pension contributions. Doing this to help resolve today’s fiscal problem would simply store up another fiscal problem for the future.

How so?

The Government has already seen this potential problem coming. In 2000, the Government acted to face up to a pension crisis that was appearing on the horizon. The population was ageing and living longer, private pension provision was well below what it needed to be and it looked as if the State would face major difficulties in meeting its pension requirements by 2025.

As part of its response, the Government set up the National Pension Reserve Fund to which 1 per cent of GNP was to be paid each year to try to offset the 2025 problem.

Nine years on, what has changed?

Well, as noted here previously by Fintan O’Toole we’ve made almost no money at all on said NPRF.

Virtually all pension funds have seen hopefully temporary but substantial reductions in their value as a result of the sharp decline in equity prices. Individuals and companies are struggling to make pension contributions because of the effects of recession.

Defined benefit pension schemes are facing grave difficulties. The pension reserve fund itself has been diverted from its long-term strategy and is now helping to fund the recapitalisation of the banks.

The only thing that hasn’t changed is the basic demographic fact that underlays the establishment of the pension reserve fund: we have an ageing population and, from 2025 onwards, the State will face a major challenge in meeting its pension obligations.

Note the ‘hopefully temporary’. We all live in hope. When we’re not living in fear.

The State cannot be expected to fund pensions for everyone. Private pension provision for those who can afford it offers the only prospect of alleviating the burden on the State.

Okay. Let’s hold on right there. What is the basis for this proposition that the State cannot be expected to fund pensions for everyone and that only private pensions offer a prospect for alleviating the burden on the State? I can cite examples from abroad where states do fund pension from taxation with a contributory element from employees and employers.

To ensure as many citizens as possible provide for their own retirement, they must be encouraged to make regular payments into pension schemes. The taxation system is central to ensuring this happens.

Now more than ever, tax relief on pension contributions and investment income and gains should be maintained at the marginal rate.

There is an easy argument made currently that tax relief on pension contributions currently “costs” the exchequer €3.2 billion. This is misleading, though: once a pension fund is being paid out during retirement, income tax is then paid on it, so what is called tax “relief” is in fact only tax deferral.

It is this deferral of tax that makes saving for retirement worthwhile for individuals.

That’s a lovely notion, but it ignores the basic fact that there is a mismatch between the tax relief and the tax take on the final pension. In other words you’re not deferring all your tax through tax relief, but only a portion of it. Furthermore it’s a self-serving argument. He’s still not explained why the state shouldn’t be expected to fund pensions or why the only alternative is [private] pension schemes. Now, it’s his job to be self-serving, he is, after all a representative of the pensions industry. But, it’s also his job to address some basic flaws in his argument.

And there’s one glaring aspect of pension provision in the private sector which curiously he doesn’t directly mention, that being that many can get tax-free lump sums of up to 25% of a fund on retiring as part of their pension plans (although there is some talk that that facility may be closed down ).

And I can do no better than refer you to Pension Schemes and Pension Funds in the United Kingdom by David Blake and this page here …which notes that if we exclude the tax-free lump sum then tax liability is deferred and not avoided although, and here we see a crucial caveat:

(The position is slightly more complicated than this because of the possibility of tax arbitrage, that is, it is possible for an individual to transfer the tax liability from a period where he or she faces a high marginal tax rate – that is, when he or she is in work – to a period where he or she faces a lower marginal tax rate – that is, when he or she is retired.)

Slightly more – eh? That’s a pretty big benefit.

Back to our original article…

There have also been claims that the current pensions regime is regressive – that it favours higher earners over lower earners. However, because both pillars of our pensions system – State pensions and private pensions – are inextricably linked, both must be taken into account when assessing whether the system is fair or not.

The reality is that the State pensions are hugely subsidised by higher earners – and few would argue with this principle – and this far outweighs any benefit these earners gain through the tax treatment of private pensions.

But, by diverting funds that the State has to raise all pensions towards individual tax relief one could easily argue that those higher earners are gaining a personal share that is inequitable when set against the rest of the population who must scrimp by on the lowest, or lower, levels. But there’s a second and more important reason, and oddly it is one which McCarthy in the eponymous Report et al use. We can’t afford such indulgence to higher earners who, by the standards of the OECD have a very light tax burden indeed compared to that which they would experience in all other states.

Indeed think-tank TASC has a useful leaflet on just this topic which notes that…

These tax reliefs have disproportionately benefited the wealthiest in society: the top 20 per cent of earners receive around two-thirds of all pension-related tax subsidies, while the bottom 20 per cent received just 1.1 per cent (employees) and 0.2 per cent (self-employed).

In 2005, the most recent year for which figures are available, a small group of people earning over €250,000 annually shared a staggering €121 million in pension-related tax breaks1. During the same year, the average tax giveaway enjoyed by these top earners was €20,813 – or thirty-four times the tax relief received by someone on an average wage (€616)2.
What this means in practice is that the check-out worker is subsidising her own CEO.
When subjected to a gender-proofing and poverty-proofing process, it is clear that the incentive-backed private pension system is regressive, benefiting higher earners and those in secure, long-term employment. Tax reliefs, and the private pensions they are designed to promote, do nothing to benefit the weakest sections in our society: those on low incomes, women, migrants and atypical workers.

This is hardly a surprise, those on higher wages pay more tax so hence they get more tax relief, but… those on higher wages are on higher wages and therefore in a better position to allow a stream of their disposable income drain into the pension pool while those on lower incomes can only hope for a trickle… hmmm… I don’t do that sort of illustrative language very often… I suspect there’s a reason for it.

Of course even our intrepid correspondent can’t ignore the lump sum issue, but he approaches it from the side…

There are aspects of the current system which are seen as unfairly favouring well-off individuals. Take the advantages currently received by those fortunate enough to be able to put their pension fund into an Approved Retirement Fund (ARF) on retirement. Typically (although not always), such funds are availed of by the relatively well off. People can effectively accumulate substantial wealth within these funds and then take large tax- free lump sums out of them later.

This is not fully compatible with the concept of deferred taxation.

Not fully compatible? Why no, no it’s not!

In these cases, an individual may have made tax-free contributions to their pension fund and then may have been able to use the ARF mechanism as an inheritance-planning device. This is something that could be addressed to ensure fairness and equity.

For example, a reasonable cap could be placed on tax-free lump sums at retirement and the proportion of an ARF that must be distributed each year could also be increased.

Indeed.

Pension provision is currently facing substantial difficulties and the clock is ticking steadily towards the time when Ireland’s current substantial underprovision for retirement will be very badly exposed. In this context, the introduction of a new 1 per cent levy on insured pension arrangements from 1st August is not helpful at this time.

Any further reduction in the tax advantages of providing for retirement may turn a serious problem into a crisis. It could deal a fatal blow to private pension provision, which in the end will increase reliance on the State.

Oh, I know what he means, but could you see any finer encapsulation of the problems with a certain view of these matters? He believes that doing away with tax advantages for private pensions will increase reliance on the state? A tax advantage, or relief is the state underwriting private provision.

Now, I don’t have a problem with that as long as the playing field is leveled so that all gain a better universal pension and those who want more above that pay more from their own incomes. That won’t, short of the communist millennia, guarantee that all will have the same pension payment, but it should allow for a much more equal approach with all on sustainable pension.

And let’s not think that the ‘reliance on the state’ issue is merely confined to an economic view, for it’s not. Indeed we’re talking about a broader attitude in the insurance and pensions sphere which… well, look, consider the submission from the Irish Insurance Federation to the Green Paper on Pensions in 2007 and read why…

* We do not support the idea of mandatory pensions. The introduction of fully mandatory pensions would create more problems than it would solve. There would be a high degree of complexity involved and it would be very difficult if not impossible to design a regime which would be appropriate for all participants. In our opinion the better option is a reasonable basic State pension and voluntary provision on top of this.

* Why not mandatory? Because:
o Enhancing the “Pillar 1” State pension, as recommended, would go a long way towards providing an adequate retirement income for low- to middle-income earners; this in turn reinforces the idea that any additional pension provision – while it should be promoted and incentivised by the State – should remain voluntary;
o It represents an abdication of personal responsibility and it weakens the link between effort and reward;
o It removes personal choice;
o It enshrines the principle that citizens must be taken care of by the State from ‘Cradle to Grave’ and increases ‘Big Government’;
o It creates a dilemma regarding who should manage funds and may result in a lack of individual savers’ control over the management of their retirement funds.

I must comfort myself when – God willing – in twenty two odd years I sit beside the fireplace and realise that despite working fifty and fifty five hour weeks my lack of proper pension provision is due not the abysmal wages I had well into my late 30s but is instead the representation of an ‘abdication of personal responsiblity’ and that were I to enjoy a reasonably financed mandatory pension I would in fact be ‘weakening the link between effort and reward’ and ‘enshrining the principle that citizens must be taken care of by’ ‘Big Government’.

Good to know.

You might think the IIF is a marginal group. You might think wrong. The IIF represents such titans as AXA and Allianz, both of which have extensive pension arms. It’s somehow not at all comforting to know that they’re willing to sign up to such nakedly ideological analyses. Of course they’re in business and they want to extend it… but let’s not pretend that they’re not implicitly by cleaving to that viewpoint essentially dismissing many many working people who through no fault of their own cannot purchase their products.

The submission from the Irish Association of Pension Funds is more measured, but again, it seems to miss the point when it notes that:

We believe that removal of many of the barriers that exist in relation to people taking out pensions is the best means of increasing coverage and adequacy.

Problem is it ignores the primary reason why I and perhaps you don’t take out pensions like this, we’re not paid enough. And our employers aren’t going to cough up the readies to make up the shortfall. As long as that central issue remains unadressed (and here’s thought provoking piece from some years back) I see little scope, or what was that word he used – hope, for change.