1. Letter to Mr. Seamus Brennan, T.D. Minister for Social & Family Affairs
2. Mandatory Report
3. Appendix A - Fitzpatricks – Final Report V3
4. Appendix B - Economic Impact – Mandatory Pension Systems mod 1
5. Appendix C - Soft mandatory systems
6. Appendix D - Report by Life Strategies
7. Appendix E - Life Strategies projections results - Part 1
8. Appendix E - Life Strategies projections results - Part 2
Background (Chapter 2)
1.1 In February 2006 Séamus Brennan T.D., Minister for Social and Family Affairs, wrote to the Pensions Board ("the Board") and asked that 'the general principles in relation to a mandatory or quasi-mandatory [pension] system… [be] fully explored with a view to recommending the most appropriate system for Ireland at a practical level and to cost this'. This report is the Board's response to the Minister's request.
1.2 There are differing views among members of the Board of the rationale for and the merits or drawbacks of mandatory pensions, which were set out in the report of the National Pensions Review (NPR). This report is a technical examination of the practical issues associated with a mandatory pension system. It is not a recommendation by the Board for or against the introduction of a mandatory system. The views expressed in the report are the collective views of Board members and do not necessarily represent the views of nominating representative organisations. Furthermore, the collective recommendation was made notwithstanding that Board members may individually have other preferences.
Key objectives and policy context (Chapter 3)
1.3 One of the core objectives of the current agreed Programme for Government (2002) is to help all older people to live in dignity by implementing a coordinated programme of measures to address the full range of issues of concern to older people. Pension provision in Ireland has been subject to considerable analysis over decades, but particularly over the last year.
1.4 The Board, through the NPR in 2005, also examined the current Irish pensions system and made proposals designed to improve pension provision.
1.5 The new partnership agreement 'Towards 2016' includes a specific commitment that the Government and the social partners will work together to enhance pension provision and income supports and that future policy in this area will be considered in the context of the NPR, the outcome of the further work requested in relation to mandatory pensions, the publication of a Green Paper by the Government on pension policy and the views expressed by stakeholders including social partners.
1.6 The objectives of this report are both to explore the general principles of a mandatory system and to make specific practical recommendations.
1.7 In undertaking the project, a number of principles were agreed by the Board at the outset
(a) Ireland already has a good level of pension provision and a sound pension base and any changes should build on this. As far as possible, changes must not damage existing pension provision or worsen the existing position of any pension scheme.
(b) Any mandatory system should ensure both adequacy and coverage objectives are met.
(c) In considering how the system would be introduced any adverse effect on the current system of pension provision will need to be minimised.
(d) The costs, economic impact, and effect on competitiveness of any model
being considered will be examined as fully as possible.
(e) Any recommendations made must be practical, capable of implementation, and likely to further the objectives of the mandatory approach.
Approach and background (Chapter 4)
1.8 The approach adopted in this report is to identify different types of mandatory system and, within each type, to define and specify the important parameters. These specific systems are then subjected to quantitative and qualitative assessment.
Overview of mandatory systems (Chapter 5)
1.9 The most basic choice in a mandatory system is between an extension of the current State pension and the creation of an additional mandatory supplementary pension. As part of this project, the Board considered both approaches in depth.
1.10 A number of countries have introduced mandatory supplementary systems in the last 25 years. Among the best known examples are Australia, Chile, Singapore, Sweden and Switzerland.
1.11 The Board commissioned
- Life Strategies, a firm of actuarial consultants, to provide projections of the effect of a number of pension systems.
- The Economic and Social Research Institute (ESRI) to quantify the macro-economics for Ireland of the introduction of the various types of mandatory pension systems examined. The ESRI used their medium-term model HERMES to simulate the economic effects of alternative pension systems on macroeconomic variables such as Gross National Product (GNP), employment and unemployment. The medium term effects were then used by the Board in the long-term modelling by Life Strategies of the alternative systems.
- Fitzpatrick Associates to assess the likely broad economic impacts of the introduction of a mandatory pension system in Ireland, including the impact on discretionary savings, fiscal balance/national savings and competitiveness; the labour market effects of compulsory savings; and the prospective implications of the proposed system on potential economic growth rates.
The Board recognises that additional economic and projection of any proposed system would be of benefit.
1.12 The ESRI's modelling projected that any alternative system would have a negative impact on GDP and GNP growth and employment. It also projected a negative effect on real disposable income, wages and balance of payments. The level of impact on each of the macroeconomic variables differed from system to system.
The Fitzpatrick's study indicates that while mandatory pension contributions can negatively impact on the labour market, with repercussions in terms of national competitiveness and overall economic growth, a scheme could, with appropriate design and delivery, increase overall levels of saving.
It should be noted that there are differences between the projections of ESRI modelling and the report by Fitzpatrick Associates about the effect of mandatory pensions on the national savings ratio.
1.13 Having considered international experience, and the differences in the prevailing Irish economic and social situation, the report deals with particular mandatory pension systems which have potential for being introduced in Ireland, that is a first pillar, second pillar and a hybrid scheme as well as a soft mandatory option.
First pillar model (Chapter 6)
1.14 Chapter 6 considers whether the objectives of mandatory pension provision could be achieved by an increase in the contributory State pension.
1.15 The specific model examined in detail was based on the assumption of an increase in the amount of the State pension from its 2006 level of about 33% of Gross Average Industrial Earnings (GAIE) in 2005, to 50%, or from the current amount of about €193 per week to about €300 in 2006 value. It is assumed in the costings that the pension is increased from its current level to the target level over a period of ten years, and its level maintained as a proportion of GAIE thereafter through an explicit link between the State pension and earningsincreases. It is also assumed that anyone receiving a contributory State pension will be entitled to the increased State pension amount, irrespective of when they retired. Voluntary pension provision would continue as at present although some impact on the level of voluntary pension provision in light of the scale of the increase in the State Pension could be expected.
1.16 The economic impact and cost projections of this system are contained in chapter 6 as well as the other issues arising from such a model.
1.17 Increasing retirement benefits by increasing the State pension is conceptually and administratively straightforward, and the level of expense depends on the amount of increase being considered. Some of the aspects of such a system are worth highlighting
(a) Any increase in the State pension will result in additional income for those who have already retired as well as for future pensioners. Redistribution will therefore occur between the current generation of workers and those who have already retired or who will shortly retire.
(b) An increase in the State pension will not result in any additional administrative cost, as it will not cost the Department of Social and Family Affairs any more to administer the increased pension payments.
(c) Unless the cost of the increase is fully met from additional contributions, the result of an increase will be that the Exchequer will be providing an additional benefit to all pensioners, irrespective of whether they need it or not. This may be seen as a less efficient use of those resources compared to a more targeted approach and would give rise to significant opportunity costs in terms of overall public expenditure.
(d) If people are obliged to make additional contributions in return for an increased State pension, they will want reassurance that the State will have the capacity to provide the promised level of the State pension. However, the State pension amount is set by the Government each year, and there are no long-term commitments about the level of benefit or any increase in the pension once paid, or even the age at which it will be paid or the qualification conditions. If additional contributions are to be charged, more definitive commitments may be thought necessary, which may have important implications in restricting budgetary flexibility going forward.
(e) An increase in the level of State pension would result in a reduction in contributions and benefits from supplementary schemes which have a Social Welfare offset. There might also be a reduction in supplementary coverage resulting from the view that the higher State pension would provide adequate income.
Supplementary model (Chapter 7)
1.18 Chapter 7 examines a mandatory pension system which obliges qualifying earners to contribute to a funded supplementary system. Such systems are usually intended to provide contributors with retirement income above that provided by basic State provision.
1.19 The supplementary model chosen for analysis was as follows:
(a) Eligibility All employees and self employed (but see discussion of harmonisation in section 7.27 below).
(b) Eligible income All earned income between 200% and 600% of the State pension (between approximately €20,000 and €60,000 as at June 2006)
(c) Benefit type Defined contribution
(d) Contribution rate 15% of eligible income
(e) Exchequer contribution 5% (included in the 15% above). This would be in lieu of any employer and employee PRSI relief and of any employee tax relief on contributions
(f) Pre-retirement access None
Contributions would increase gradually from zero to the full amount in the ten years after introduction. Those with adequate existing provision would be exempted from the mandatory scheme. Additional voluntary provision would be allowed on top of the mandatory scheme.
1.20 The economic impact and cost projections of this system are contained in chapter 7 as well as discussion of the issues arising from proceeding with such a model.
1.21 The design of a mandatory supplementary pension system is extremely complex. There are a large number of decisions which must be made about many aspects of the new pension arrangements and their interaction with existing pension provision before a detailed implementation recommendation can be made. The most significant issues which require detailed examination are set out below.
(a) A mandatory supplementary system will require significant new structures to be created, including:
- Contribution collection and supervision mechanisms
- Compliance monitoring
- Harmonisation arrangements for existing schemes.
Most Board members thought it unlikely that the cost of these structures could be recovered from contributors. Furthermore, depending on the model chosen, these structures could involve some element of operational risk, which could possibly be substantial. It has to be decided whether the resulting eventual improvement in contributors' retirement provision justifies this effort.
(b) If existing pension provision is to be protected and encouraged to continue, it is inevitable that relatively complex harmonisation rules will be needed. It is not certain that these rules would work effectively to ensure the successful knitting together of current voluntary and future mandatory supplementary pension saving.
(c) A fundamental decision is how much contributors will be exposed to market investment and its resulting volatility: the alternative may be some form of State guarantee or Stateinvestment management. The Board member nominated by the Minister for Finance believes that State guarantees would transfer unknown and unquantified risks onto the Exchequer and future taxpayers.
Soft mandatory models (Chapter 8)
1.22 There is a great deal of support in Ireland and worldwide for soft mandatory or automatic enrolment pension systems. A soft mandatory system can be defined as a pension system where eligible workers are obliged to join, but they have the right to opt out and cease contributing if they wish.
1.23 It is planned to introduce soft mandatory savings schemes in New Zealand (the 'KiwiSaver') and in the U.K. (the National Pensions Savings Scheme, or NPSS). An outline of these proposals is provided in Appendix C.
1.24 The model chosen for analysis was as follows:
(a) Eligibility - All those beginning employment on or after the date of introduction of the scheme who do not become members of occupational schemes immediately on beginning employment. There would be no obligation for those who are self-employed to join, but those who wished could. Those in employment at the date of introduction of the scheme would also have the option of joining.
(b) Employee - 5% of income contribution
(c) Employer - 2% of income contribution
(d) Exchequer - 2% of income, to a maximum contribution of €750 p.a. contribution
(e) Opt-out - Contributors could cease contributions after three months' contributions had been made. No immediate refund of contributions would be allowed in the first year. Employer and Exchequer contributions would be returned to them rather than to the employee.
All employees who would be eligible to join on beginning employment would be allowed to recommence contributions at any time on one month's notice.
(f) Access to funds - Contributors would be allowed to access 25% of their funds tax-free on one occasion before or at retirement.
1.25 The principal implementation issues for a soft mandatory scheme are
- The number of participants in a soft mandatory scheme as described here will be smaller than a fully mandatory scheme. The approach adopted for contribution collection is therefore more likely to be an adaptation of an existing system than a new creation.
- The biggest compliance problem is likely to be employers and employees colluding to avoid the scheme. Supervision of compliance would be challenging.
1.26 A soft mandatory system is much less likely to be disruptive of existing occupational pension arrangements than a mandatory supplementary scheme as outlined in chapter 7.
1.27 It is extremely difficult to predict the take-up of a soft mandatory system: the success of such a system will depend on how effective the promotion of such a system is and how much it captures the interest of potential savers.
Hybrid model (Chapter 9)
1.28 It was decided to examine a proposal that would incorporate elements of both first pillar and supplementary mandatory systems to see whether a combined approach offered advantages over one or other alternative.
1.29 The hybrid system examined comprises an increased State pension as well as a mandatory supplementary system. The proposed increase in the State pension was a 20% increase over the current level. This would increase the pension from the current level of 33% of GAIE to 40%, and in current values, would increase the weekly pension from €193 to €232.
In addition to the increased State pension, a mandatory supplementary system would operate as follows:
(a) Eligibility - All employees and self employed
(b) Eligible income - All earned income between 125% and 500% of the increased State pension (between approximately €15,000 and €60,000 as at June 2006)
(c) Benefit type - Defined contribution
(d) Contribution rate - 15% of eligible income
(e) Exchequer contribution - 5% (included in the 15% above). This would be in lieu of any employer and employee PRSI relief and of any employee tax relief on contributions
(f) Pre-retirement access - None
It is assumed in the costings that the pension is increased from its current level to the target level over a period of ten years, and its level is maintained as a proportion of GAIE thereafter. It is also assumed that anyone receiving a contributory State pension will be entitled to the increased amount, irrespective of when they retired.
1.30 The economic impact and cost projections of this system are contained in chapter 9 as well as the advantages and disadvantages of proceeding with such a model. The implementation issues identified in chapter 7 for a mandatory supplementary scheme also arise for this model: indeed, because the mandatory supplementary contributions under this system are greater than under that described in chapter 7, these issues are of more importance under this system.
Conclusion and recommendation (Chapter 10)
1.31 This report recommends that the most appropriate and practical approach to improving the position of pensioners in Ireland would be a combination of an increase in the State pension with a mandatory supplementary system for those at work who are not making supplementary provision. The system would be known as the Special Savings for Retirement (SSR) and individuals would hold Special Savings for Retirement Accounts or SSRAs.
This recommendation is being made in response to the specific request of the Minister for Social and Family Affairs in his letter to the Board of 6 February 2006. It is not a recommendation for or against the introduction of such a system. Furthermore, the collective recommendation was made notwithstanding that Board members may individually have other preferences.
The Board member nominated by the Minister for Finance believes that owing to such factors disclosed in the report as the significant Exchequer costs, the broader macroeconomic effects and the prospective adverse impact on existing voluntary provision, the Board's recommendation does not comprise a workable option.
1.32 The report specifically recommends that the contributory State pension be increased to 40% of GAIE over ten years until 2016 or similar period, and that the real value of the pension be maintained at least at that proportion of GAIE thereafter.
1.33 In addition, it is recommended that a supplementary system called Special Savings for Retirement be set up for all employees who are not members of occupational schemes or do not have sufficient supplementary savings.
The detailed provisions of the scheme are similar to those described in chapter 9 and are as follows:
(a) Eligibility - All employees and self employed who are not members of an approved pension arrangement or do not have sufficient supplementary savings would be automatically enrolled to the Special Savings for Retirement scheme (see 10.9(b) below)
(b) Eligible income - All earned income above 50% of GAIE (approximately €15,000). An upper limit of no less than 200% of GAIE is recommended (approximately €60,000) though a limit of €90,000 was also suggested.
(c) Total contribution rate - 15% of eligible income. The split among employee/employer/Exchequer to be agreed as part of partnership.
(d) Benefit type - Defined contribution (but subject to a minimum – see 10.9(f) below)
(e) Access to funds - There would be no pre-retirement access to funds except in specified exceptional circumstances.
The mandatory contributions to the SSR would be introduced gradually over 10 years.
The projected costs of this system are summarised in chapter 9 and given in considerable detail in Appendix E.
1.34 The primary reasons why the above system is being proposed are as follows:
(a) There is considerable support amongst the Board for an increase in the State pension as a means of improving retirement incomes for all existing and future retirees. The increase proposed above is intended to balance the considerations of improved retirement income and sustainability.
(b) Because the proposed improvement in the State pension would be felt by many to be an inadequate retirement income, additional provision would be made through obligatory contributions to a supplementary savings scheme.
1.35 Some brief comments on the other systems considered are:
(a) Although there is much support for the increase in State pension to 50% of GAIE as examined in chapter 6, the projected costs are seen to be a significant difficulty.
(b) A mandatory supplementary system as described in chapter 7 will eventually deliver benefits close to the NPPI targets. However, such a system would take about 40 years to provide full benefits, and raises considerable issues of implementation and design complexity, although these issues also arise to some degree in relation to the Board's preferred option.
(c) Although there is much support in a soft mandatory system as described in chapter 8, there is concern that the take-up of the supplementary provision would be too low to achieve the desired objectives. It would however have the advantage of facilitating individuals in making their own retirement savings decisions.
1.36 The following is a summary of the observations on the Board's recommended mandatory system made by Fitzpatrick Associates in their report.
- Potentially highest costs of implementation
- Still some potential for negative external perceptions of additional 'taxation'
- Labour market impact more significant than purely supplementary scheme
- Guarantees greater minimum income in retirement
- Guards against regressive impacts with lower income threshold
- Stops higher income groups from using scheme as alternative investment option
The full text of their report is given in Appendix A.
1.37 Any change to supplementary pensions can potentially increase complexity and may have unintended consequences. The Board would therefore be in favour of further study of the detailed implementation of the supplementary mandatory system proposed, in combination with appropriate public consultation before the system could be introduced.
A number of relevant implementation issues were identified in chapters 6 and 7. The Board's current views on these topics are:
(a) A number of the Board members are in favour of increasing the contribution to the NPRF sufficiently to cover the entire long-term cost of the increase in the State pension. The amount of this increase is estimated to be about an additional 1.3% of GNP, or about €1.7 billion per annum. However, other Board members are not in favour of pre-funding these payments.
(b) Those making existing adequate occupational pension provision or who have sufficient savings would not be required to contribute to the SSR scheme. Detailed regulations would be required to define what would constitute adequate alternative provision and appropriate certification procedures would have to be designed and supervised.
(c) The Board's initial view favours the use of the PRSI system for collection of contributions, but recognises that considerable further investigation is needed.
(d) There is a range of views about what the upper limit for eligibility should be. There is some support for setting this limit at 3 times GAIE or approximately €90,000.
(e) The Board's initial view favours the investment of contributions by the State, possibly through the National Treasury Management Agency.
(f) Some Board members believe that it would be appropriate to provide investment guarantees for contributions to the SSR scheme. Such guarantees could provide a minimum investment return, or could ensure a minimum retirement income.
(g) The Board notes that the introduction of the Special Savings for Retirement system would require an increase in the regulatory resources required for ensuring compliance. This may include some or all of the Pensions Board, the Financial Regulator, the Revenue Commissioners, the Department of Social and Family Affairs, and possibly other bodies.
1.38 The Special Savings for Retirement system outlined in this report could improve retirement incomes for all existing and future retirees and encourage additional saving for retirement by those in the workforce.
1.39 The Board believes that the operation of the scheme should be carefully monitored so that any changes can be made in light of progress towards objectives and changes in circumstances affecting pensions. This may be the case if the scheme has any unforeseen effects.
1.40 While further consideration will need to be given to some of the implementation issues, the report provides a realistic picture of the practical implications of introducing such a system from a range of perspectives. In conjunction with the findings of the NPR, the Board believes that the up-to-date costs and projections shown in this report and its conclusions and recommendations will make a sound contribution to future decision making on pension provision.