Interaction between AE and conventional pensions

[Colm Fagan]

@Duke of Marmalade posted yesterday on another thread:
"What a dog's dinner the 2018 Strawman is turning out to be. Here is the litany of errors.
1. Four providers would compete at the retail level. That has now been changed to the CPA being the single interface with the end user.
2. Those who did not want to choose a provider would be apportioned one on a random basis - the carousel. This nonsense was quickly dropped.
3. The proposition would follow the SSIA successful precedent, in particular benefits would not be taxed. Have they actually ditched this silliness? The fact is that we know nothing about the decumulation phase despite being promised in 2018 that this key aspect would be sorted out in time for launch. Not so.
4. The 0.5% cap on AMC is conspicuously absent from the Heads of Bill, though the DSP do still claim that this is the intention.
5. And finally the (two) elephants in the room. They have not addressed the two major distortions (in different directions) caused by introducing this 1 for 3 top up instead of the traditional tax relief. The least of the worries is that this causes is the need for parallel systems. It simply won't work."

The Duke is right. It's a mess. The question is how to fix it. One problem area is differences in tax treatment between conventional pensions and AE. I once thought that Brian Woods' suggestion of giving all AE contributors the 1 for 3 top-up AND giving them entitlement to tax relief in the same way as a conventional pension BUT eliminating double incentivisation by negative tax credits (see the attached submission to the SSISI) would do the trick. But it doesn't. It means that low-income (say 20% taxpayers) do worse under conventional pensions, so it would force the closure of all such schemes, at least for contributions up to the AE limit.
Having thought about it some more, I conclude that the best way forward (not perfect - nothing is perfect, given that the 1 for 3 top-up was poorly thought-out in the first place) is to operate AE completely outside the tax and SW systems and to match the 1 for 3 top-up on the way in with a 25% deduction from all benefits on exit. There is gross roll-up in the fund.
It is very reasonable to ask why treat everyone the same. The answer is that it's the job of the tax and SW systems to ensure that the poor are protected and that the rich pay a fair proportion of the cost of keeping the show on the road. To ask the AE system to help achieve that purpose is sending a girl out to do a woman's job.
I agree with critics that there's an element of smoke and mirrors to my proposal and that it's reasonable to ask why government is effectively investing some of its money in the AE system, since it's certain to get it back eventually. One could argue that it's some compensation for all the hidden liabilities the state has in other areas. Its big plus though is that it reduces the risk of existing good pension schemes being closed just because of AE, as would be true for the proposed scheme as currently envisaged.
I should add, finally, that this is quite separate from any arguments about the merits of my smoothed equity proposal, other than I'm proposing contributions from employers and workers of just 3% of earnings (rather than 6%) and 1% rather than 2% from the state. This leaves more room for top-ups under conventional pension arrangements.

 

[Duke of Marmalade]

I agree with critics that there's an element of smoke and mirrors to my proposal and that it's reasonable to ask why government is effectively investing some of its money in the AE system, since it's certain to get it back eventually. One could argue that it's some compensation for all the hidden liabilities the state has in other areas. Its big plus though is that it reduces the risk of existing good pension schemes being closed just because of AE, as would be true for the proposed scheme as currently envisaged.

Well Colm, I think I would be one of those critics. Just to make everything clear let's look at an example, Consider a member contributing 300 from take-home pay and that investment growth is 100%. Well, they get 400 invested and finish up with 800 and they are then deducted 25% leaving 600 retirement benefits (tax free thereafter). But the top-up has been pure illusion, as left to their own devices, the 300 would have ended up as 600 anyway. The top-up has been an investment by the State for its own benefit. You are right that there are merits in that but surely the State should manage its own investments rather than leave it to the hoi polloi.
Your proposal is of course much worse than traditional for all taxpayers. But I agree that the Woods/Irish Life solution leaves AE better for all taxpayers.
There is a solution which preserves the 1 for 3 top up. AE should be CE (Compulsory Enrolment) just like PRSI/OAP. In fact, just like the old UK SERPS which was a supplementary to OAP. There would probably need to be a provision for contracting out like in SERPS or alternatively the CE limit should be reduced to say €50k. All problems of comparison between CE and traditional disappear just as there is no issue of comparing PRSI/OAP with traditional.
And of course CE is perfect for your smoothing proposal as it eliminates much of the residual anti selection and, as you say, 3% contribution from the EE/ER, esp. on a lower upper limit, leaves lots of headroom for traditional.

 

[Duke of Marmalade]

Colm has PM'd me to point out that I omitted the employer contribution element in the calculus of my last post. Fair point. It still remains that the 1 for 3 top-up on the employee contribution followed by 25% deduction would be an illusion and not an efficient way for the State to invest its funds. So the revised system would simply be tax free roll-up, no State intervention at entry and 12.5% deduction at exit.
This would be inferior to traditional for 20% tax-payers and superior for 40% taxpayers, the opposite of the current DSP proposal.
Colm agrees with me that compulsion would remove the relevance of which system was better and I agree with him that at this stage that is a non starter. He also points out that the problem does not arise if we adopt the ESRI suggestion that AE should be treated the same as traditional but again that would seem to be a non runner at this stage though definitely would have been a valid starter back in 2018 as it simply follows the UK NEST example.

 

[Colm Fagan]

OK, @Duke of Marmalade , you're right again - as usual.
One possibility is to change the 1 in 3 AE top-up to 1 in 4. This adjustment, together with Brian Woods' suggestion of a negative tax credit, as set out on pages 28 and 29 of the JOC Report and in the SSISI submission on the Whelan/Halley paper (attached above) seems to achieve parity of esteem between the two systems for anyone paying tax. Non taxpaying contributors to a conventional scheme still do better under AE.
The big question, though, is whether government will be prepared to backtrack and change the 1 in 3 to 1 in 4? The only alternative, if conventional schemes are not to be put at a disadvantage to AE, is to increase the tax relief on conventional schemes. Government never signed up for this amount of largesse.