Letter in today's IT re: AE

[nest egg]

Spotted this in today's IT. It's a good parallel to the perverse incentive O'Toole wrote recently about.

 

[Colm Fagan]

Well done, Brian! DSP seems to have gone on a solo-run with AE from the start. This is just another example of the mess they've made of it. Other posters on this forum have pointed to the ludicrousness of their plan to bypass the Revenue Commissioners for collection of contributions, whose expertise in this area is well-recognised, and also to bypass NTMA for investment of funds.
The net result of the tax proposals, if I read Brian's letter correctly, is that every contributory scheme in the country, no matter how good, will have to be restructured to allow lower-paid members to avail of the better tax reliefs for autoenrollment, resulting in massive unnecessary costs for scheme sponsors.

 

[jpd]

This shows what happens when schemes are thought up in ivory towers, or offices, and the rules appear fair and reasonable at the time but years later when the economy has moved to a completely different place, you find that they schemes have not and lead to anomalies

When the state pension scheme was setup, it was inconceivable that large numbers of people would move to Ireland and start paying PRSI late in life - Ireland in the 60s, 70s and 80s really was a different country

 

[Fortune]

I'd guess the government does intend to move to a single rate of pension tax relief (vaguely recall some party floating the idea), but just like every other pensions idea they had, they forgot to implement half of their plan. PRSAs to replace PPPs, PRBs and AVCs: introduce the PRSA, forget to get rid of the others. Now they e brought in their new tax relief, but forgot to get rid of the old ones

 

[Duke of Marmalade]

I'd guess the government does intend to move to a single rate of pension tax relief (vaguely recall some party floating the idea), but just like every other pensions idea they had, they forgot to implement half of their plan. PRSAs to replace PPPs, PRBs and AVCs: introduce the PRSA, forget to get rid of the others. Now they e brought in their new tax relief, but forgot to get rid of the old ones

A flat rate of pension incentivisation is certainly plausible and has been discussed at length in the UK. It is ideologically different from our current EET system and effectively removes subsidization of pension provision by high earners. But running the two systems in parallel is a recipe for disaster. Companies will need two parallel systems and move members between the two according as which gets the gets the better State subsidy.

 

[Duke of Marmalade]

This is not a sloppy mistake by the DSP mandarins - it has survived 5 years! It is deliberate high school leftie policy as is so clear from their presentation to the Joint Oireactas Committee last spring. Verbatim extracts are reproduced below. My commentary is shown in red.



It has been suggested that the State top-up approach should not be used, and tax relief maintained because this does not have an impact on whether people stay in or not. I think that is too simplistic an analysis. First, it is worth noting that the AE system is the only retirement savings system that people may be compelled to join by law [compelled?]. Therefore, the Government decided that all people within that pseudo-mandatory system should be afforded the same level of incentivisation from the State to ensure equality of treatment. [egalité, fraternité etc.] Everyone’s euro gets incentivised in exactly the same way. The tax relief system would not do that

As I say, if the committee wishes to make this point then it would obviously be a matter for the Minister for Finance in the first place and so on. [and Fintan O’Toole has the nerve to say these departments operate in silos] The only thing I would say to Deputy Ó’Cuív is that technically what he said was correct about how some people would do better in either a private or occupational scheme in terms of their net income following all the machinations [evil tax avoidance by the elite], at the high rate. The ones at the low rate, however, will do better under AE. Therefore, three out of four of the Deputy’s constituents who will be in AE will be delighted. [and 1 out of 4 will be conned, but they are fat cats, so who cares?]

The reason for this is that there is balancing going on. Instead of somebody getting an incentive at 20% as they would during the tax relief system , they are going to get it at 25% [actually 26.67% of gross income foregone] to make up for that increase in the incentivisation. High earners will also get it at 25% [actually 20% of gross income foregone], not at 40%, as they do in the tax relief system. As I said at the beginning, and maybe the Deputy missed this, you either buy the premise that people should be treated equally in terms of incentivisation and that every man’s euro is as valuable as another’s. If you do not, then you will definitely be in the tax relief camp. If you do, you cannot be in the tax relief camp. That is what it boils down to. [You’re either a neo liberal capitalist or a caring human being, forget about the fact that under EET the fat cats will pay 40% + higher rate USC on their pension.]

 

[JimmyB99]

I must admit I don't understand parts of this letter, as follows:

1. "Standard rate taxpayers in the auto-enrolment scheme will get an effective 26.6 per cent top-up of their gross income" - what does this actually mean and where does the 26.6% come from?

2. "They [higher rate taxpayers] currently get tax relief of 40 per cent of gross income forgone, but under auto-enrolment will only get a third of 60 per cent of that amount" - what's this meant to mean?

3. "Existing tax relief will therefore be a full double of the Department of Social Protection €1 for €3 top-up proposal" - again what does this mean?

 

[Duke of Marmalade]

I must admit I don't understand parts of this letter, as follows:

1. "Standard rate taxpayers in the auto-enrolment scheme will get an effective 26.6 per cent top-up of their gross income" - what does this actually mean and where does the 26.6% come from?

2. "They [higher rate taxpayers] currently get tax relief of 40 per cent of gross income forgone, but under auto-enrolment will only get a third of 60 per cent of that amount" - what's this meant to mean?

3. "Existing tax relief will therefore be a full double of the Department of Social Protection €1 for €3 top-up proposal" - again what does this mean?

That is understandable. The DSP says 1 for 3 top-up is equivalent to 25% tax relief for all taxpayers. What they mean is that a 1 for 3 top-up is 25% of the amount invested in the pension fund. That is a misleading comparison in terms of tax relief. It would only be equivalent to 25% tax relief if you were taxed at 25%!
The more accurate comparison with tax relief proceeds as follows:
1. A standard rate taxpayer sees 80% of their gross income in take-home pay (ignoring PRSI, USC etc.) . The key point is that the 1 for 3 top-up is added to after tax take-home pay and so amounts to 1/3rd of 80% of gross income for a standard rate taxpayer, which is 26 and 2/3rds per cent.
2. For a 40% taxpayer after tax income is 60% and a 1 for 3 top-up is therefore 1/3rd x 60% = 20%.
3. Clearly (I hope) this 20% of gross income support is only half of the 40% under the tax relief system.

 

[JimmyB99]

Thanks for replying, Duke

I find your approach very interesting. This is the way I always thought about it. Hmmmmmm. Excuse the formatting here!

	Trad approach		AE approach
Relative income	100​	100​	Relative income	100​	100​
Pension contrib	3​	3​	Tax rate	20%​	40%​
Net taxable	97​	97​	Net income	80​	60​
Tax rate	20%​	40%​	Net AE contrib	2.25​	2.25​
Net income	77.60​	58.20​	Net income after AE	77.75​	57.75​
Amount in Employee pension fund	3​	3​	Employee pension Fund	3​	3​

Only difference between Trad and AE approach is the treatment of contributions	20%​	40%​
Actual monetary differences in final net income	0.15	-0.45​
Expressing this monetary difference as a % of gross employee pension contribution	5%	-15.00%​
Actual relief on gross employee pension contribution as a % of that contribution under AE	25%​	25%​

 

[Duke of Marmalade]

@JimmyB99 Totally agree your figures. First of all let us accept that this debate, over a percentage of what, is not a big deal. We all agree that 1 for 3 top-up is somewhat better than tax relief for the 20% taxpayer and quite a deal worse for the 40% taxpayer.
You have taken the DSP approach and expressed the percentages in terms of the the amount invested. But a possibly more valid way is to think in terms of 100 pre-tax income directed to pension savings. The 20% taxpayer has 80 to direct whilst the 40% taxpayer only has 60. Under the current system that is cancelled out by the State providing a top-up equal to the tax deducted i.e. 20 and 40 resp. Under the 1 for 3 top-up the State subsidy is 1/3rd of 80 and 60 resp.
I think, if you agree the sums but please feel free to ask for clarification, we could park it at that - as I say, no big deal how you describe it.

 

[Duke of Marmalade]

@nest egg This is what we can expect if the tax anomalies are not sorted out

Earning €42,000 or more... beware!
According to the department there is approx 200,000 higher rate employees that will be brought into the AE scheme. For this cohort a Master Trust arrangement would generally be a preferable option for those employees. Employers need to seek advice and enable advisors to educate this cohort of employees in the benefits of alternative options instead of staying in the auto enrolled scheme.

 

[nest egg]

@nest egg This is what we can expect if the tax anomalies are not sorted out

I'm trying to wrap my head around why they've come up with two different incentive systems, the existing tax relief one, and this new scheme. It seems a backward move to make an already complex system more complicated.

I agree the "€1 for €3" has an attractive 'sales pitch', similar to the old SSIA scheme, and no doubt the idea is well intentioned, but did anyone stand back for a moment and ask the simple question, if you're auto-enrolling people, do you really need the 'sales pitch'?

 

[Towger]

I'm trying to wrap my head around why they've come up with two different incentive systems, the existing tax relief one, and this new scheme. It seems a backward move to make an already complex system more complicated.

I agree the "€1 for €3" has an attractive 'sales pitch', similar to the old SSIA scheme, and no doubt the idea is well intentioned, but did anyone stand back for a moment and ask the simple question, if you're auto-enrolling people, do you really need the 'sales pitch'?

The problem is you have to pay tax to get tax relief. We have system in Ireland (created by Bertie & Co) were the lower paid pay no Income Tax. The AE system is designed to give pensions to the lower paid and *in the long run reduce the burden on the state.

* 'Reduce the burden on the state' by denied by some.

 

[Duke of Marmalade]

The problem is you have to pay tax to get tax relief.

Indeed, a SSIA type incentive is required for very low or zero income tax payers. 1 for 3 is 33% better than 20% tax relief but it is a massive 50% less than 40% tax relief! The winners will be the financial advisors who will have a field day setting up parallel arrangements where employees switch between whichever system is best for their individual circumstances. Nonetheless there will be a large number of those 200,000 40% taxpayers who are automatically enrolled and who through ignorance or inertia will only get a half of the State subsidy that is available to them with a conventional arrangement.

 

[nest egg]

The problem is you have to pay tax to get tax relief. We have system in Ireland (created by Bertie & Co) were the lower paid pay no Income Tax. The AE system is designed to give pensions to the lower paid and *in the long run reduce the burden on the state.

* 'Reduce the burden on the state' by denied by some.

You have to look at the result. Ending up with duplicate incentive systems, with all of the associated additional overhead which goes with it, is a drastic response to that problem. By all means top up those who don't earn enough, but do it within the existing system. Every variable adds to complexity exponentially, creating yet another system doesn't serve the state nor its citizens well.

 

[Fortune]

You have to look at the result. Ending up with duplicate incentive systems, with all of the associated additional overhead which goes with it, is a drastic response to that problem. By all means top up those who don't earn enough, but do it within the existing system. Every variable adds to complexity exponentially, creating yet another system doesn't serve the state nor its citizens well.

The introduction of the PRSA was supposed to simplify pensions, but the government didn't fully implement the plans.

AE will similarly complicate matters, but there was never an intention it to simplify pensions (unless there's an objective of eventually making all tax relief on all pensions operate on the €1 for €3 basis).

 

[Duke of Marmalade]

AE will similarly complicate matters, but there was never an inventor it to simplify pensions (unless there's an objective of eventually making all tax relief on all pensions operate on the €1 for €3 basis).

Very interesting point. It is currently structured as an SSIA. Even the benefits, which will be paid 100% as a lump sum, will be tax free up to €200k, taxed at 20% between €200k and €500k and subject to full marginal tax (and USC?) over that amount. A 1 for 3 top up across the board would make the scheme unattractive to use this vehicle to provided for large pensions.
One could certainly argue why should the State incentivise high pension funds. It is clear from listening to the DSP defending the 1 for 3 top-up at JOC they do have the ultimate goal of achieving this across the board. That is why we have seen a big paring back of the attractiveness of funding for large pension funds through supplementary State subsidised arrangements.
There seems to be a general sense that the 100% lump sum benefit is only a temporary measure until they get their act together on how pensions will actually be delivered. The general assumption is that this will eventually be along current lines of only 25% being by lump sum. But nowhere has the DSP said this and it was not in the draft Heads of Bill. Maybe all will be revealed next Wednesday when the draft Bill itself is expected to be published.