Pension Tax Relief

I heard Fr. Sean Healy on the radio yesterday suggesting that all tax reliefs should be at the Standard Rate, including the tax reliefs associated with pension contributions.
Whatever about the logic for this in relation to medical costs etc, I cannot follow the logic in relation to Pensions. If I am only going to get tax relief at say 20% on the contributions but will be taxed at 41% on the income, why save for retirement? Remenber that all the pension income (the original capital and the investment growth) is taxable as income in retirement. So if I am paying more tax on the income than I am getting tax relief on the contributions, it makes no sense in such saving.
Unfortunately the Fingleton example (a complete disgrace for a mickey-mouse building society) only gives ammunition to this argument. But yet again I was disappointed at Roisin Shortall on Q&A last night who jumped on the bandwagon when complaining about pension tax breaks. Alan Dukes had to remind her that there is now a Pension Cap on pension funds. The horse may have bolted in relation to Mr. Fingleton, but why should all the ordinary decent pensioners (prospective pensioners) be penalsied for the actions of a few renagades?

Agree wholeheartedly - standard rating tax relief on pensions would be a foolish move. The notion of the super-rich getting most benefit from these tax reliefs is a myth. If you have a multi-million pension fund at retirement, then you're going to be paying high-rate tax on your pension when you retire, so the Exchequer will be getting tax back off you.

Those who get maximum benefit from pension tax relief are those who are paying high-rate tax during their working life but only accumulate a pension fund of a size that will be taxed at the standard rate (or not at all) in retirement. These aren't the Fingletons of this world.

If they do this, vast numbers of higher-rate taxpayers will simply stop their pension contributions, rolling back all the good work done by pensions awareness campaigns of the past few years. And yes, it will cause redundancies in the industry in which I work, so there's my vested interest.

This is a subject on which I have been soap-boxng a lot recently...
http://fergablog.blogspot.com/2009/03/pension-tax-cuts-in-budget.html

I've been thinking a lot about this.

Firstly I believe the tax free lump sum cannot be justified. It's the most abused element of the tax incentives for private pensions, being used for tax efficient mortgages, etc.

Second we have to look at who benefits. Say the social welfare pension is approx €12k, the standard tax rate kicks in at an income of €18k and the higher rate kicks in at €36k.

A standard rate tax payer is therefore incentivised to provide €6k retirement income leaving them below the taxation threshold once this is added to the social welfare pension.

The higher rate taxpayer has an even greater incentive to provide €6k retirement income for themselves with lesser incentive up to €24k and little incentive beyond this point.

Given that there is very little benefit to providing for a retirement income in excess of €24k per annum (€36k p.a. when added to the social welfare pension), I would personally have no problem capping pensions relief at the point where a persons fund guarantees them this level of retirement income (adjusted for inflation). People can adjust their contributions accordingly.

If the relief on pensions contributions is standard rated, however, there is no incentive for anyone to aim to provide for a retirement income of more than €6k p.a. for themselves. This, personally, is where I see a problem. I don't think it an extravagance to incentivise anyone to provide for a retirement income of €36k if they're willing to stump up most of it themselves. Remember it is only the first €6k that gets full relief, the next €18k will be taxed at the standard rate so the net incentive is lower.

The one issue I'd be concerned about is that the higher rate tax payer gets a greater incentive to provide a private pension. It is easy to get over this once you remember that this incentive is only possible because the person on the higher rate of tax is paying this amount, and more, in extra taxes to begin with!

To summarise my position. I'd do away with the tax free lump sum and continue to allow marginal tax relief on pension contributions only up to the point where a person builds up a sufficient pension fund to provide a retirement income (including social welfare) up to the higher rate tax band. I don't think the government need to incentivise retirement income greater than this even if the tax treatment only provides for a deferral of taxes.

I'm equally dependant on the private pensions industry as LDFerguson and my overriding feeling is that people should be incentivised to provide for their own retirement, but only up to a point.

Just to add, I think the likes of Fr Sean Healy and Paula Clancy of TASC are living in some kind of theoretical communist paradise. They evidently do not believe that people need to be incentivised to look after themselves.

It is in the interests of the state to encourage every member of society to ensure that they do not end up a burden on society but rather take sensible steps, with appropriate incentives, to provide for the future.

I'd like to know whether Fr Healy has heard the expression that God helps those who help themselves?

That's quite a hard hitting attack.

I have to disagree on your point that the approximately 50% of people who have no form of private pension are the smart ones who have somehow copped on to something that those who do take out pensions do not seem to comprehend.

The reality is that the majority of those who do not take out pensions are the lower paid who either cannot afford the contributions or are not incentivised enough to do so.

I'd also take issue with your point on charges. Working for an insurer with a presence in every major market across the world, the margins on the Irish business are close to the most competitive in the world.

You've also stated that people would be better off putting their savings in simple deposit accounts if they were able to avail of the tax breaks. The fact of the matter is that most pension providers now offer simple deposit accounts with low fees and interest rates comparable to the banks as a fund choice.

As regards your comment that people need to put away 30% of income to get a secure retirement I think we need to think about it more clearly. A person of 30 starting a pension can expect to pay into it for 35 years and draw down from it for 20 to 25 years. You can obviously only get back what you put in. This is not an industry failure.

I think your failed industry jibe is way off the mark. The regulation and statutory protections for Irish Pensioners compare very favourably to any other industry. Other industries could actually learn quite a lot from an understanding of the regulations in the industry.

The tone of your post is negative in the extreme. There are abuses and short comings in the industry and I think these can be tackled with well thought through actions such as the ones described in posts above. Providing better incentives for those on incomes below the average industrial wage would be a priority for government.

The insurance/pensions industry has always showed itself to be innovative and adaptable in the past. It can encourage broader pension coverage amongst the lower paid provided the government takes sensible decisions to target incentives in a worthwhile way.

There is a social good in incentivising people to provide for their retirement as it ensures they are not a future burden on society. My view is that the social welfare payable in old age is currently sufficient to provide for a very basic standard of living, but those relying solely on this do require publicly funded health care, medical cards, etc. Well thought through incentives that reward those who save rather than squander will benefit society in the long run.

Those who suggest scrapping such incentives need a reality check, all this will achieve will be to penailise consciencious individuals who wish to look after their own financial future rather than rely on state support.

Every time there is a stock-market crash, it drags down the average performance figures of pooled funds of all sorts, including pension funds and people come out claiming that pensions are a bad idea and should be scrapped etc. Then the markets recover and only those who were foolish enough to cash in at the market low have actually lost anything and the world keeps turning.

Peter - in separate pension-bashing threads, you suggested an alternative pension system with no risk and no charges. Such a proposition has merit and could be considered by some of the banks - a deposit-type pension. But it would not replace all other forms of pension system - it would only be suited to those with a very low risk tolerance. There are vast numbers of people out there, myself included, who understand that over the long term, a fund investing in higher-risk assets such as equities, property etc., will outperform a lower-risk fund, even if the value will be decimated from time to time by cyclical market crashes.

A little over a week ago two letters appeared in the Irish Times: one written by me, and one from TASC. These letters explicitly described the private pensions industry as a "failed industry", and called for a completely different model where the consumer rather than the industry would get the benefits of the tax-relief. I do not know of any other industry in Ireland which, if labelled a "failed industry" would not have responded with a storm of rebuttal. Incredibly, there was not a single response in defence of this industry (I predicted this non-reaction in a communication with Paula Clancy of TASC). The reason is clear. The pensions industry knows it is indefensible.

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I didn't see the letters in question as I rarely read the letters page in the Irish Times. But I wouldn't be interpreting any lack of rebuttal as some form of grand conspiracy of silence. I could write a letter today to the Irish Times accusing the pensions industry of being responsible for the disappearance of Shergar. I wouldn't expect a rebuttal. Like your opinion that the pensions industry is a failed industry, the allegation would simply be wrong. Like every other pension system, the Irish pension system is not perfect and could certainly be improved. But it hasn't failed the hundreds of thousands of pensioners it has served well over the years.

Just to add to what LDFerguson has said, I don't actually believe deposit/cash based funds are a "no risk" strategy in relation to pensions.

If Europe were to follow the lead of the USA and effectively print money to drag the economy out of recession then this would put upward pressure on inflation. I don't think it is sound advice to tell someone to hold their pension funds in cash over very long terms as their real values could be seriously eroded by inflation.

Inflation is as big a risk to long term investments held in cash as stock market returns are to equity based pensions.

The Irish Association of Pension Funds has called on government to consider issuing inflation linked bonds which pension providers could offer to their customers. This would give a guarantee of secure real returns to private pensions.

Interesting debate alright . .

One thing I would say is that clients putting their pension monies into cash isnt necessarily over exposed to tactics like printing money.

If you are on the higher tax rate getting the 41% relief on your savings, the value of your currency has to dip significantly for you to lose the value of your investment.

I agree that Cash is generally not a long term strategy that people should take up but Some clients like the idea of getting 1%-3% return on their investment and look at the advantages of the tax relief as their gains.

There is also a scenario whereby some clients can leave their €59 invested in Cash and can Invest their €41 in equities. In essence, they look on it that this is €41 that they wouldnt of had anyways, so they are willing to take a calculated gamble on this monies, ensuring that the actual cost (€59) of savings should maintain a decent value.

Irrespective whether you invest the pension contributions in Cash or Equities (or something else) my point is that if you only get Standrad Rate relief on the way in but are taxed at Marginal Rate on the way out, then the process makes no sense. "Tax relief" in pension plans is really only "tax deferral", in that you get tax relief on the way in and pay full tax on the way out. Remember that the full pension is liable for tax, not just the growth.
In contrast to non-pension investments, where no tax relief applies, investors are only taxed (Exit Tax) on the growth (not on the element that is the return of the original invested capital).
I fully accept that the Tax Free Lump Sum element is a bit of "cream" and therefore in the current climate is probably a target for some tax hit.

Peter Murray:

Things are now so bad that middle-income people are now being advised that they will need to invest 30% of their incomes to assure (we hope!) retirement security. Few middle-income can invest this much in their pension. Ergo, these products are unsuitable for middle-income people.

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This is as logical as the rest of your comments. Just because many(most?) middle income people may not be able to afford to invest 30% p.a. of income into a Pension does not mean the vehicle is unsuitable. It simply means that they may have to scale back their expectations in terms of income in retirement.

Finally, it is also worth remembering that for a sizeable portion of the poulation, the State Pension (circa €22,700 p.a. for a couple over age 65) may well be sufficient. If you take average industrial earnings at say €34,000 then the State pension represents circa 2/3rds of income. For this sector of the population they made have no need for a private pension.
However for the self employed (who may not get a State pension) the need for private provision is more critical.

peter murray said:

4. There is no reason whatsoever to believe that things will be any different in the future.

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There's no knowing what way things will go in the future. For years nobody thought the 10 years equity return index could be negative. In the same way people casting their minds back no further than 20 years would not see inflation as a serious potential threat to cash on deposit

peter murray said:

9. My argument is not that the tax-relief should be abolished, but that it has not gone to the people or for the purpose for which it is ostensibly intended.

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And this is due to tax policy which is not dictated by the pensions industry. I think your main objectives would be achieved if the government simply limited relief based on the potential retirement income.

peter murray said:

10. There are no products available from the major financial institutions which match my requirements. They all have the same catch. After an initial "come-on" period when the money is invested in an interest-bearing fund with positive returns after charges, the institutions become free to reduce the interest rate below the level of the charges so that the investor is forced to accept negative returns or transfer into a high charges equity-based fund. No thanks.
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There are several offerings that guarantee to track ECB

peter murray said:

11. If the state pension is adequate for people with modest incomes why are the institutions and agents trying to flog private-pensions to these people - particularly because such people are in no position to gamble on risky products, and where it is well known that they are unlikely to be able to sustain a sufficient investment over a sufficient period of time to generate a worthwhile sum on retirement?.

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It does people no harm to provide a little extra retirement income for themselves no matter what their income. One particular advantage of PRSAs is that charges are capped no matter how small your fund i.e. pension providers take a loss on those paying low premiums

I think you've made a number of sensible points and I see merit in most of them. An overhaul of the taxation incentives around pension provision and increasing the competitiveness of charges cannot be argued with.

I don't think cash funds, however, are a "no risk" strategy for long term investment and I don't think that it would be a wise idea to nationalise the administration of private pensions provision for reasons of efficiency

Off hand I know Irish Life and Eagle Star offer that with an ongoing fee based on percentage of fund.

I don't think that they can compete directly with the banks in terms of charges due to more onorous ongoing administration costs associated with pensions; PRSAs for example have very onorous disclosure both up front and and on an ongoing basis throughout the lifetime of the policy

Just to clarify the management charge on pensions is set at a level that will cover general administration charges and provide a certain level of profit. It does not reflect the costs of asset trading alone. A typical example would be where 0.15% of a 0.75% per annum charge covers the day to day trading of the funds, with the remaining 0.6% covering administration charges and profit