The (Witch) Hunt for Pensions Equality
Recent weeks have seen an outpouring from various media and lobby groups decrying the pension provision of certain high profile individuals and seeking greater equality in the area of pension provision. Whilst there may be a rational for certain elements of the witch hunt, the recent report by the ESRI suggesting a radical overhaul of the pensions framework is totally misplaced.
The ESRI report “ A Level Playing Field” written by Professor Gerard Hughes of Trinity College seeks to promote “equity in pension tax relief” and suggests that this is achieved by penalising one section of the pension investor community so as to incentivise another section. In particular it demonises those higher earners(!) seeking to make pension provision for their old age and suggests that by penalising such group we will encourage a greater take-up by those not currently making such provision. This and much else in the report is just flawed logic.
The report continually refers to equality. But this search for equality has shades of the totalitarian states of yesteryear, where equality is achieved by reducing everybody to the lowest common denominator. The reality is that the world is not equal:
Some people are more talented than others (Rory McIlroy)
Some people are more intelligent than others (Albert Einstein)
Some people make more use of their talents and intelligence than others
Some people are better looking than others (Halle Berry)
Some people earn more than others (Michael O’Leary)
Some people live longer than others
We seem to have reached a stage in Ireland where those earning more than €100,000 p.a. are vilified and have become a target for certain ideological groups. It seems that irrespective of their work and contribution (whether it is saving lives or creating employment), such individuals should be taxed out of existence. Rather than seeking to encourage success (if measured in income terms) we seek to drag such individuals down in the interest of “equality”.
Professor Hughes report seems to follow in this vein by suggesting:
That the current pension tax system favours the higher paid at the expense of the lower paid
That by reducing the tax relief (penalising?) available to the higher paid we will encourage more lower paid individuals to invest in pensions
Personal contributions to pension funding should be granted tax relief on the way in at standard rate only
The earnings cap (the income on which pension provision is targeted) should be reduced to €75,000
The pension fund cap (the maximum fund an individual can accumulate to provide for old age) should be capped at €622,500
We are only short of introducing the Mao suit as a standard dress code for all citizens.
The premise for much of the proposals above is based on a flawed understanding of how pensions operate:
Reducing Tax Relief :
The Irish pension system is largely based on a “deferred taxation” model. This means that pension investors get tax relief on the way in and pay tax on the way out (on their pension income). The only genuine “tax break” is the facility to take a small portion of the pensions pot as a tax-free lump sum.
So currently higher earners get tax relief on contributions invested at a marginal rate of 41% but these individuals will more than likely pay tax on the resulting pension income at a similar or higher rate. Currently higher earners are more than likely to be paying tax at 48% (41% PAYE+ 7% USC) on their pension income.
If the tax relief on the way in was reduced to say 20% for all, but the eventual income was to be taxed at 48% (or more) it would in fact be a disincentive/penalty for such individuals to save for their old age. It is important to remember that the full income is liable to tax (i.e. the capital invested and any investment growth). So if you Standard Rate the relief on the way in, then the eventual income must be taxed similarly on retirement.
There is no evidence to suggest that by penalising higher earners in trying to make provision for their old age, that we would somehow encourage those lower paid to make similar provision. It seems like penalising higher paid simply because they are higher paid.
The reality is that for those lower paid individuals in our society, the priority is about managing today rather than trying to manage 20 or 30 years down the road. That is where the State Pension and other benefits, come in as a basic safety net.
Pension saving is about deferring consumption today so as to provide a reasonable (not extravagant) income in 20 or 30 years time. For those that can afford some pension savings, penalising them for so doing is hardly equitable. Capping the eventual fund has some logic, but the relationship between the fund cap and the potential income it might provide needs to be re-examined.
The report suggests that the total cost of tax relief is some €3b (a figure disputed by many). But this ignores the tax on pension income, i.e. tax relief on the way in but taxed on the way out.
Reducing the Salary Cap
Reducing the salary cap to €75,000 seems to be part of this concept that people earning such amounts are “rich” and don’t need to be encouraged to plan for their retirement. The reality is that if such a self-employed individual contributed say 15% of such income to a pension structure for say 30 years, the eventual fund (based on reasonably conservative assumptions) would likely only be sufficient to provide a pension of about 23% of income at retirement.
The report’s proposal seems to be based on the concept that one should not be allowed a total pension of more than €37,500 p.a. (State pension + private pension) plus a retirement lump sum of €112,500 (150% of €75,000). This has overtones of the “single child policy” in China.
Reducing the Fund Cap
As a consequence of the maximum pension of €37,500, the Professor proposes a reduction in the Fund cap to €622,500. After allowing for the lump sum, the residual fund in theory provides a private pension of €25,500, which when added to the State pension totals €37,500.
Even if one accepted the €37,500 figure as being reasonable (I consider it totalitarian), the reality is that the residual fund of €510,000 would not buy an annuity (pension) of €25,500 in today’s annuity market. Such a sum would only purchase an annuity of circa €15,500.
The 20:1 conversion factor favours those in Defined Benefit schemes (such as Professors in TCD) in that it downplays the notional market value of their pension benefits, but results in a totally unrealistic fund for say the self employed person who can only accumulate a Defined Contribution fund. A more equal conversion factor, based on real annuity rates, would be circa 30:1
So if Government want to reduce the Fund cap to that sufficient to provide a pension income of €60,000 (as in the Program for Government), then the cap needs to be not less than €1.8. Whilst €1.8m might seem a huge sum (and it is if you won it on a Saturday night in the Lotto and nothing else changed), in pension terms it equates to €60,000 p.a. A typical male retiring today at age 65 has a life expectancy of some 20 years and in the case of females it is approaching 24 years. So that fund has to last a long time, particularly if one builds in a modest indexation rate and provision for the pension to continue to be paid (even at a reduced rate) to a surviving spouse on the death of the pensioner.
The report focuses on a small number of headline cases where very significant funds were accumulated. But extrapolating from such indefensible arrangements and penalising the vast majority of ordinary pension investors simply trying to be financially prudent by saving for their old age, is grossly inequitable. Bad cases make bad law.
The reality today is not that excess funds are being invested into pension plans and benefitting from substantial tax breaks, but the reverse. Industry figures show that the level of pension contributions is falling (whilst longevity is rising). Reducing the tax relief on the way in to Standard Rate (and doing nothing about the tax on the eventual pension income) will effectively result in huge numbers of people ceasing contributions entirely (other than those locked into contributing to Occupational Pension Plans, such as public servants). Where funds are locked away for some 30 or 40 years in an effort to reduce ultimate pensioner poverty, workers need a tangible tax inventive to defer consumption now in favour of income in 30 or 40 years from now. If tax relief on the way in was reduced to 20% but the eventual income was to be taxed at say 48%, I suspect that 100% of self employed would immediately cease all contributions. Whilst this might satisfy some equality ideologists today, it will do little for future generations of pensioners.
The current witch hunt on those “rich” earning over €100,000 (and those seeking to prudently plan for an income in old age) is largely misplaced. Rather than vilifying such individuals we should be encouraging others to aim for such success and thus increase employment and national wealth. A policy of dragging everybody down to the lowest common denominator is not a strategy that will serve this nation well, either in the short term or long term. The difficulty with pension planning is that it is by its nature a long term exercise. Individuals locking money away for some 30 or 40 years need a level of taxation certainty. The current uncertainty around the taxation of pension plans is doing nothing to encourage what should be prudent financial planning. This uncertainty is resulting in the amount of pension contributions being saved reducing significantly and thus the amount of tax relief is reducing also. Previous Governments have been rightly criticised for various short term taxation policies in the past (e.g. Charlie McCreevy's policy of spending all taxation income when he had it). I expect that the current short-term pension taxation focus is something that many will live to regret in the future.
Recent weeks have seen an outpouring from various media and lobby groups decrying the pension provision of certain high profile individuals and seeking greater equality in the area of pension provision. Whilst there may be a rational for certain elements of the witch hunt, the recent report by the ESRI suggesting a radical overhaul of the pensions framework is totally misplaced.
The ESRI report “ A Level Playing Field” written by Professor Gerard Hughes of Trinity College seeks to promote “equity in pension tax relief” and suggests that this is achieved by penalising one section of the pension investor community so as to incentivise another section. In particular it demonises those higher earners(!) seeking to make pension provision for their old age and suggests that by penalising such group we will encourage a greater take-up by those not currently making such provision. This and much else in the report is just flawed logic.
The report continually refers to equality. But this search for equality has shades of the totalitarian states of yesteryear, where equality is achieved by reducing everybody to the lowest common denominator. The reality is that the world is not equal:
Some people are more talented than others (Rory McIlroy)
Some people are more intelligent than others (Albert Einstein)
Some people make more use of their talents and intelligence than others
Some people are better looking than others (Halle Berry)
Some people earn more than others (Michael O’Leary)
Some people live longer than others
We seem to have reached a stage in Ireland where those earning more than €100,000 p.a. are vilified and have become a target for certain ideological groups. It seems that irrespective of their work and contribution (whether it is saving lives or creating employment), such individuals should be taxed out of existence. Rather than seeking to encourage success (if measured in income terms) we seek to drag such individuals down in the interest of “equality”.
Professor Hughes report seems to follow in this vein by suggesting:
That the current pension tax system favours the higher paid at the expense of the lower paid
That by reducing the tax relief (penalising?) available to the higher paid we will encourage more lower paid individuals to invest in pensions
Personal contributions to pension funding should be granted tax relief on the way in at standard rate only
The earnings cap (the income on which pension provision is targeted) should be reduced to €75,000
The pension fund cap (the maximum fund an individual can accumulate to provide for old age) should be capped at €622,500
We are only short of introducing the Mao suit as a standard dress code for all citizens.
The premise for much of the proposals above is based on a flawed understanding of how pensions operate:
Reducing Tax Relief :
The Irish pension system is largely based on a “deferred taxation” model. This means that pension investors get tax relief on the way in and pay tax on the way out (on their pension income). The only genuine “tax break” is the facility to take a small portion of the pensions pot as a tax-free lump sum.
So currently higher earners get tax relief on contributions invested at a marginal rate of 41% but these individuals will more than likely pay tax on the resulting pension income at a similar or higher rate. Currently higher earners are more than likely to be paying tax at 48% (41% PAYE+ 7% USC) on their pension income.
If the tax relief on the way in was reduced to say 20% for all, but the eventual income was to be taxed at 48% (or more) it would in fact be a disincentive/penalty for such individuals to save for their old age. It is important to remember that the full income is liable to tax (i.e. the capital invested and any investment growth). So if you Standard Rate the relief on the way in, then the eventual income must be taxed similarly on retirement.
There is no evidence to suggest that by penalising higher earners in trying to make provision for their old age, that we would somehow encourage those lower paid to make similar provision. It seems like penalising higher paid simply because they are higher paid.
The reality is that for those lower paid individuals in our society, the priority is about managing today rather than trying to manage 20 or 30 years down the road. That is where the State Pension and other benefits, come in as a basic safety net.
Pension saving is about deferring consumption today so as to provide a reasonable (not extravagant) income in 20 or 30 years time. For those that can afford some pension savings, penalising them for so doing is hardly equitable. Capping the eventual fund has some logic, but the relationship between the fund cap and the potential income it might provide needs to be re-examined.
The report suggests that the total cost of tax relief is some €3b (a figure disputed by many). But this ignores the tax on pension income, i.e. tax relief on the way in but taxed on the way out.
Reducing the Salary Cap
Reducing the salary cap to €75,000 seems to be part of this concept that people earning such amounts are “rich” and don’t need to be encouraged to plan for their retirement. The reality is that if such a self-employed individual contributed say 15% of such income to a pension structure for say 30 years, the eventual fund (based on reasonably conservative assumptions) would likely only be sufficient to provide a pension of about 23% of income at retirement.
The report’s proposal seems to be based on the concept that one should not be allowed a total pension of more than €37,500 p.a. (State pension + private pension) plus a retirement lump sum of €112,500 (150% of €75,000). This has overtones of the “single child policy” in China.
Reducing the Fund Cap
As a consequence of the maximum pension of €37,500, the Professor proposes a reduction in the Fund cap to €622,500. After allowing for the lump sum, the residual fund in theory provides a private pension of €25,500, which when added to the State pension totals €37,500.
Even if one accepted the €37,500 figure as being reasonable (I consider it totalitarian), the reality is that the residual fund of €510,000 would not buy an annuity (pension) of €25,500 in today’s annuity market. Such a sum would only purchase an annuity of circa €15,500.
The 20:1 conversion factor favours those in Defined Benefit schemes (such as Professors in TCD) in that it downplays the notional market value of their pension benefits, but results in a totally unrealistic fund for say the self employed person who can only accumulate a Defined Contribution fund. A more equal conversion factor, based on real annuity rates, would be circa 30:1
So if Government want to reduce the Fund cap to that sufficient to provide a pension income of €60,000 (as in the Program for Government), then the cap needs to be not less than €1.8. Whilst €1.8m might seem a huge sum (and it is if you won it on a Saturday night in the Lotto and nothing else changed), in pension terms it equates to €60,000 p.a. A typical male retiring today at age 65 has a life expectancy of some 20 years and in the case of females it is approaching 24 years. So that fund has to last a long time, particularly if one builds in a modest indexation rate and provision for the pension to continue to be paid (even at a reduced rate) to a surviving spouse on the death of the pensioner.
The report focuses on a small number of headline cases where very significant funds were accumulated. But extrapolating from such indefensible arrangements and penalising the vast majority of ordinary pension investors simply trying to be financially prudent by saving for their old age, is grossly inequitable. Bad cases make bad law.
The reality today is not that excess funds are being invested into pension plans and benefitting from substantial tax breaks, but the reverse. Industry figures show that the level of pension contributions is falling (whilst longevity is rising). Reducing the tax relief on the way in to Standard Rate (and doing nothing about the tax on the eventual pension income) will effectively result in huge numbers of people ceasing contributions entirely (other than those locked into contributing to Occupational Pension Plans, such as public servants). Where funds are locked away for some 30 or 40 years in an effort to reduce ultimate pensioner poverty, workers need a tangible tax inventive to defer consumption now in favour of income in 30 or 40 years from now. If tax relief on the way in was reduced to 20% but the eventual income was to be taxed at say 48%, I suspect that 100% of self employed would immediately cease all contributions. Whilst this might satisfy some equality ideologists today, it will do little for future generations of pensioners.
The current witch hunt on those “rich” earning over €100,000 (and those seeking to prudently plan for an income in old age) is largely misplaced. Rather than vilifying such individuals we should be encouraging others to aim for such success and thus increase employment and national wealth. A policy of dragging everybody down to the lowest common denominator is not a strategy that will serve this nation well, either in the short term or long term. The difficulty with pension planning is that it is by its nature a long term exercise. Individuals locking money away for some 30 or 40 years need a level of taxation certainty. The current uncertainty around the taxation of pension plans is doing nothing to encourage what should be prudent financial planning. This uncertainty is resulting in the amount of pension contributions being saved reducing significantly and thus the amount of tax relief is reducing also. Previous Governments have been rightly criticised for various short term taxation policies in the past (e.g. Charlie McCreevy's policy of spending all taxation income when he had it). I expect that the current short-term pension taxation focus is something that many will live to regret in the future.