# The (Witch) Hunt for Pensions Equality



## Conan (19 Nov 2012)

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.


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## DerKaiser (19 Nov 2012)

The capping of private pensions does not preclude anyone from separately making long term investments (outside of the pensions infrastructure) to provide for retirement. I don't get the totalitarian comment.

In fact, I see limiting tax relief granted (based on a maximum retirement income of €37,500) as a non-debate, since providing for pensions earnings in excess of this cap is not tax efficient and even though many people do it currently, I feel they have been badly advised.

The current system is actually quite elegant if used properly. It encourages middle earners to provide moderate incomes for themselves in retirement. 

The two proposals that would be most destructive are a fund cap of less than €800k (as it would be insufficient to provide the stated income) or the granting of standard tax relief only.

Footnote: There seems to be a working assumption that granting only standard rate relief would need to be accompanied by limits on contributions or funds. The reality is that standard rating tax relief would pretty much stop everyone from contributing as the amount you could earn in excess of the OAP before becoming eligible for income tax would be minimal. A lack of understanding of this does not inspire me with confidence that the author fully grasps the system.


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## orka (21 Nov 2012)

DerKaiser said:


> I see limiting tax relief granted (based on a maximum retirement income of €37,500) as a non-debate, since providing for pensions earnings in excess of this cap is not tax efficient and even though many people do it currently, I feel they have been badly advised.


I think this is a really really important point. If someone has already passed the point where they are likely to be high-rate tax-payers in retirement, it is a marginal call whether further contributions make sense as they may end up paying more tax overall than they would by taking taxed cash now and investing it to provide retirement income outside the pension framework. Advising someone to keep investing and/or lobbying for tax relief to be maintained above a point when it might be advisable for someone to invest is perhaps not in the best interest of the customer. Conan, I agree with you that there is a bit of a witch-hunt against high earners and if someone can afford to provide themselves with a high retirement income, then that should be encouraged not pilloried – but why would it be advisable for someone to fund a pension in excess of the high rate cutoff point? Surely they would be better funding in a pension structure to the cutoff point and then investing after-tax income in other investments to provide retirement income just not inside a pension?

Which brings me to one of my big bugbears with all these potential changes – there is very little impact on members of defined benefit schemes, particularly non-contributory ones – their employers are free to fund whatever pensions they want - so if someone is on a 240K salary, they can get a 160K pension, fully funded by their employer with no tax impact on them (except obviously it is taxed as income in retirement). Whereas if a self-employed or non-DB person wants to fund that, they cannot within the pension framework.

I wonder what the plans are for non-contributory schemes if tax-relief is reduced from marginal rate. How will the reduction in tax-relief be applied to non-contributory DB schemes? In theory, members should be charged BIK on the benefit they accrue in a year but that could be horrendously expensive in a single year if someone gets a payrise so that the ‘value’ of their fund increases instantly. At the moment the issue doesn’t arise as the contributions are invisible, not attributable to any one member and there’s full tax relief anyway – but in fairness to self-employed and DC people affected by any reduced tax-relief, the same should apply to DB members too.


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## Chris (22 Nov 2012)

Conan, I agree with your assessment that there is a witch hit on "the rich". It is beyond me how we got to a stage where so may people see someone who has had financial success as an evil drain on society.

As for pensions, I believe that there will not be good news in the budget, not for rich or middle income earners. I posted elsewhere about the total flaw in the social welfare system. The average earner pays about €2,700 per year in prsi and USC; over a 45 year career that is about €120,000 paid into the system (not a fund). Life expectancy is 84, so over a 17 year period a pensioner will receive €200,000 paid out. And of course PRSI and USC is meant to cover a lot more than just pensions.

My point is that everything has to be done to encourage people to prepare for retirement. The system we have is broken and will eventually totally and utterly collapse. This talk of inequality is total bunk and a distraction from the real issue.


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## Conan (23 Nov 2012)

I see that FF are now jumping on the SF bombwagon by proposing cutting pension tax relief. Next they will propose the taxation of protection rackets, drug dealing and diesal laundering. That at might ruin SF's main fundraising sources.........so I don't expect Pierce Doherty to suggest that.


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## bullworth (23 Nov 2012)

Conan  said:


> 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
> ...



Even a capitalist like me can see that our business and political leaders have proven themselves unworthy, criminal, criminally incompetent and neglectful , useless and far from earning anything special on merit. yet despite costing the state billions and despite being corrupt they still manage to hold onto undeserved salaries, pensions and pay offs etc while their victims end up bearing the brunt. I wish this wasnt true but sadly we do not have a meriticracy where this subject is concerned.


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## Azriel (1 Sep 2013)

There is more to the mathematics underpinning pension saving than tax relief on contributions and tax payable in retirement - there is the lump sum on reaching retirement age (25% of the lump sum), the ability to bequeath any residual value in an ARF to one's estate (without having suffered any tax on drawdown in retirement plus tax free investment growth.

The consideration is not whether pension saving makes sense, but rather how does it compare to the available alternatives.

Properly constructed pension saving plans do make a significant amount of sense - the challenge I see is that these plans tend not to be made available to lower earners (through a lack of advice being made available to them, a lack of cashflow to allow them to take advantage, or terms being provided to them that are desperately unattractive).


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## Conan (2 Sep 2013)

Azriel,
A few points of clarification:
- I said in my original post that the only real tax break is the facility to take a 25% lump sum most of which might be tax free
- from the remaining 75% the individual has to draw down a minimum of 5% each year and pay tax (at marginal rate) on same
- on death the fund (ARF) is taken over by a surviving spouse, who will also pay tax on any drawdown each year
- only after both have died, if any funds remain and are passed on to children, then this is also taxed (at 33%)

Pension planning is available to all, but I fully accept that some people cannot afford to save such amounts (just as some people cannot afford a car or a house or a foreign holiday). That's why the State provide a safety net pension for all (contributory or means tested for non-contributors). 

My essential point is that if you standard rate the relief on contributions but still tax the eventual income at marginal rate (20% relief but 48% tax on pension income) then you are penalising those trying to save for old age without any encouragement to those not making any pension provision. Where is the "equity" in that?


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## Azriel (4 Sep 2013)

Conan

Not disagreeing with you, but the ability to receive relief at 41% for a marginal rate taxpayer (and then draw at nil / 20% / 33%) makes pension saving more attractive for a higher rate tax payer.

And higher rate taxpayers have greater capacity to save, greater access to advice and can access better terms (typically).

All this means that higher rate tax payers get a (very significantly) better deal - and I would argue that this means that the allocation of limited taxation resources to support pension saving comes under increasing challenge.

The counter-argument is that higher earners contribute more in PRSI towards a flat State Pension benefit, however that is a feature of the tax system (society?)generally.


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## Sunny (4 Sep 2013)

Azriel said:


> Conan
> 
> Not disagreeing with you, but the ability to receive relief at 41% for a marginal rate taxpayer (and then draw at nil / 20% / 33%) makes pension saving more attractive for a higher rate tax payer.
> 
> ...



People who pay the high rate of tax aren't necessarily wealthy. The current pension rules benefit a large proportion of middle Ireland that are on salaries of not much than €30k. That is not a large salary. 

People on low salaries will rarely save for their pensions because they can't afford to. Giving increased tax relief on contributions to these people won't change that. Just as lowering tax relief won't really bother the genuinely rich people out there. So once again middle class people get squeezed and burnt because they are stuck in the middle of two ideologies.


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## Azriel (13 Sep 2013)

For individuals on a salary of €30,000, they will benefit from a Tax Free Lump Sum (0% tax) on retirement plus a pension income on which they would pay low rates of tax.

Your points seem a little off topic versus where Conan started? (his reference to a maximum pension of €37,500 pa - which is unobtainable for the group you are referring to?)


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