# Pensions, Taxation and the 0.6% Levy



## Conan (11 May 2011)

*Planning for your retirement in spite of Government policy*

The reason why retirement planning is much more important now than it might have been for earlier generations is down to longevity. People are living a lot longer in retirement than was the case in times past. Some 40 years ago, a male retiring at age 65 had an average life expectancy of some 13 years. Today, that has increased to over 20 years. That’s a 60% increase. And for females you can generally add an extra 3 or 4 years.

With people living much longer in retirement, pensions also have to last much longer. Consequently, making provision for one’s retirement years is now more important than ever. 

*Government Policy*
Against this background, why are Governments doing their best to discourage or even penalise individuals who try to make prudent financial provision for their retirement years?

Government planning in relation to pension provision (whether that be Social Welfare pensions, public sector pensions or private sector pensions) has been as well thought out as its management of the financial crisis. We have had numerous white and green papers, statements from Ministers, a National Recovery Plan, Budget changes, etc., and the net result is that most people, in the private sector at least, are totally confused as to how they should go about trying to finance their retirement or indeed whether it is now worthwhile at all putting aside funds for retirement. Continuous policy changes in relation to pensions have only served to confuse.

Just take a look at the proposals and changes adopted in recent times:
•	If you are self-employed, you cannot contribute to a personal pension plan in respect of any income above €115,000 p.a. (circa 50% of the salary on which senior Civil Servants are provided with pension benefits).
•	The FF/Green Government proposed in the National Recovery Plan document to cut tax relief on personal contributions (paid by self-employed or employees) to standard rate of 20% by 2014.
•	The Fine Gael policy during the election campaign was to retain tax relief at the marginal rate, but instead introduce a 0.5% Levy on all pension funds.
•	More recently, the current Government have suggested that the rate of tax relief would be set at a common rate of 33% irrespective of one’s marginal tax rate (which would be in addition to the Levy above?). This is supposedly designed to encourage lower paid individuals to fund pension benefits.
•	In the December Budget, the Government reduced the capital value of pensions which individuals could accumulate to €2.3m, with any excess taxed at 41% in addition to the normal income tax on the subsequent drawdown of the remaining 59% (equivalent to a composite rate of 69%).
•	The current Government have also suggested that they will reduce the fund cap further, as part of their Policy for Government.
•	The maximum tax-free lump sum which one can take on retirement has been capped at €200,000.
•	Those individuals who invest their post retirement fund (out of a Defined Contribution plan) into an Approved Retirement Fund must now draw down a minimum of 5% of the fund each year and pay tax on same.
•	Finally, in the last Budget, the PRSI/Health Levy relief has also been removed on employee contributions to occupational pension schemes, thus reducing the tax relief by circa 8%.

Against this background, is it any wonder that some individuals are taking the view that conventional pension funding is on a slippery slope to oblivion?

*New 0.6% Levy*
And now we have a new Pension Tax, designed ostensibly to fund the Jobs Initiative:
•	The current Government have now proposed to tax all pension funds – oops my mistake – to tax all private sector pension funds (including, perhaps, some pensions in payment and Approved Retirement Funds, though this is not clear at present) at a rate of 0.6% of the total fund value. So members of private pension funds who have been reasonably prudent in attempting to fund for their retirement will have 0.6% of their fund value sequestered (despite the challenging investment results of recent years) whilst members of occupational pension schemes which are unfunded (largely or entirely in the Civil/Public Service) escape. Can this be simply because 0.6% of nothing is …nothing?
•	Whilst it is relatively simple to apply the Levy in Defined Contribution cases (because there is an actual fund for each individual), it is much more complicated in a DB scheme where there is simply one overall fund. If the Fund pays out 0.6% of its total value each year for say 4 years, how is that translated back to individual members in terms of reducing benefits or increasing contributions? Does it simply increase the current funding deficit? Or does the Employer effectively have to meet the cost?
•	In relation to pensions in payment, the Irish Association of Pension Funds estimates that the 0.6% Levy on fund values would reduce pension payments by circa 9%, but it could be more. However, it seems that this would only apply to annuities paid out of the pension fund as opposed to where the pension fund offloaded its liability by buying an annuity from a Life Assurance company. Again, will this reduction of 9% or more apply only to private sector schemes where the annuity is paid out of the fund, but not to public sector pensions where the pension is paid out of general taxation?

*Implications*
I would pose the following questions:
•	Why are self-employed restricted to funding a pension in retirement based on an income of half a senior civil servant’s salary?
•	Why would any individual contribute to a pension plan if tax relief on the way in was limited to 20% (as proposed under the FF/Greens National Recovery Plan) but the income in retirement was potentially going to be taxed at circa 50% (top rate tax plus Universal Social Charge)?
•	In addition to the Levy, the new Government seems determined to reduce the maximum tax relief as well, admittedly not to 20%, but to 33%. That might be fair if the subsequent income was only taxed at a maximum of 33%, but I cannot see that happening. So do we face both a fund Levy and a reduction in the tax relief?
The reduction in the pension fund cap to €2.3m may not seem that penal. If you are a member of a Civil Service pension plan (or indeed a member of a private sector Defined Benefit occupational pension scheme) the cap equates to a gross pension income of €115,000 (because Defined Benefit pensions are valued at a notional 20:1). Many might say that such a cap is not unreasonable in the current difficult times. Perhaps. But it is not that simple, as I have outlined below.

*Dire Straits (not Mark Knopfler et al) *
I fully appreciate that we live in straightened times and that the Government stands in dire need of new revenue, to be achieved either by increasing tax income or by limiting reliefs. Obviously, looking at the estimated €75bn set aside in private pension funds, it is tempting to take just a little of that (0.6%) to finance the much-needed jobs initiative. In defending the move, various Ministers have referred to the “very generous tax breaks which the Pensions industry has enjoyed over many years”. In point of fact, the “pensions industry” has not enjoyed any tax breaks — it is pension scheme members who “enjoy” these tax breaks (or, more correctly, tax deferral). But even if that were true, then it applies equally to public and private sector employees. So why do only private sector employees get the opportunity to finance the jobs initiative?

Minister Joan Burton, in justifying the Levy, stated that the “pensions industry” had focused unduly on high net worth individuals. Whilst clearly a small number of such individuals did accumulate very large pension pots (presumably with the approval of their Boards of Directors and within Revenue regulations at the time), it’s hardly a justification for penalising the “ordinary decent” pensioner with far more modest pension pots. Equally, Minister Noonan’s comment that this Levy will see funds “brought home to invest in jobs” is astounding. The Levy may be brought home, but this move hardly encourages Pension Trustees (who have a legal responsibility to manage the funds prudently on behalf of members) to invest more domestically, particularly since such Funds have suffered very significant losses on Irish equities and Irish Government Bonds over the last few years. 

If the value of private pension funds is circa €75bn (covering an estimated 500,000 people), that equates to an average fund of some €150,000. So on average (and averages can be deceptive) the Levy will cost each member circa €900 p.a. for 4 years. But the Comptroller and Auditor-General recently estimated that the unfunded liability for public service pensions is some €108bn. Since this covers some 330,000 employees, it equates to an average “fund” of €327,000 (more than twice the figure in the private sector).

Let me stress that this is not a rant about public service pensions. I am simply pointing out that one sector of the pension population are being asked to fund the jobs initiative whilst another sector (most public and civil servants and politicians) are not been required to contribute. My underlying concern is that all these changes and proposed changes seem to be designed to deter individuals making any further pension provision at the very time when they should be prudently planning for a longer period in retirement.

*Breach of Trust*
By its very nature, pension planning is a long term exercise. Pension funds are often accumulated over 30 or 40 years. Implicitly, individuals enter into a contract with Government when they start out to set aside funds for their retirement. The Irish model for decades has been based on deferred taxation – tax relief on contributions on the way in and tax on income on the way out. However the recent changes, some might argue, are a breach of that contract.

If an individual had been prudent in building up a pension fund of say €2.2m under the previous rules and was still say 4 or 5 years from retirement, the sudden introduction of a €2.3m fund cap will mean that individual cannot avoid the penalty of double taxation. Even if they cease all future contributions, even meagre investment growth will bring them above the €2.3m cap by the time they retire. Perhaps the only benefit of the new 0.6% Levy will be to help reduce the excess by which such individuals would otherwise have exceeded the cap.

The 20:1 valuation basis adopted for Defined Benefit schemes (including private sector schemes and schemes for Civil Servants, Judges etc.) is particularly favourable in comparison to how members of Defined Contribution schemes are treated.
Take the following example:
- Senior Civil Servant earning €200,000 at retirement
- Retirement pension of €100,000 (50% of salary) plus a lump sum of €300,000 (150% of salary)
- Notional values is – 20 x €100,000 + €300,000 = €2.3m 
- Result, no double taxation at retirement 

Compare that to an individual in the private sector trying to fund a comparable benefit at say age 65 out of a Defined Contribution plan:
- Cost of buying a joint-life annuity of €100,000 with indexation in payment is circa €2,700,000
- Add cash lump sum of €300,000
- Total fund required = €3,000,000
- Tax liability at 41% of €700,000 = €287,000 

So in effect, if the private sector (Defined Contribution) individual tried to replicate the senior Civil Servant retirement benefit package, requiring a fund of circa €3m, he would have to surrender all his lump sum as a tax penalty. Is this equitable?

*Conclusion*
I fully understand that the Government want to reduce the tax relief given to pension funding (even if it is only tax deferral). However I believe that if they proceed with all their proposals, they will save far more than planned, simply because many people will cease funding entirely and thus forego any tax relief. (The Law of Unintended Consequences comes to mind.) Whilst this may be the real plan (though not stated publicly), this is surely yet another short term decision, not unlike the decision of the previous Government to rely on transient property taxes in framing long term Government expenditure plans. The net effect could be to condemn future generations to longer years of poverty in retirement. 

If we have to tax pension funds (individuals saving for retirement) to fund the jobs initiative, so be it. It is perhaps a price worth paying if it helps to regenerate the economy and there is no other alternative. But equity requires that all pension savers should contribute. Those making the decisions to tax private sector pensions should show an equivalent level of commitment to the venture.

The Minister has stated the Levy will only apply for four years and will neither be extended nor increased. It is to be hoped that this promise is one that will be kept. 

For the past number of decades, Ireland’s longer term social policy goals have included the encouragement of pension savings. Despite a few headline cases, the vast majority of pension tax reliefs have been availed of by middle income earners (not rich fat cats) attempting to make prudent financial planning decisions for their old age. These are mostly individuals who, whilst getting tax relief at marginal rates, will also pay tax on the eventual retirement income at marginal rates (probably even a higher marginal rate).

Because pension planning is such a long term commitment, it therefore requires a sustainable and reliable long term tax regime so that individuals can make rational long term decisions. Basing pension policy on a handful of high profile cases where individuals have accumulated pension pots of €27m, etc. is not a sensible strategy. The “ordinary decent” pensioner deserves a better thought out and more equitable policy from our political masters, particularly when those political masters are themselves exempt from some of the more draconian elements of such policy.


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## Conan (11 May 2011)

Further points


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## Brendan Burgess (12 May 2011)

_Declaration of interests: As I have retired, I am not affected by the levy. I don't have an ARF either. I am in receipt of an annuity. While I was contributing to a private pension scheme, it struck me that the reliefs were probably too attractive.


_*I strongly agree with the following *

  The development of pensions policy has been poorly thought out and very inconsistent. Successive  governments have  publicly encouraged people to contribute to pension schemes while at the same time they have changed the rules to discourage people from  contributing..

  Reducing the tax relief to 33% is a huge disincentive and will have the unintended effect of stopping people on the marginal rate making further contributions. 

  Changing the rules for new contributions might be ill advised, but changing the rules retrospectively – the 0.6% levy and the 69% effective tax rate – is a gross breach of trust. The effect is such that people probably should no longer use pensions as a vehicle for savings if they cannot be sure of the rules. 

  I had not noticed the attacks on the “pension industry” and it is important to clarify that this is a tax on individuals. 

*But tax reliefs on pensions have been way too generous and they should be limited  for future contributions.*

  As you rightly point out, pensions policy for ordinary people should not be determined by the few excessive pension pots. However, I think that policy should be designed to encourage people to build up a pot sufficient to provide them with a modest pension of around €60,000 a year in retirement. I think that the €2.3m cap is still too high and I would support it being brought down even further. 

  If someone has more than the cap, they should not be allowed to contribute any further, but any excess due to growth should not be penalised in any way. 

  In practice, the cap may have to be age related e.g. €2.3m at age 60; €1.7m at age 50; €300k at age 30. 

  People should get marginal relief on contributions up to the cap and no relief beyond that. 

  I would scrap the percentage of salary limit as the cap on fund size would cover it. Some people have highly volatile salaries and highly volatile expenditure. The annual limit on salary affects these but a fund size cap would cater for them. 

  I fully appreciate that this is very difficult to apply to DB schemes and public sector pensions. And indeed it might even be unfair. But this is not an argument for not doing it. The principle of putting a cap on pensions is a good idea which needs to be adapted to existing schemes and DB schemes. 

*It is right that ARF owners be obliged to drawdown 5% a year.*
  You seem to be objecting to this but I am not sure why. The ARF is supposed to provide an income, so I can’t see any objections to forcing people to draw down 5% a year. I am not stuck on 5% but I don’t think that people who have other income should be able to accumulate a tax-free pot for ever. 


*The fact that the levy does not apply to public sector pensions is not an argument against the levy. *
  I don’t agree with the 0.6% pensions levy and it should be stopped. But arguing that it will not apply to civil servants and politicians is not an argument. The fact that it does not apply can be taken into consideration when  public service salaries are next reviewed. 

*Does the current emergency justify these changes? *
  I don’t think so. Destroying confidence in pension schemes is not a good idea to raise “only” €2 billion. Having said that, the financial emergency is such, that we are going to have to do many things, which I would be totally opposed to in principle e.g. a significant wealth tax. 


*Giving notice that the marginal tax rate will be reduced is exactly the opposite of what the government should be doing.*
  It would be a great help to the Exchequer finances if people reduced pension contributions for a few years. Threatening to abolish relief at the marginal rate of tax at some time in the future encourages people to maximise their contribution this year, as I have argued in this thread.  Of course, the 0.6% levy tempers this to some extent.


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## Conan (16 May 2011)

Brendan,
In relation to some of the points you raised:
- Some within the Pensions industry proposed a levy rather that a reduction in the tax relief to 20%. Other groups favoured the reduction in tax relief as the least worst option. 
But it really came down to whether you favoured hanging or the firing squad. The argument is that if the tax relief was reduced to 20% it would be a positive disincentive for any individual who was likely to be taxed in retirement at the top rate to fund for any pension (without in any way encouraging those currently on Standard Rate tax to start contributing). Also if the relief was reduced to 20% it was hard to see it going back up - ever. At least with the Levy, there was some hope (!) that it might be dropped at some stage.

-  I have no argument in principle that individuals should not be allowed to accumulate pension pots of €27m based on any tax arrangement. So now we are only haggling over the price. Should the cap be €5.4m, €2.3m or €1.2m? My argument is about how the Govt (Dept of Finance) went about calculating the value of differing pension plans, i.e. why is 20:1 a correct basis for valuing a DB pension (it was actually lifted from UK legislation)? As you can see from the example in my original post whilst a DB pension of €115,000 is notionally valued at €2.3m, if you actually went to buy an annuity of €115,000 in the market today (for say a male aged 65, with an attaching spouses pension and with post retirement indexation) you would actually need a fund of circa €3.4m. The critical issue is to ensure equity between DB and DC and perhaps to take age into account. Remember that a certain former Taoiseach (or is it two) "retired" on pensions of over €150,000 in their 50's. The real market value of such pensions are in excess of €6.5m (an annuity rate of circa 2.3% or a multiplier of over 40.  

-  I have no major argument with the 5% drawdown, except that some ARF holders are being forced to drawdown more that the annuity equivalent (e.g. if they used the fund to buy an annuity the annuity rate would perhaps be less than 4% as demonstrated above)

-  The fact that the Levy does not apply to most public servants is only relevant in that one sector of the pensions world bears all the cost whilst another (including the decision makers) make no contribution. If both public and private sector pension members contributed, we might expect the rate to be 0.4%. And if retired pensioners contributed, the Levy would be even lower. My gripe is lack of equity. Its like the generals sending the soldiers into battle, but the generals remaining in HQ. The fact that a few notorious individuals  managed to salt away pots of €27m plus (and continue to evade justice) is no basis for penalising the 99.99% of pension members who played by the rules. I understand that so far the Revenue have only received some 300 applications for Personal Fund Thresholds over €2.3m, not the vast numbers that some media outlets would suggest.


-  My main complaint, is that in spite of numerous reports, papers, policy frameworks etc etc, legislation and taxation policy in relation to pensions is completely haphazard. Because of the long term nature of pension funding, it requires a level of certainty around taxation policy. I fully understand the dire need for additional taxation (and thus the Levy), but we also deserve a thought out strategy so that individuals can make rational long term investment decisions. We still don't know if the Levy is instead of a reduction in the tax relief or whether we will also see the rate reduced to 33% or even 20%. If the rate of relief falls to 33% (or worse still 20%), then the volume going into pension funds will drop significantly, with perhaps only  public servants (and politicians) continuing to contribute because of their gold-plated pension benefits.

Finally, I continue to be amused by RTE and other media outlets referring to ARFs as vehicles used by the super rich, when in fact ARFs can be used (instead of buying an annuity) by any self employed individual retiring out of a Personal Pension, by any holder of a PRSA on retirement, by any employee retiring out of a DC scheme (and yes by any Company Director retiring from an occupational pension).

And finally finally, I am available to advise the Minister for a large fee.

Conan


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## Complainer (17 May 2011)

Brendan Burgess said:


> It is balanced in that it acknowledges both sides of the arguments.



Not really - so here's a bit of balance. Let's hope the Minsters and TDs read all the way down the thread.

1) Any conflict of interest should be declared. I had always assumed that, based on Conan's excellent helpful and detailed answers to pensions queries on AAM, Conan worked in the pensions industry. If this is the case, it should be declared openly. For the record, I'm currently working in the public sector, so I will be a public sector beneficiary when I retire. I've spent most of my career to date in the private sector, so I have private pension funds in place also.

2) The post repeatedly questions why the levy hits private sector pensions and not public sector pensions. I suspect that Conan already knows the answers to this, but here goes;
- public servants have been paying a pensions levy for 2 years now, and there is no fixed time limit on how long they will continue to pay this levy for.
- public servants don't have a fund to base a levy on (hence the pensions levy based on income). Instead of a fund, they have a promise from a Govt that is increasingly likely to default on some aspects of its debts over the next few years. 
- many public servants will be paying this new levy, because despite the impression often given here on AAM, many public servants have worked in the private sector, building up some private pension funds (like me) and/or are buying AVCs to supplement their public pension.
Strangely enough, I don't recall posts from Conan or others wondering why only public servants were hit with the public pensions levy two years ago.

3) Much of Conan's post is based on a presumption that tax relief is an essential feature of any and all pension provisions. It's not. People are welcome to save for their future through a whole range of investment types. Some of these attract tax relief with the usual limits and some don't. Removal of the tax relief does not discourage people from providing for their future. It just removes the Govt subsidy.

4) Conan and others seem to feel that the Govt's hands should be tied on changing pension policy, simply because it is a long term investment. This just cannot be the case. You could make the same argument about property investments. You could make the same argument about public sector salaries, given the long term career decisions that many people have made. But none of these stand up. There is no 'implicit contract' or guarantee that there will not be future changes. The Govt is entitled to change pensions policy, and has done so in a measured way, following detailed consultation with the industry. In fact, it has made pretty much the exact changes proposed by the industry.

5) Conan repeatedly benchmarks the private sector against 'senior civil servants' on salaries of €200k. There are a tiny number of civil servants at these levels - Asst Secs and upwards - maybe about 50-80 people in all, at a guess. Across the entire public service of 300,000 people, there is probably something like 300 people earning these salaries, in addition to the hospital consultants. Let's not pretend that these are anything like a typical public sector salary.

6) The 330k figure quoted for the number of public servants covered by the C&AG's estimate is wrong. The correct figure is 400k "Public service pension schemes cover over 300,000 staff and more than 100,000 existing 
pensioners, and their dependents.  "

This a modest, measured tax on assets that have been built up largely on the back of tax relief - no more, and no less.


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## Brendan Burgess (19 May 2011)

Folks

This thread is now "closed". Please do not reply. It is technically open so that the two main contributors can edit their posts. 

Brendan


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