Irish Times opinion piece by Colm Fagan: "Auto-enrolment plan seriously flawed"

nest egg said:
As you've raised the tax free lump sum, if they don't need the money, wouldn't it be in the members' best interests not to take it?
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You’ve brought up another interesting angle.
Under my proposals, workers won’t have an option. They MUST take the lump sum at retirement, whether they want to or not. This is to avoid optionality, which cannot be allowed. Otherwise, there’s a risk that members would take the cash if smoothed value exceeded market value at retirement but would leave the money in the fund if smoothed value was less than market value. They would be able to “financially select” against the fund. That is verboten.
Of course they can always reinvest the gratuity, but they’ll have to do it outside the fund, possibly getting advice from their local financial adviser.
There is also the practical aspect that it will probably be in their best interests to take the cash because it will be tax-free while it would be treated as income if taken as part of the regular withdrawal in retirement. I’m loath to introduce that aspect though because of the Duke’s sad experience when he mentioned tax
 
Okay that makes sense, optionality isn't an option. So the next question is, would they really be materially better off to take the lump sum?

Consider a) the lower returns, and higher charges paid, on the sum outside of the scheme, b) that sum within the scheme would grow without deemed disposal, CGT etc, c) that the income is taxed a low effective rate when drawing down (harder to bank on, perhaps the merits of 1 and 2 alone are enough)

Politically, getting rid of tax-free lump sum may not be a runner, but then again this whole approach is at the cutting edge, so why not consider it.
 

Hi @nest egg. I smiled when I saw the above suggestion in your last post. I thought exactly the same when I first came up with the idea for a smoothed approach to auto-enrolment back in 2018. I considered proposing no gratuity whatsoever in my original submission to government in November 2018, for much the same reason as yourself ("Great minds think alike ..."- let's not finish the quote!)

However, a good friend with long experience in the pensions business said that it would be difficult enough to get political buy-in for my idea without causing myself further trouble by suggesting that the cash option be got rid of. I didn't realise how right he would be about the political opposition!
 
I think removing the lump sum facility would be a major negative in the eyes of most potential members:
- the lump sum can be tax-free up to €200k
- if the lump sum was removed, then the additional drawdown income might be taxable (as opposed to being tax-free as a lump sum)
- for many future retirees, the lump sum might be the largest cash amount they have access to, perhaps to pay off the balance of a mortgage, finance upgrades to house, use for travel etc.
- the facility to get a tax -free lump sum offers flexibility in terms of managing finances in retirement
Assuming that the lump sum facility is retained in current pension structures (traditional occupational pension schemes), then it would be perceived as a major negative if the AE did not have that facility also.
 
Opposition from outside and in; if the private sector no longer got a lump sum, what would that mean for the civil & public servants? The thin end of the wedge!
 
Hi Colm, a question and apologies if this has been asked already. For an Irish fund what does 100% in equities in a passive management (from the asset allocation perspective) fund look like - what is the index? MSCI world index?
 
RonnieShinbal88 said:
Hi Colm, a question and apologies if this has been asked already. For an Irish fund what does 100% in equities in a passive management (from the asset allocation perspective) fund look like - what is the index? MSCI world index?
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Not my specialist subject. Sorry, Would envisage a genuine world equity fund, passive, low cost. Eventually, some unquoted stuff. Long-term, could have up to 40% in illiquid, unquoted stuff, because of low weighting for market value and no liquidity pressures - ever (remember, no transfer values allowed; cash flows predictable for years, possibly decades).
 
I am just trying to think through - if the constitution of the index tracked can change, it might introduce some risk for investors, e.g. it is higher risk when I join and I insure earlier investors then the constitution changes and it gets lower risk and I get less equity premium, might not net out to as good a deal. If you were changing the constitution I think you would need some risk/factor model to ensure risk parity of the tracked index, it becomes less of a passive index.

The flip side is that if you pick a fixed index like the MSCI world index and a particular region or country is giving amazing growth, you can't overweight that later, your hands are tied, but that might be justified as a feature of passive investment (once you weren't tied to something that obviously might later become a bad choice). I think picking e.g. MSCI world index ETF might not be controversial in keeping with a passive index solution.
 
The question has been asked as to why I have failed to persuade Civil Servants of the merits of my proposal. Some in this parish have suggested that my character flaws, e.g. my irritation with critics and refusal to engage with them, may be part of the reason. That may be true, but the last message I got from government was that "to my knowledge, the proposal has not been tested in a market setting (i.e., that no commercial pension scheme has adopted the approach proposed) and consequently, there is a lack of evidence as to observed outcomes."

Doh. Of course it has not been tested in a market setting - it's completely novel and hasn't been tried anywhere in the world, ever. And of course no commercial pension scheme has adopted the approach, because it's designed for a national auto-enrolment pension scheme, not for a commercial one. I have always insisted that it will not work in a commercial environment. The lack of "commercial" angle may be part of the problem. It could even be more important than my character flaws.

If we as a country take that approach to new ideas and concepts, will we ever achieve anything?

I should add, of course, that I am not asking government to endorse my proposal without question. All I ever asked was that they commission an independent consultancy, e.g., ESRI, to kick the tyres in order to check its viability. That's all I'm asking now. It won't cost much compared to the enormous benefits to society and to the state if it does work - a more than 50% improvement in value for money compared with a more "conventional" approach to AE. Brian Woods and I have offered to make all our calculations and stochastic simulations available to whoever is appointed to do the work, together with our other studies and analyses, and to help them in whatever way we can to complete the evaluation.

Is that too much to ask?
 
My understanding is that investments would be up to the Trustees/Directors having due regard to the purpose of the fund which is to provide pensions. What Colm's proposal removes from their consideration are individualised risk/reward profiles. They will take due cognisance of the cash flow projections of the fund e.g. the fact that there will be minimal liquidity constraints. This should lead them, without any specific stipulation, to 100% growth assets with a significant proportion in illiquid. They will certainly not be hostages to any particular index.
 
Not all 100% growth funds are the same though, I see a risk to investors if the risk profile of the fund changes significantly or is changed by the trustees.

A higher risk fund that later switches to a lower risk one is a risk for me as an investor because when I pay in I insure the higher risk fund to cover any crash in that for people withdrawing funds at that time, but then after a crash, if the fund de-risks, I receive the lower risk fund risk premium for the rest of my investment period.

That was why I think there would need to be some stated risk target for whatever the fund was or use a single index.
 
Ronnie, I duck these questions by taking a more helicopter though perhaps naïve view. The Trustees' mandate is to do what they think best for the aggregate in their view, with the main purpose to provide the highest pension at acceptable risk - a pretty subjective mandate. No way do I envisage detailed investment guidelines being enshrined in statute.
What Colm's proposal does is free the Trustees from considering individualised volatility risk - which invariably seems to lead to the abomination of "lifestyling".
Colm has assumed that this mandate will lead to 100% equity investment and 100% participation in the ERP, assumed at 4% (which is backed up by that very informative spreadsheet of Damodaran that you posted). The Trustees may not agree with Colm and indeed the ESRI may not agree with Colm, but let's find out.
Thoughts like the one you have expressed would lead to some sort of individualisation such as treating the class of '24 differently because macro-economic circumstances and thinking has moved on. Again you are making a good case for the likes of the ESRI to contemplate these things.
 
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I was actually suggesting that it's important the different vintage classes need to be treated the same in terms of risk - but to do that you need to define what risk they are all consistently subjected to and it seems important that risk should be consistent across time for the fund.

If the market price of risk was always the same everywhere and over time and you had perfect foresight in estimating long term expected return for any given equity portfolio, then targeting any portfolio with an ERP of 4% takes care of the risk side too (you get 4% worth of risk all the time). It's a big if though, I'd be wary of leaving room for any major portfolio changes over the fund life, someone targeting what they estimate will give 4% return could construct an array of actual risk/return outcomes.
 
Ronnie, I have in mind something like the Norwegian Oil Fund, NGPFG:
Norway Government Pension Fund Global, a universal asset owner, owns around 1.3% of all listed stocks. According to the report, central to the management mandate is the benchmark index consisting of 70% equities and 30% fixed income.
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It is loosely a "pension" fund but it is not hidebound by considering individual risk. Colm proposes 100% in equities. Modern Portfolio Theory talks about the Capital Market Line where the Efficient Frontier consists of anything from 100% risk free to unlimited leverage investment in the fully diversified equity market. Where you pitch on the line is a matter of risk/reward preference with 100% being simply one point along the line. @nest egg has sort of suggested 80/20. The Norwegians have chosen 70% and I understand it is very big political football in those parts, as it should be. Pension experts and actuaries can only go so far in deciding the right position on the line.
What Colm's proposal does is free that decision from the shackles of individual risk/reward considerations and make the decision for the good of the aggregate. Lifestyling is such a huge and unnecessary surrender of national wealth.
 
I just had a look at the presentation on Youtube.

Before commenting, I'd like to read the latest draft of the written proposal - is there a link to it?
 
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