My submission on auto enrolment

Brendan Burgess

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Submission on auto-enrolment

Brendan Burgess, Consumer Advocate and founder of Askaboutmoney.com.

31 October 2018

Introduction

The strawman proposal is fundamentally flawed. It fails to consider the integration of pensions and home ownership. Questions to consider such as those about age and earnings thresholds are irrelevant until the strawman is revised to consider the main issue affecting people who want to provide for their current needs and for their retirement – how can I afford to buy a home for my family?

The proposed auto-enrolment system will hit people who want to buy a house very hard.

· They will be effectively obliged to contribute 6% of their gross salary to a pension fund which would have been very useful towards the deposit

· Employers will be obliged to contribute 6% of the gross salary. In practice, this means that they will not be able to afford salary increases they would otherwise have paid to employees.

The Strawman proposal in its current form will be very unpopular and will have a poor take-up as it prevents and delays people from buying a home.

If it is revised to allow people to get on the housing market quicker, it will be popular and would have a much higher take-up.

Summary suggestion

Those people in their 20s who think about the future, do not think about pensions. They think about how they might get on the housing ladder.

Living rent-free in retirement should be the individual’s priority and it should also be the state’s priority for the individual.

Home buyers must be allowed to use part or all of their pension fund to help them buy a home.

· This would make the proposed auto-enrolment system more acceptable

· It would reduce the amount of people opting out

  • It would not force young people to prioritise a pension over buying their own home
  • They would never stop contributing to their pension fund



Imagine a world without tax incentives for pensions …

What would be the right strategy for someone in their 20s saving up to provide for a comfortable retirement?

· First they should save the deposit for a home.

· Then, having bought a home, they should clear the mortgage as quickly as possible.

· Then, they should invest their savings to provide a fund on which to live in retirement.

They should not be taking out a mortgage at 4.5% interest while tying up money in a long term risky investment with a return which is likely to be less than 4.5%. This is a violation of the first rule of investing: Do not borrow to invest! They should pay off their mortgage before investing. It is also a violation of the second rule of investment – stay flexible and don’t tie up your money where you can’t access it.

The current system which encourages people to save through a pension fund while borrowing money from a mortgage lender leads to most of the tax benefit being dissipated through the profits of mortgage lenders and pension fund managers.

So while the individual does not benefit, the state loses a lot of tax revenue.

The first financial objective for an individual should be to own their own home so that they can live rent-free in retirement

Leaving aside the distortions caused by tax incentives, what is the difference between someone who reaches retirement with a €200k house and €300k of savings and someone who has €500k of savings and no house?

There is no difference as the person with the house can sell it and be in the same position as the other person. Likewise the person with €500k can buy a house for €200k and reduce their savings to €300k

The Exchequer’s objective is the same as the individual’s: that the person lives rent-free in retirement and is not dependent on the state for their housing needs.

It doesn’t make any difference to an individual whether they have €200k savings and no house or a €200k house and no savings. But it makes quite a difference to the Exchequer. It is much easier and cheaper to administer and pay a pension than to provide someone with housing.

So the Exchequer should also be prioritising rent-free living for people in retirement.




Proposal 1: Allow a person’s pension fund to buy their family home up to a maximum of €300k.

Allow the pension fund to buy the family home up to a limit of, say, €300k.

When a person has a fund of around €60k, the fund would take out a mortgage for the balance to buy the house. The mortgage would be paid down quickly via pension contributions.

A person reaches retirement with a fund of €500k which is comprised of a home worth €300k and investments of €200k. That is the same as having €500k in cash.

This would make pension funds meaningful for young people. They could see an immediate benefit from maxing their contributions. They would get on the housing ladder much earlier than they would otherwise.

The financial system would be much stronger as there would be no need for 90% Loan to Value mortgages. The maximum LTV could be reduced to 80% for a First Time Buyer and 70% for Second and Subsequent Buyers.

The dissipation of tax relief via the profits of mortgage lenders and pension fund managers would be greatly reduced.

The system would need to provide for members who want to buy a home worth more than €300k. This could be achieved by the pension fund owning a share of the house or else providing a loan to the member to buy a house.

Criticism 1 of this proposal: The wall of money released would just push up house prices

This criticism is appropriate in the dysfunctional housing market we are in at present. Throwing cash at it without building more houses would push up prices.

However, this is a long term proposal and not targeted at solving the present problem. In normal markets, where supply increases to meet demand, this proposal should not have distorting effects. Certainly the distortions would be less than the distortions caused by allowing First Time Buyers 90% mortgages.

Any distorting effects could be reduced or eliminated by reducing the maximum LTVs allowed.

Access to pension money could be very useful during a period where lenders are unable or unwilling to provide housing finance.

Criticism 2 of this proposal: The state should not be subsidising home ownership.

It’s not clear to me why people object to the state providing tax incentives for pensions but not for home ownership?

The state interferes with the housing market in many ways. They provide social housing at less than market rent. They provide Housing Assistance Payment to people who can’t afford their rent.

So is allowing people a tax break to buy their own home that much of a problem?

It seems to me that it would be better and cheaper for everyone if a person were incentivised to buy their own home rather than to rely on the state to provide them with housing.




Proposal 2: Allow the member a limited advance on their pension

A member would be allowed an advance of 100% of their pension fund up to a limit of €20k and a further 50% of any balance over €20k up to a further €30k.

The advance would be secured on the home and repayable in full if the house is sold. It could be borrowed again if the member trades up.

If the house is not sold before retirement, the advance, adjusted for inflation, would be deducted from any tax-free lump sum payable on retirement.

By limiting the amount advanced from the pension fund, it deals in large part with the criticism that the state is subsidising home ownership.

It also deals with the wall of money criticism in that the amounts are much smaller.

These limits could also be adjusted to meet public policy objectives – for example, the limits could be higher for the purchasers of new homes to encourage house building.



Other countries do allow house buyers to access their pension schemes to buy their home

The KiwiSaver scheme in New Zealand and the Wohn Rieter in Germany can be withdrawn in full and the proceeds used to buy a home. The person’s own contributions, the employer’s contributions and the State’s tax relief/top-up can all be withdrawn in full.

One problem with the KiwiSaver scheme is that when people buy a house, they often stop contributing to the KiwiSaver. Under my proposals, they would continue contributing to their pension fund.

In the United States and in Canada, home owners can take a loan from their pension savings account to buy a house but they must repay this loan, usually over about 15 years.
 
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