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From the Times at the weekend. Brian Woods pointing out some huge flaws in the Auto Enrolment system, with contributions from @Colm Fagan ...
Why auto-enrolment pensions are ‘a disaster in the making’
The new state retirement savings system, due to launch in September, could leave up to 200,000 higher earners worse off, according to experts
https://www.thetimes.com/article/fc9f234d-d501-4e55-a236-73e9df907c28
Brian Woods didn’t plan to become a campaigner against the government’s plans to introduce an auto-enrolment pensions system this year, but he has made it his mission to raise the alarm over what he sees as deep flaws in the scheme.
“I’m retired and I can’t play golf, so this is what I do instead,” he says.
The former financial director at Ark Life and self-employed actuary is trying to draw attention to a glaring defect in the incentive structure for the new system that could mean up to 200,000 people are forced into a financially inferior set-up when it goes live on September 30.
Those affected are workers who pay tax at the higher rate of 40 per cent and, therefore, are entitled to tax relief at that level on pension contributions. But this group is about to be swept up into the new state scheme automatically because they are not currently enrolled in a private or occupational scheme with their employer, meaning they will have to put in 1.5 per cent of their earnings unless they opt out.
However, the state’s auto-enrolment system isn’t offering the same tax relief as a private or occupational pension would. Instead, the state is contributing €1 for every €3 an auto-enrolled member puts in, which works out as substantially less attractive for this group.
“If you were starting with a blank sheet of paper, €1 for €3 is the best way,” says Woods, before pointing out that, for higher earners, the existing system is twice as financially beneficial as auto-enrolment. “But this is practically unworkable in parallel with the existing system. You need to fix it before it goes live. Launching it as it is would turn out to be a disaster.”
Woods has been joined in his efforts by his old boss Colm Fagan, another retired actuary, whose career spanned Standard Life, Hannover Re and Berkshire Hathaway. Fagan has been poking holes in auto-enrolment for months, although his main gripe is that the system exposes members to too much investment risk rather than “smoothing” outcomes for pensioners on retirement.
The two believe the misaligned financial incentives are just one of many cracks in the foundation of auto-enrolment that could bring down the whole edifice before its planned launch this autumn.
But they see a window of opportunity for the government to act by delaying its implementation and ordering an independent review to iron out the kinks before it goes live.
With the launch of the agency overseeing the system not yet established and other key milestones still in the distance, they think the government needs to reconsider — otherwise it risks undermining the system.
“The penny will drop eventually and it won’t go ahead,” Woods says. “Are they going to put people in auto-enrolment even though they’d be better off going in another direction? The whole thing is messy and impractical and it’s not going to work.”
The two list several issues that have yet to be resolved: no request for tender has been issued for asset managements to run the investment strategies; no fee structure has been agreed; and nobody knows if or how enrolled members can move between auto-enrolment and private schemes when their financial circumstances change.
They point to the UK’s Nest system — the model for Ireland’s scheme — which has indeed increased enrolment in retirement savings, but has a high dropout rate, low levels of investment and high administration costs.
But the key issue for them is the big difference between the benefit the state provides across two parallel systems, which creates an arbitrage opportunity.
“The best way to get out of this is a root-and-branch review of the whole thing,” Fagan says.
Originally proposed by the late Fianna Fail minister Séamus Brennan in 2006 as a way to expand pensions coverage more universally across the workforce, the idea was later championed by Labour’s Joan Burton, somewhat forlornly in the depths of the financial crisis. So for a long time it was just that — an idea, something that could be implemented in other countries such as Australia, but not ready for reality in Ireland.
It wasn’t until 2018, under Fine Gael’s Regina Doherty, that consultation with stakeholders began in earnest with the publication of a “straw man proposal” setting out a draft design for the system. This is where the €1 for €3 incentive structure was conceived.
Doherty’s successor Heather Humphreys shepherded the proposal through the various stages of consensus formation, eventually producing a piece of legislation last June, with the launch date of September 30 confirmed in October, just in time for the general election.
But the disquiet around the design of the system, which was there from the start, never really went away. In fact, the potential for arbitrage — effectively taking advantage of inequalities between the existing pensions system and auto-enrolment — was identified early in the process, yet nothing was done to address it.
An internal departmental paper written in 2020, “Designing a financial incentive for the automatic enrolment retirement savings system”, laid out the problem clearly.
The proposed auto-enrolment matching system values the net contribution from the state at 33.3 per cent of the member’s contribution. However, a worker taxed at the standard rate of 20 per cent gets the equivalent of a 25 per cent contribution via tax relief, while someone taxed at the higher rate of 40 per cent gets a 66.7 per cent boost from the state.
The incentives are clear. The 600,000 workers without a pension who are on the lower rate of tax are getting a better deal from auto-enrolment, but the 200,000 who pay tax at the higher rate would only get half the benefit available to them from a private pension scheme.
As the report notes: “One could envisage that there would be significant pushback if individuals were ‘unknowingly’ defaulted into a system which was ‘knowingly’ less attractive to them on the basis of financial incentives.”
“That 47-page paper sets out very explicitly that there’s a real problem here,” Woods says. “If that paper had been published, it would have stirred up huge debate.”
That debate has yet to emerge, though, as awareness of auto-enrolment remains quite low. Data from the Central Statistics Office, published in December, showed just 28 per cent of eligible workers were aware of the scheme. That lack of awareness means many will be swept into a savings system without having assessed whether it suits their financial circumstances.
Unsurprisingly, the pensions industry was alert to this problem from early in the process. Consultation submissions, excerpted in the report, from advisers and providers almost uniformly warned of the opportunity to game the incentives, with several warning explicitly of “arbitrage”.
“There is a risk of undoing the significant coverage already achieved by the existing regime if members are confused as to which regime would be more beneficial to them and try to select against the system,” wrote the Association of Pension Lawyers.
Mercer pointed out “a huge arbitrage opportunity that will inevitably be exploited”, while the Irish Association of Pension Funds lamented “a whole new level of complexity”.
The report offered three alternative funding options to deal with the problems identified with the €1-for-€3 incentives, but none were taken up in the final design. Instead, auto-enrolment was constructed with simplicity in mind, the better to communicate its benefits to the target audience and to achieve greater transparency than exists with the current rather ornate system of two-tier tax relief, fund thresholds and contribution limits.
But the engineered simplicity of auto-enrolment didn’t conclusively win the day. A sharp exchange at a February 2023 hearing of the Oireachtas committee on social protection between the TD Éamon Ó Cuív and Tim Duggan, the assistant secretary in the Department of Social Protection in charge of pensions, showed the problem lingered.
The two bickered over sums until Duggan was forced to admit that there was a “difference in outcomes” for someone on the higher rate of tax and that “some people would do better” in a private or occupational scheme, but went on to argue that three quarters of those affected “would be delighted”.
Ó Cuív, for his part, voiced support for a single rate of relief and concluded that “the whole system is rotten because it favours the rich”, who could not only contribute more but get twice the tax relief while doing so.
It therefore makes perfect sense that many consultation submissions early in the design process focused on the preservation of generous tax reliefs for high earners against a possible move to a universal 33 per cent rate for everyone, arguing that it would reduce incentives to save for retirement among those already enrolled in schemes. In effect, a universal rate would risk reducing enrolment among one constituency to increase it with another.
“There is no reason why marginal rate relief on contributions to occupational pension schemes and other schemes cannot sit alongside the proposed auto-enrolment system,” Chartered Accountants Ireland wrote. “Excessive change to the tax benefit system for pension savers could weaken the confidence in the stability of the tax system, thereby reducing the commitment of savers to long-term savings.”
But the industry has gone quiet since the legislation was passed and the timetable for implementation was announced.
Woods thinks this is because the industry sees an opportunity to sell. On the one hand, providers want to set up occupational schemes for employers that wish to avoid getting caught up in auto-enrolment, which is seen as potentially expensive and administratively difficult. On the other hand, employees who are disadvantaged by auto-enrolment could be receptive to pitches for private pensions.
“Arbitrage has been hard-coded into the system, and arbitrage is manna from heaven for any adviser,” Woods says. “It’s going to be a field day for brokers. Financial advisers will jump all over it and auto-enrolment will fall into disrepute.”
Ironically, while higher earners who get caught in the auto-enrolment net are losing out, an unknown number of workers who are contributing to pensions already and getting relief at the standard rate are also missing a benefit. Those employees would have to drop out of existing schemes to get access to auto-enrolment’s comparatively better €1-for-€3 contribution from the state, which effectively offers €1 for €4 in the conventional system.
Rather than neatly getting a huge portion of the workforce tidily into a state-administered scheme, there could be a scramble for the best deal as members become aware of the advantages of seeking out the best incentive, toggling between systems or opting out entirely, according to Woods.
“That’s probably even worse,” he says. “It’ll be total chaos.”
Why auto-enrolment pensions are ‘a disaster in the making’
The new state retirement savings system, due to launch in September, could leave up to 200,000 higher earners worse off, according to experts
https://www.thetimes.com/article/fc9f234d-d501-4e55-a236-73e9df907c28
Brian Woods didn’t plan to become a campaigner against the government’s plans to introduce an auto-enrolment pensions system this year, but he has made it his mission to raise the alarm over what he sees as deep flaws in the scheme.
“I’m retired and I can’t play golf, so this is what I do instead,” he says.
The former financial director at Ark Life and self-employed actuary is trying to draw attention to a glaring defect in the incentive structure for the new system that could mean up to 200,000 people are forced into a financially inferior set-up when it goes live on September 30.
Those affected are workers who pay tax at the higher rate of 40 per cent and, therefore, are entitled to tax relief at that level on pension contributions. But this group is about to be swept up into the new state scheme automatically because they are not currently enrolled in a private or occupational scheme with their employer, meaning they will have to put in 1.5 per cent of their earnings unless they opt out.
However, the state’s auto-enrolment system isn’t offering the same tax relief as a private or occupational pension would. Instead, the state is contributing €1 for every €3 an auto-enrolled member puts in, which works out as substantially less attractive for this group.
“If you were starting with a blank sheet of paper, €1 for €3 is the best way,” says Woods, before pointing out that, for higher earners, the existing system is twice as financially beneficial as auto-enrolment. “But this is practically unworkable in parallel with the existing system. You need to fix it before it goes live. Launching it as it is would turn out to be a disaster.”
Woods has been joined in his efforts by his old boss Colm Fagan, another retired actuary, whose career spanned Standard Life, Hannover Re and Berkshire Hathaway. Fagan has been poking holes in auto-enrolment for months, although his main gripe is that the system exposes members to too much investment risk rather than “smoothing” outcomes for pensioners on retirement.
The two believe the misaligned financial incentives are just one of many cracks in the foundation of auto-enrolment that could bring down the whole edifice before its planned launch this autumn.
But they see a window of opportunity for the government to act by delaying its implementation and ordering an independent review to iron out the kinks before it goes live.
With the launch of the agency overseeing the system not yet established and other key milestones still in the distance, they think the government needs to reconsider — otherwise it risks undermining the system.
“The penny will drop eventually and it won’t go ahead,” Woods says. “Are they going to put people in auto-enrolment even though they’d be better off going in another direction? The whole thing is messy and impractical and it’s not going to work.”
The two list several issues that have yet to be resolved: no request for tender has been issued for asset managements to run the investment strategies; no fee structure has been agreed; and nobody knows if or how enrolled members can move between auto-enrolment and private schemes when their financial circumstances change.
They point to the UK’s Nest system — the model for Ireland’s scheme — which has indeed increased enrolment in retirement savings, but has a high dropout rate, low levels of investment and high administration costs.
But the key issue for them is the big difference between the benefit the state provides across two parallel systems, which creates an arbitrage opportunity.
“The best way to get out of this is a root-and-branch review of the whole thing,” Fagan says.
Originally proposed by the late Fianna Fail minister Séamus Brennan in 2006 as a way to expand pensions coverage more universally across the workforce, the idea was later championed by Labour’s Joan Burton, somewhat forlornly in the depths of the financial crisis. So for a long time it was just that — an idea, something that could be implemented in other countries such as Australia, but not ready for reality in Ireland.
It wasn’t until 2018, under Fine Gael’s Regina Doherty, that consultation with stakeholders began in earnest with the publication of a “straw man proposal” setting out a draft design for the system. This is where the €1 for €3 incentive structure was conceived.
Doherty’s successor Heather Humphreys shepherded the proposal through the various stages of consensus formation, eventually producing a piece of legislation last June, with the launch date of September 30 confirmed in October, just in time for the general election.
But the disquiet around the design of the system, which was there from the start, never really went away. In fact, the potential for arbitrage — effectively taking advantage of inequalities between the existing pensions system and auto-enrolment — was identified early in the process, yet nothing was done to address it.
An internal departmental paper written in 2020, “Designing a financial incentive for the automatic enrolment retirement savings system”, laid out the problem clearly.
The proposed auto-enrolment matching system values the net contribution from the state at 33.3 per cent of the member’s contribution. However, a worker taxed at the standard rate of 20 per cent gets the equivalent of a 25 per cent contribution via tax relief, while someone taxed at the higher rate of 40 per cent gets a 66.7 per cent boost from the state.
The incentives are clear. The 600,000 workers without a pension who are on the lower rate of tax are getting a better deal from auto-enrolment, but the 200,000 who pay tax at the higher rate would only get half the benefit available to them from a private pension scheme.
As the report notes: “One could envisage that there would be significant pushback if individuals were ‘unknowingly’ defaulted into a system which was ‘knowingly’ less attractive to them on the basis of financial incentives.”
“That 47-page paper sets out very explicitly that there’s a real problem here,” Woods says. “If that paper had been published, it would have stirred up huge debate.”
That debate has yet to emerge, though, as awareness of auto-enrolment remains quite low. Data from the Central Statistics Office, published in December, showed just 28 per cent of eligible workers were aware of the scheme. That lack of awareness means many will be swept into a savings system without having assessed whether it suits their financial circumstances.
Unsurprisingly, the pensions industry was alert to this problem from early in the process. Consultation submissions, excerpted in the report, from advisers and providers almost uniformly warned of the opportunity to game the incentives, with several warning explicitly of “arbitrage”.
“There is a risk of undoing the significant coverage already achieved by the existing regime if members are confused as to which regime would be more beneficial to them and try to select against the system,” wrote the Association of Pension Lawyers.
Mercer pointed out “a huge arbitrage opportunity that will inevitably be exploited”, while the Irish Association of Pension Funds lamented “a whole new level of complexity”.
The report offered three alternative funding options to deal with the problems identified with the €1-for-€3 incentives, but none were taken up in the final design. Instead, auto-enrolment was constructed with simplicity in mind, the better to communicate its benefits to the target audience and to achieve greater transparency than exists with the current rather ornate system of two-tier tax relief, fund thresholds and contribution limits.
But the engineered simplicity of auto-enrolment didn’t conclusively win the day. A sharp exchange at a February 2023 hearing of the Oireachtas committee on social protection between the TD Éamon Ó Cuív and Tim Duggan, the assistant secretary in the Department of Social Protection in charge of pensions, showed the problem lingered.
The two bickered over sums until Duggan was forced to admit that there was a “difference in outcomes” for someone on the higher rate of tax and that “some people would do better” in a private or occupational scheme, but went on to argue that three quarters of those affected “would be delighted”.
Ó Cuív, for his part, voiced support for a single rate of relief and concluded that “the whole system is rotten because it favours the rich”, who could not only contribute more but get twice the tax relief while doing so.
It therefore makes perfect sense that many consultation submissions early in the design process focused on the preservation of generous tax reliefs for high earners against a possible move to a universal 33 per cent rate for everyone, arguing that it would reduce incentives to save for retirement among those already enrolled in schemes. In effect, a universal rate would risk reducing enrolment among one constituency to increase it with another.
“There is no reason why marginal rate relief on contributions to occupational pension schemes and other schemes cannot sit alongside the proposed auto-enrolment system,” Chartered Accountants Ireland wrote. “Excessive change to the tax benefit system for pension savers could weaken the confidence in the stability of the tax system, thereby reducing the commitment of savers to long-term savings.”
But the industry has gone quiet since the legislation was passed and the timetable for implementation was announced.
Woods thinks this is because the industry sees an opportunity to sell. On the one hand, providers want to set up occupational schemes for employers that wish to avoid getting caught up in auto-enrolment, which is seen as potentially expensive and administratively difficult. On the other hand, employees who are disadvantaged by auto-enrolment could be receptive to pitches for private pensions.
“Arbitrage has been hard-coded into the system, and arbitrage is manna from heaven for any adviser,” Woods says. “It’s going to be a field day for brokers. Financial advisers will jump all over it and auto-enrolment will fall into disrepute.”
Ironically, while higher earners who get caught in the auto-enrolment net are losing out, an unknown number of workers who are contributing to pensions already and getting relief at the standard rate are also missing a benefit. Those employees would have to drop out of existing schemes to get access to auto-enrolment’s comparatively better €1-for-€3 contribution from the state, which effectively offers €1 for €4 in the conventional system.
Rather than neatly getting a huge portion of the workforce tidily into a state-administered scheme, there could be a scramble for the best deal as members become aware of the advantages of seeking out the best incentive, toggling between systems or opting out entirely, according to Woods.
“That’s probably even worse,” he says. “It’ll be total chaos.”
