Pensions: Total Contributions Approach and Automatic Enrolment Pensions - what does this mean for you?
A key concern for most people is having adequate income in retirement. Current proposals to reform pensions in Ireland could make a significant difference to how you live in retirement.
Earlier in 2018 the Government announced major changes to pensions in Ireland in its Roadmap for Pensions Reform 2018-2023. The Government needed to look at reforms given that people are living longer which has created a big challenge in ensuring the future sustainability and security of the pension system in Ireland. A longer life means we will need to provide ourselves with an income for a longer period of time post-retirement. Government demographic projections indicate that the ratio of people of working age to every person aged over State pension age will reduce from its current rate of 4.5 to 1, to just 2.3 to 1 over the next 40 years. It is also evident that most Irish workers are not saving enough, or at all, for their retirement years and many will be faced with a serious reduction in their living standards when they retire. A mere 4 in 10 workers are in pension plans, despite the current tax advantages and the financial realities of longer retirements.
The two most fundamental reform measures contained within this article relate to the introduction of the Total Contributions Approach (TCA) to the State pension from 2020 and the implementation of an Automatic Enrolment supplementary retirement savings system for employees without pensions coverage from 2022.
What does the “Total Contributions Approach” mean?
From 2020, the Government proposes to change the State pensions system to a Total Contributions Approach (TCA), which means the total of a person’s social insurance PRSI contributions paid and credited will determine the level of State Pension (Contributory) that they receive. Current proposals indicate a person may need 40 years of PRSI contributions paid or credited in order to receive the full rate State Pension (Contributory). People with less than 40 years will receive a pro-rata fraction of the full rate. That is, people will receive 1/40th of the full rate State pension for each year of social insurance contributions. Stay-at-home parents will be able to claim a maximum of 20 years HomeCaring credits.
It is expected the new State Pension will pay an equivalent of 34% of average earnings, with future pension increases linked to CPI. For most people, this would not be enough to fulfil their retirement goals and live comfortably, particularly if they wish to continue covering the costs of essentials such as private healthcare insurance, which becomes all the more important with old age.
Anomalies in the current Yearly Averaging Calculation
The proposed TCA scheme would replace the current Yearly Averaging Calculation of contributions made by a person during their time working. The current system means that a person’s rate of State pension is not linked to their total contributions.
People with gaps in their social insurance PRSI contribution record can therefore be disadvantaged under the Yearly Averaging calculation. Tens of thousands of people, many of whom are women who left or had no choice but to leave the workforce decades ago to raise families are disadvantaged by the current method of assessing the State pension. Those who took time out of the workforce since 1994 have been able to discount up to 20 years from their working life for the purposes of calculating their State pension, but many of those reaching retirement now would have left work before 1994. The post-1994 discounting only applies to those who left work to raise a family or to care for relatives. The Government has stated that the pension’s model from 2020 will prioritise those people impacted upon by anomalies in the yearly average system in place since 1961, and whose home-caring prior to 1994 has not been recognised until now.
Pension automatic enrolment
In the Roadmap, the Government has stated that a new state sponsored automatic enrolment retirement savings system will be introduced from 2022 to support and encourage personal savings provision in Ireland. It is proposed that all workers, including workers without a private pension, will be automatically enrolled onto an automatic enrolment retirement savings system. It is proposed that it will cover employees over the age of 23 who earn more than €20,000 per year, and who don't yet have a private pension.
The new retirement savings system would operate on the basis of contributions made by both workers and employers and supplemented with a Government top-up. It is indicated that the Government proposes to move towards contributions of 6% from employees, 6% from employers and 2% from the State, which is drawn down at the same age as the worker qualifies for the State Pension. However, it is considered likely to take a number of years to get to that level of contributions and so contributions will start lower and be phased in over time.
Under the system, it is proposed workers would have the freedom to opt-out should they so choose, however experience in other countries indicates that automatically enrolled workers tend to remain in the system.
State Pension Age
While the State pension age is set to increase to 67 in 2027 and 68 in 2028, it is proposed there will be no further increase before 2035. However, you may have to wait longer than 68 to get the State pension if you retire after 2035. The Government has indicated that any change to the State pension age after 2035 could be directly linked to increases in life expectancy.
Some concerns with these proposed pension reforms
While there are welcomed proposals for reform such as seeking to address the inequity in the State pension system towards certain sectors, on the other hand it is likely that workers may need to work for much longer than they currently do to qualify for the full State pension. Under the current State pension system, one can qualify for the full State pension if you have 10 years of social insurance contributions.
The Government’s Roadmap suggests that a person would not be paid their auto-enrolment pension until their State pension becomes payable. Therefore, you may have to wait until the age of 68 to draw down your pension under the auto-enrolment scheme.
Auto-enrolment may make it harder for Irish employees to make savings into their pensions if employers chop their contributions to pension schemes to match the minimum contributions required under the auto-enrolment scheme as was the situation that occurred in the UK.
There are grave concerns that higher-rate taxpayers could lose out on tax relief once auto-enrolment kicks in. The Government has indicated in its Roadmap that with auto-enrolment, instead of paying pensions tax relief, the State might contribute €1 for every €3 paid into the pension scheme by a worker. So should the Government proceed with auto-enrolment on the basis of a €1 State contribution for every €3 paid by a worker, it appears that higher rate taxpayers would no longer be able to get 40% tax relief on their pension contributions, instead, they would be getting the equivalent of 33% tax relief. Alternatively, those paying the lower 20% rate of tax could, however, end up better off under auto-enrolment because the State contribution could be worth more to them than their current rate of pension tax relief. For higher-rate tax payers it might be worth seeking financial advice on whether to maximise your pension contributions before auto-enrolment is introduced in the next 3 ½ - 4 years.
In addition, there are concerns that some self-employed and part-time workers could lose out with the State pension if a 40-year social insurance contribution rule is brought in, as these workers may not have had enough time to build up the required level of contributions.
While there are many concerns that the Government needs to iron out, many people will undoubtedly be better off as a result of these new proposed reforms, however, there will be many others who will be worse off. We will just have to be patient and see what the future may hold for the proposed pension reforms which will and need to take place.
It is important to note that the Government is still in consultations with representative groups on the proposed reforms and thus any of the information contained in this article is not definitive in regard to the framework for the TCA and the operational structure of the automatic enrolment system, and is subject to change.
