Following the budget at the end of 2009, the public sector has seen a series of changes, including the introduction of a career average scheme. Helen Morrissey reports
The run up to Ireland’s December 2009 Budget was rife with speculation as to how the government would look to plug a budget deficit projected to equate to 11.6% of GDP. Among the issues under discussion were further cuts to public sector salaries as well as possible amendments to the tax relief available on pension contributions and lump sums.
When the budget was finally delivered on December 9 it was much quieter on the pension front than expected. While finance minister Brian Lenihan did mention in his speech that the issues of tax-free lump sums and pension contribution taxation would be considered in the future, nothing would be done straightaway. So while the private sector breathed a sigh of relief, it was the public sector bearing the brunt of the pain.
The announcement of the career average scheme for the public sector was very significant and I’m sure the unions will have a lot to say about it
First of all was the announcement that defined benefit pensions would be stopped for all new public sector hires with a career average scheme being introduced from 2011. The retirement age for public servants would be increased from 65 to 66 with future increases being linked to state pension age. Finally the announcement was made that the government was considering linking increases to pensions in payment to consumer price inflation (CPI) rather than earnings.
So was the budget a success? Did it bring in the important cuts needed to help the Irish government balance its books or did it sidestep key issues? According to the Irish Association of Pension Funds (IAPF) policy director Jerry Moriarty the budget was a good one.
“There had been much speculation about possible changes to pension contribution tax relief but they parked that and that means private sector schemes breathed a sigh of relief,” he said. “The main feature of the budget was to reduce public sector pay and on this point the budget did deliver. However, as yet we haven’t seen any real detail – there will need to be a lot of negotiation with the unions before the matter is finally settled.”
Career average scheme
Probably the biggest news of the budget was the decision to launch a career average scheme for new recruits. However, with few, if any details being released as to contribution rates or how the scheme would work is the planned 2011 launch date a bit optimistic?
“The announcement of the career average scheme for the public sector was very significant and I’m sure the unions will have a lot to say about it,” said LCP partner Martin Haugh. “However, I feel that the 2011 launch date is more of an aspiration right now considering we don’t have much detail as to how it is expected to work.”
However, according to Hewitt senior actuary Philip Shier people should not be too concerned about the 2011 deadline and that the career average scheme could bring huge benefits in terms of costs savings and efficiency.
“The career average scheme has been launched for new recruits but considering there is a recruitment freeze in the public sector right now then nothing needs to be done straightaway,” he said. “It’s more of an admittance that current levels of pension provision are unsustainable. Another thing is that career average will cater more easily for people’s shifting work patterns than defined benefit pensions. Issues like working part time or going on maternity leave will be less difficult to account for as your earnings are determined on what you did in that particular year. From that point of view the career average scheme is an easier model to manage in many ways. Also the fact there will be a single scheme will make it easier to manage so there will be administrative savings too.”
So bearing in mind the huge cost savings that could be generated by going down the career average route could this move have wider consequences for the private sector also? While many private sector employers are looking to close down their defined benefit schemes – could career average prove to be a viable alternative rather than going down the straight DC route?
“The fact of the matter is that most DB funds in Ireland are underfunded and many companies are going through the process of assessing how to make up this deficit,” said Moriarty. “Career average from this point of view could be an option worth considering.”
Pensions in payment
Another aspect of the budget with far reaching consequences was the decision to change how to calculate increases to pensions in payment. Up until now the system has generously linked increases to wage increases but any future increases will now be linked to CPI.
“The decision to link future pension increases to inflation rather than wages is something that could have a big impact over time,” said Moriarty. “Pension increases tend to be a big cost when it comes to working out liabilities. The benchmarking of these increases was meant to centre on issues like productivity and changing working practices over time so why should pensioners get these increases if they are not actually working?”
Shier agreed saying that public sector pensioners have benefited from wage increases, but have not been affected by the wage cuts suffered by many public servants in recent years. He concluded saying: “I think linking pension increases to CPI is still pretty generous.”
So while it would seem the private sector got off pretty lightly in this budget the spectre of change continues to linger. While not directly targeted in the budget the minister did say that changes to the taxation of tax free lump sums and pensions contributions would be coming. Last year the commission on taxation issued a report recommending that lump sums over €200,000 (US$278,000) should be taxed at a standard rate with sums below this amount remaining tax free. While such a move may be treated with concern, the IAPF’s Moriarty pointed out that such a move “would not affect the vast majority of people”.
Shier continued saying that change is this area is inevitable.
“We can’t expect the lump sum to remain tax free forever – it is unsustainable,” he said. “It’s also worth pointing out that savers get tax relief on their contributions, so should they get more tax relief on the way out? We need to give this issue proper consideration and not make kneejerk reactions.”
The catalyst for any real change to private sector pensions will come with the long awaited Pensions Framework document. The Pensions Framework was announced by the Department of Social and Family Affairs following publication of a green paper on pensions in 2007 and is expected to drive pensions policy in Ireland for the foreseeable future. Any changes to private sector pensions such as the taxation issues mentioned above will need to be considered in the wider context of the document and so the industry is waiting eagerly for it to be unveiled – they have been waiting a long time.
“The fact the framework document has not been published yet has done nothing to help long-term planning,” said Moriarty. “We’ve been waiting so long for this document but then there have been many changes to the economy since the green paper was published. We have discussed the issue of putting together a Retirement Commission which would take retirement issues such as pensions and long term care out of the political arena altogether and enable more long term decisions to be made. According to a report there were 468,000 over 65s in Ireland in 2006, yet in 30-years time this number is expected to swell to 1.4 million so we need to start making decisions.”
Shier shared in Moriarty’s frustration saying that until the framework document “is published we can’t move forward with the key issues.”
So the Irish pensions industry continues to grapple with a variety of challenges. While some progress has been made in the public sector arena, there is still much to do in the private sector. In November 2009 the OECD called for Ireland to reorganise private sector provision –so what more can be done to improve efficiency?
“The size of the Irish market means it is often difficult to get economies of scale and we need to see if there is any way we could open up the market internationally so we could bring down costs,” said Haugh. “We need to make the process of setting up and saving into a pension as straightforward as possible – we won’t see charges drop significantly until there is more scale.”
One answer according to Moriarty would be to set up collective pension schemes across industries.
“It’s very hard to cut costs while improving pension provision – at the moment only half of people have supplemental pension provision,” he said. “We need to look towards more collective pension schemes which would bring benefits in terms of scale and administration costs as people who move jobs within the same industry would not need to keep changing their pension scheme.”
However, Shier remains unsure that many employers would be willing to take on the risks associated with taking a more collective approach
“I’ve seen the issue of industry wide schemes before but I’m sceptical,” he said. “Maybe if we had standardised benefits but not right now. It doesn’t address the issue of post service deficits – who wants to pay someone else’s deficit? What happens if one employer goes insolvent – would the other employers in the scheme have to make up the shortfall?”
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