Minister for Social Protection Joan Burton T.D Launches the OECD Review of the Irish Pension

Today the Minister for Social Protection Joan Burton T.D. launched the OECD Review of the Irish Pension system.

Review’s Main Findings and Policy Recommendations:

• Ireland is facing challenges on the financial sustainability of the pension system as the population ages; despite large projected increases in expenditure over the next 50 years, however, Ireland's pension spending will still be comparatively low in international comparison.


• The economic situation of pensioners in Ireland is comparatively good, both with respect to other age groups in the population and in international comparison.


• Ireland and New Zealand are the only OECD countries which do not have a mandatory earnings-related pillar to complement the State pension at basic level; as a result, Ireland, like New Zealand, faces the challenge of filling the retirement savings gap to reach adequate levels of pension replacement rates to ward off pensioner poverty.


• Private pension coverage, both in occupational and personal pensions, is uneven and needs to be increased urgently.


• Pension charges by the Irish pension industry on large occupational Defined Contribution (DC) plans are not too high when assessed on an international context; they are however rather expensive for small occupational schemes and personal pension schemes.


• The existing tax deferral structure in Ireland provides higher incentives to save for retirement to high incomes as the incentives work through the marginal tax rates.


• The Irish legislation regarding the protection of Defined Benefit (DB) plan members is weak. For example, the guarantee schemes in Ireland (Insolvency Payment Scheme and the Pensions Insolvency Payments Scheme) provide partial protection to DB plan members' benefits in case of sponsor insolvency. In addition, the legislation allows any sponsor to walk away from DB pension plans, shutting them down, without creating a high priority debt on the employer. Moreover, the priority currently given to pensioners before other members if a scheme winds up creates large inequalities across members. This outcome is particularly harsh for those close to retirement.


• There is unequal treatment of public and private sector workers due to the prevalence of DB plans in the public sector and DC plans in the private sector


• The State pension system lacks transparency, both with respect to the calculation of benefit entitlements and to the interplay of the contributory and non-contributory pensions.


• The link between contributions and benefits in the Irish State pension scheme is very weak, for reasons spelt out in the report, contrary to what people‘s perceptions of this link may be.


• The State pension scheme could be modernised to encourage working longer in line with the prevailing international trend.


• The new scheme for public servants is being phased in only very slowly and is unlikely to affect a majority of public sector workers for a long time.

Parametric changes in the State pension system

• Within the existing State pension system, Ireland could consider a number of parametric reforms which would improve the financial sustainability of the pension system in the future.


• The long-term retirement age, which at 68 is relatively high in international comparison, could be linked to life expectancy after 2028 in order to ensure that improvements in life expectancy do not significantly extend the duration of retirement.


• To provide incentives for workers to remain in the labour market longer and on the other hand provide more flexibility in making the retirement decision, increments and decrements of the State pension could be introduced for early and late retirement.


• More flexibility could also be provided in allowing retirees to combine work income and pension receipt; this could also ensure better adequacy of retirement income.


• Looking ahead, the adjustment of pensions – which have been frozen in recent years - also needs to be considered as this has a large impact on the evolution of pensions in payment; various options of combining indexation to wage growth and price inflation could be considered.

 

Structural reform of the State pension system

• Given the complex structure and the inequities resulting from the benefit calculation method in the public pension scheme and the interplay between the contributory pension, the non-contributory pension and other means-tested elements of retirement income provision, Ireland should consider a structural change of the State pension scheme.


• At a minimum, the current inequities in the treatment of workers‘ contributions to the system should be removed and all contributions made should be honoured in the calculation of the pension benefit, as foreseen in the current plans to adopt a total contributions approach from 2020 onward.


• The best two options out of the three described in the report, for a structural reform of the State pension scheme are: a universal basic pension or a means-tested basic pension. Both of these options would have the advantage, compared with the existing scheme, of introducing a much simpler, more transparent and less costly public pension scheme.

 

Option 1: a universal basic pension scheme

• A universal basic pension scheme for the entire population would be based on residency requirements, provide a single flat-rate benefit and cover all of the Irish population, regardless of their life-time work or contribution status. It could be financed by taxes, contributions or a combination of the two.


• A basic pension scheme could be complemented with either mandatory private pension provision or auto-enrolment into to private pension schemes.  Participation could be targeted at workers above a certain income level as workers on low earnings would already be receiving a comparatively high replacement rate through the basic pension.


• The Household Benefit Package and Free Travel Scheme could either be transformed into a cash supplement and merged with the basic pension or it could be awarded to pensioners who need the extra benefit as a means-tested cash supplement.


• Setting the level of such a basic pension for all citizens in order to meet the twin goals of social adequacy and financial sustainability would require more detailed analysis, including the costing of alternative revenue scenarios.

 

Option 2: a single means-tested pension

• An alternative would be a single means-tested pension financed out of general revenue. The Household Benefit Package, the Free Travel Scheme, and other means-tested "advantages" would be included in the pension amount.


• The main design issues to be addressed under such a scheme would again be the appropriate level of the means-tested benefit, at what schedule the benefit should be withdrawn for higher earnings, what type of administrative arrangements would be needed and how much this scheme would cost under alternative scenarios.


• Combining the public and the private pension pillars, a means-tested scheme would function best in combination with mandatory participation in private pension plans. In a voluntary scheme, even with an auto-enrolment mechanism, there would be disincentives to contribute to a private pension, unless a certain amount of pension savings were exempted from the means-test for lower-earning groups.

 

Reform of the public service pension scheme

• At a minimum, a faster phase-in of the new rules of the occupational scheme for public servants should be considered; this would entail including existing public servants in the new scheme based either on a certain cut-off age or on length of service.


• Any new private pension scheme for private sector workers should also be extended to public servants, at a minimum for new entrants but ideally also for some of the existing public servants.

 

Policy options to expand private pensions coverage and retirement savings

• To increase adequacy of pensions in Ireland, there is a need to increase coverage in funded pensions. Increasing coverage can be achieved through (1) compulsion, (2) soft-compulsion, automatic enrolment, and/or (3) improving the existing financial incentives.


• Compulsion, according to international experience, is the less costly and most effective approach to increase coverage of private pensions (OECD Pensions Outlook, 2012, Chapter 4).


• Automatic enrolment is a second-best. Its success in increasing coverage depends on how it is designed and on its interaction with incentives in the system.


• The cost of establishing and managing auto-enrolment may be higher. Auto-enrolment requires monitoring, accurate record-keeping, fiscal incentives and careful design. Implementing a centralised institution to manage the system and provide default investment options would add to the costs.


• There is a misalignment to correct between the existing tax deferral structure in Ireland that provides higher incentives to high-income earners and the policy goal of increasing coverage, especially for middle to low-income people.


• International evidence (Germany, Australia, and New Zealand) suggests that flat subsidies and matching contributions increase incentives to save for retirement for middle to low incomes.


• Existing private schemes need to be subjected to the same rules as the new schemes under auto-enrolment or compulsion.

 

Improve the design of DC arrangements

• The design and institutional set-up of DC pension plans need to improve in line with the OECD Roadmap for the Good Design of DC Pension Plans.


• Establish appropriate default investment strategies, while also providing choice between investment options.


• Establish default life-cycle investment strategies as a default option to protect those close to retirement against extreme negative outcomes.


• Encourage annuitization as a protection against longevity risk. For example, a combination of programmed withdrawals with a deferred life annuity (e.g. starting payments at age 85) could be an appropriate default.


• While still keeping the principle of pension savings being ―locked away, the Irish Government could consider allowing withdrawals strictly only in the event of significant financial hardship.


• Specialised private institutions (e.g. pension funds, asset managers) should manage the assets. The establishment of an autonomous public option could be envisaged to provide competition, lower costs, and a default pension fund for those unable or unwilling to make investment or fund choices.

 

Enhancing benefit security in DB schemes

• Strengthen the Irish legislation regarding the protection of DB plan members when plans wind up. For example, healthy plan sponsors should not be allowed to ―walk away from DB plans unless assets cover 90% of pension liabilities. This funding requirement would introduce some type of guarantees for members and it would allow at the same time some degree of risk sharing. The funding ratio should be calculated following prudent standard actuarial valuations. Moreover, the priority currently given to pensioners before other members if a scheme closes because of sponsor bankruptcy should be eliminated.


• Further legal reforms may be needed to introduce more flexible DB plans that for instance allow for accrued benefits to be cut in case of underfunding (e.g. the Netherlands) and, more generally, for risks to be shared between plan members and pensioners, as well as plan sponsors.


• Establish a clear framework to facilitate domestic investment in infrastructure projects, but a general subsidy to all infrastructure projects should be avoided as it would distort capital allocation. It is clearly desirable that pension funds should help support economic growth in Ireland, but the objective should not be used as an excuse to impose low returns on pension fund members.


• Revise the new funding standards as they may create new risks for pensioners by offering strong incentive for pension funds to invest in Government bonds, in particular sovereign annuities.

Further comment and analysis to follow.

Meet our BOB!

ITC are delighted to announce the launch of our Buy Out Bond (BOB).

Our ITC BOB enables clients to take control of their existing employment related pension benefits and invest them in their own personally owned pension plan, to access at retirement.
 
 

It is not unusual for people to change employment many times during their career and a Buy Out Bond provides a vehicle for clients to manage their previous pension benefits and invest them in a way that suits their needs.

Our ITC BOB provides 4 key features:

• Control
• Transparency
• Flexibility
• Security

To find out more about  ITC’s BOB download our Brochure & Terms and Conditions.

 
 

 

For further information contact our team to discuss:

• Michael Keyes (01) 614 8045 / michael.keyes@independent-trustee.com
• Sean Mc Loughlin (01) 614 9220 / sean.mcloughlin@independent-trustee.com
• Martin Glennon (01) 603 5130 / martin.glennon@independent-trustee.com

www.independent-trustee.com

Fianna Fail Launches Pension Strategy Paper

The Fianna Fail pension strategy, launched today by Willie O’Dea, deals with several issues close to our heart:

1.       The funding requirements for DB schemes

2.       The priority order for DB schemes on wind up

3.       Early Access to Pensions and

4.       The issue of Pension Charges

As chair of the Pensions Committee of the IBA I have actively involved in communicating with politicians of all shades on the issues facing pensions. The paper launched by Willie O’Dea is testament to the fact that patient and consistent dialogue does have an impact.

The funding levels DB schemes have to met is set at artificially high levels due to:

1.       the historically low level of bond yields and

2.       the additional reserve requirement imposed by the current government

The Paper proposes that this be addressed by easing the funding requirements and allowing greater flexibility as to when and if annuities are purchased.

In relation to the priority order the Paper suggests that, once a certain level of pension has been guaranteed in priority to pensioners the balance should rank equally with other members of the scheme. This would address the big gap in benefit that can exist between members either side of retirement age.

The current early access regime is too restrictive (as it only applies to AVCS) and mean spirited (as it imposes an additional 41% tax on those in difficult financial circumstances). The solution proposed is to replace it with an option to take some or all of your tax free lump sum at any stage in your life. There is no loss of tax to government and the greater flexibility enhances the attractiveness of pensions and gives relief where it is due.

On pension charges the Paper proposes the development of a Total Expense Ratio so that fund manager costs can be more easily identified. Also greater transparency on other costs is advocated.

 

To view the full paper click here.

Written by Aidan McLoughlin

Independent Trustee Company

Managing Director

Where's the money going? Part Two

In my “Where’s the money going?” Blog (Feb 14th, 2013), I mentioned the growing area of the Advisor Portfolios or Advisor Propositions.

 

To explain some of the reasons for this growth, let me go back to that period between 2007 and 2009. At the time it was estimated that 70% of pension money was held in Managed funds. A well established, general one-size fits all approach with some add-ons attached over the years i.e. Consensus and Life-styling. The strength of the Managed fund was diversification.

 

 

As we know, there’s nothing like a health scare to get a client to question his/her protection benefits. And in the same way there’s nothing like a market crash to get a client to question what went wrong?

 

 

For me some of the big questions that came from the crash about Managed Funds were:

• Did clients believe that a fund manager could switch easily to other assets?
• Were clients aware of the restrictive parameters that were set for asset allocation?
• Were clients aware of peer pressure, with fund managers constrained by benchmarking?

 

In summary - Who was managing the risk?

 

 

The realisation of the constraints of a Managed Fund, were hitting home hard. There were very few clients who had the knowledge (or interest) of how a Managed Fund operates, but the impact to their funds got them to take notice. That notice came in the form of worry, panic, anger and accusation. Not a pleasant time for all involved.

 

The response from fund managers has been to develop and promote their absolute return or risk-managed funds. A promise to focus on the risk and not just the assets.

 

The growing response from Advisors, has been to take ownership of a clients asset allocation and risk management. The availability of platforms, index funds, ETFs, bank deposits, stockbroking accounts etc. has made it easier to offer a more involved and controlled strategy.

 

Advisors who have adopted this investment model believe that this offers a more collaborative approach with clients and promotes a better client relationship.

 

The growing number of Certified Financial Planner ™ professionals and the possible move by the Central Bank to a review similar to the UK’s Retail Distribution Review, are other contributors to ITC seeing an increase in the Advisor Portfolio/Proposition approach.

 

As you know, the ITC products offer the Advisor and their clients, the structures to have choice, transparency and control.

 

 

Martin Glennon

Corporate Account Manager

Independent Trustee Company

Meet the trustees

If you are the owner of / the advisor to an ITC SSAS, do you remember to hold your annual trustee meeting?

A trustee meeting provides an excellent opportunity for the trustees to meet with the scheme financial advisor and the administrator to do a review of the scheme. Issues that are typically discussed are investment strategy and performance, scheme governance, trustee training etc. - but it’s an open forum!

The owner of an ITC SSAS is also a trustee of the SSAS, ITC being the other trustee. This is one of the key features of the ITC SSAS. The Pensions Board’s Trustee Manual, which sets down rules of conduct for trustees of occupational pension schemes, prescribes that trustees should meet at least once every year. It is most appropriately done just after the issue of the annual scheme accounts.

In ITC, we issue an invitation to a trustee meeting and the meeting agenda with every set of annual accounts. The accounts and the invitation are forwarded to the member trustee and, if we have been requested to do so, to the financial advisor. It is then up to the trustees and the financial advisor to agree the timing of the trustee meeting – but it must be held.

The meeting can be done over the phone or by meeting in the ITC offices. At the end of the meeting, the trustees observe their duty to sign the annual accounts. Minutes of the Meeting are agreed.

On occasion, issues of a legal or technical character arise. The trustee meeting is the perfect opportunity for agreeing how to solve them.

Make sure that you hold a trustee meeting at least once a year. It’s a great opportunity –  it’s your duty!

 

Tommy Nielsen

ITC Consulting

Finance Act 2013 – the Bill

The Government published Finance Bill 2013 on 13^th February 2013.

In the area of pensions, the Government introduces new thresholds to the regime for ARFs and vested PRSAs. The measures are significant because they contravene previously introduced efforts at securing pensioners’ retirement income in old age.   The new thresholds, which had not been flagged by the Minister in his Budget speech in December, means that the thresholds which applied to ARFs pre-Finance Act 2011 will now see a comeback.

Since Finance Act 2011, members of Occupational Pension Schemes and contributors to Personal Pensions and PRSAs who have an annual pension income of €18,000 can take the entirety of their pension benefits into an ARF.  Those who do not have sufficient pension income must first set aside pension benefits to the value of €119,800 in an AMRF - or buy an annuity for that amount. The AMRF has to be kept until age 75, or until such times as the pensioner becomes entitled to an annual pension income of €18,000 (whichever is the earlier).

However, from the passing of the Finance Act, the requirement of a €18,000 pension income will be reduced to €12,700. This means that recipients of the Old Age Pension (currently around €12,000) who have very limited additional pension income, no longer have to put money aside for very old age. Accordingly, Finance Act 2013 effectively marks the beginning of the end for the prudence of thinking which infused the AMRF concept.

Furthermore, from the date of the passing of the Finance Act, the max value of the AMRF will be reduced from €119,800 to €63,500.  But it is perhaps more precise to say that the value of ARFs will be increased by the difference, namely €56,300. This is significant because ARFs are subject to imputed distributions which, in turn, are subject to income tax - while AMRFs are not. So, bigger ARFs, bigger income for the Exchequer. While there can be no other reason for decreasing the value of the AMRF other than to improve the tax take for the Exchequer, the measure is, seen in isolation,  perhaps of little importance as the AMRF regime is on the way out – as already argued.

Another measure, one which was flagged in the Budget, is the access to AVCs prior to retirement in certain circumstances.  An individual who has made AVCs can make a once-off withdrawal of up to 30% of the value of their AVCs prior to reaching retirement.  This is restricted to AVC funds. Access to other types of pension arrangements, such as personal pensions, is not available.  The access to AVCs will be available for a period of 3 years from the passing of the Finance Act 2013.

Funds withdrawn in this manner will be subject to income tax at 41% but will be exempt from USC and PRSI.  If an individual can provide a certificate of tax credits or evidence that they are subject to income tax at the 20% rate, the tax payable may be less than 41%.

While this would appear to be a welcome measure at first glance, on reflection it could once again signal the government’s shift to short-sighted policies to increase the short term tax take from pension funds.  As with the changes to the AMRF regime, allowing early access to AVCs only serves to reduce the benefits available to fund an individual’s retirement which may once again leave them dependant on the State later in life.

 

Tommy Nielsen & Jennie Faughnan

Independent Trustee Company

Where’s the money going?

One of the most common questions I get asked when on my visits to Advisors is - “What are people doing with the money once they’ve set up an ITC self-administered structure?”

Let me state first that what follows is an observation of movement of existing and new money. As you know, ITC does not offer investment advice, so please don’t confuse the following as a recommendation. If you require any advice in relation to the following, please contact your Advisor.

With our compliance department now satisfied, I think the best way to answer the above question this is to look at the main areas of client interest in 2012.

 

Area 1 - Deposits

The banks thirst for deposits during 2011 and average inflation at 1.65%, made it very easy for investors to achieve “Real” growth with little or no risk.

It was noticeable in 2012 that the banks had changed their tune and were pushing headline rates down and this is expected to continue throughout 2013.

Despite the downward pressure on deposit rates, demand from clients has remained strong and an expected inflation rate for 2013 of 1.3% (HICP) is unlikely to dent this demand.

What we have seen, however, is a shift from short term deposit accounts to the more long term.

These trends are backed up by statistics from the Dept. of Finance.

• Deposits from Insurance Corporations and Pension funds increased by 6.9% in 2012.
• Shorter term deposit rates (less than 2 years) reduced from 3.57% in Jan 2012 to 3.35% in Nov ’12.
• Longer term deposit rates (more than 2 years) increased from 2.37% to 2.42% over the same period.

It’s no surprise that ARF clients are the biggest supporters of deposit strategies. Their age profile means that they have less appetite for risk. This has resulted in over 60% of ITC ARF funds being held in deposits.

We contacted the insured companies towards the end of 2012 regarding the charging structure of their ARF products. An annual management fee of 1% is very common.

This probably explains the inflows to the ITC ARF. Choosing an annual management charge of 0.5% gives most clients a reduction in fees, full access to the deposit markets and covers the Advisors continued work of research, recommendation and implementation.
 

Area 2 - Broker Portfolios

What I’m talking about here is where the Advisor has built their own offering for clients through the use of insured funds, stockbroking accounts and funds, deposit agencies etc.

The ITC products work really well in providing Advisors and clients the structures for choice and control of investments.  

The Advisor assists the client in understanding their attitude to risk/loss, and then builds an agreed portfolio around their goals and objectives.

The strengths of this approach are obvious. The client has a better understanding and more involvement in the process. This gives the client more clarity and control. There are more touch points with the client which, results in a much stronger relationship between the client and Advisor.

For many reasons (to be covered in a future blog), we believe that this type of strategy will continue to grow in 2013 and beyond.
 

Area 3 – Property

We’ve seen a significant pick up in activity for both Commercial and Residential property and the following gives an indication why we have had this activity from existing clients and new clients moving away from traditional insured funds.

• The consensus from the major estate agents is that for prime commercial property in the major cities, prices have stabilised.
• Residential property continued to fall in 2012. In Dublin it was down 2% and down 9% for the country as a whole. But South County Dublin saw an average increase of 3.1%. (Daft.ie)
• Rental yields are averaging 8.8% and the average residential property price was €140k. (Allsop Space/Goodbody 8/12)

The one thing we haven’t seen is leverage. The lenders experience of negative equity and overall impairments has obviously affected their appetite to lend. Will lending to pensions happen again? Yes, I believe so, but in prime property and with lower loan to value ratios.

Martin Glennon QFA CFP® 

Corporate Account Manager
Independent Trustee Company