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Pensions Confusion and delay - when will the auto-enrolment train arrive at the station?

Ralph Benson of Moneycube looks at the planned changes to pensions and has some advice for employees and employers.

IF YOU HAVE young kids, you might just be familiar with an episode of Thomas & Friends where the friendly tank engine stands accused of causing “confusion and delay”. There have been too many diversions, unexpected stops, and misadventures along the way – and the passengers have lost much hope of ever reaching their destination.

The introduction of auto-enrolment– the practice of automatically signing up workers to pay into a pension – follows a similar story. Successive governments have set off on the journey brimming with optimism, but taken wrong turns and ended up in sidings, or been defeated by the government equivalent of leaves on the line.

In fact, auto-enrolment has been promised to Irish workers since at least 2006. We’re the only country in the OECD which hasn’t introduced it. So, what is auto-enrolment, is it really happening, and could it be a Really Useful Engine for your pension?

A nudge in the right direction

Auto-enrolment is designed to overcome our natural inertia in getting pensions started. A Standard Life survey last year revealed how resistant we are to looking ahead with 51% saying they will begin to think about retirement when it happens! Auto-enrolment uses nudge theory to address this.

The idea is that by making opting out of a pension the default choice, rather than opting in, people will “do the right thing” and pay into pensions.

At the same time, employers will be required to contribute an element of salary, and the government will offer a tax top-up. There’s no doubt that auto-enrolment is a positive development for the people of Ireland and a much-needed route to making many people’s financial futures better.

Over 750,000 workers in Ireland have no private pension – and auto-enrolment offers them a route to fixing that.

How will auto-enrolment work?

The government’s plan has three main elements. Firstly, it will be phased in over a decade. In the early years, employers and employees will each be required to contribute 1.5% of salary, rising to 6% by 2034.

This approach is designed to ease the financial impact of the changes but is nevertheless a significant new cost to many employers, who are already facing an inflationary environment.

Effectively, employers who don’t operate a pension scheme right now should be planning for a 1.5% rise in their payroll cost from next year. And employees should be planning for a 1.5% pay cut.

Secondly, the State will offer a top-up of €1 for every €3 paid into the pension by the employee. This is equivalent to tax relief at 25%. That’s good if you pay the standard rate tax of 20%. But it is significantly worse than the 40% relief any top-rate taxpayer currently receives on the money they put in their pension from their salary.

The difference is significant. For a top-rate taxpayer, our calculations show that €100 of net pay would result in €133 in an auto-enrolment pension. In a workplace pension or PRSA, it results in €167.

Thirdly, the investment choice will be kept very simple. It’s expected that there will be a choice of four investment funds of differing risk-reward profiles, including a default “life-cycle” fund which will dial down risk-reward as you approach retirement. The providers of these funds are unidentified, but the government hopes that total costs will be capped at 0.5% of the value of each pension.

Auto-enrolment is coming down the track

This time, it looks like auto-enrolment will actually happen, most likely in the second half of 2024. The government has built up a head of steam. More importantly, demographic change is putting pressure on the State pension, which is probably unaffordable in its current form over the long term, when there will be many more retirees than workers.

Another survey by Standard Life – recently released – reported that around 80% of people admit to “very little knowledge” about the plan, that is likely to change. You can expect a heavy advertising and public awareness campaign over the coming months as the scheme is introduced.

So is an auto-enrolment pension the best option from 2024?

Auto-enrolment is a lot better than no pension at all. We certainly wouldn’t recommend opting out altogether. But for those who have the option, a company pension is almost certainly a better alternative.

Here are five reasons an existing company pension or PRSA is likely to serve workers better if they have the choice.

  1. The government top-up of €1 for every €3 you put in (equivalent to tax relief at 25%) is worse for anyone paying top-rate tax at 40%.
  2. It’s unclear how workers can boost their pension. If 1.5% per year is not enough – and it isn’t for most people – how can they increase their contribution, and will the State continue to top it up? The government documents state that: initially, it won’t be possible for members to pay additional voluntary contributions (AVCs) into their AE pots, but this is something the [administrator] may consider at a later phase. Worse still, it seems there is no way for employers to make one-off lump sum payments into auto-enrolment pensions in Ireland – for example in a year of exceptional trading, or as a way to pay a bonus.
  3. The fund choice is more limited than any pension available in Ireland. That might make the administrator’s job simpler, but it’s not obvious that it benefits the end-user. There is no mention, for example, of the availability of ethical funds. If the fund managers of the four funds perform poorly, what is the pension holder to do?
  4. Accessing an auto-enrolment pension will be significantly less flexible. It appears these pensions will only be accessible before State pension age (ie age 68 for most joiners), which will be serious ill health The only circumstances that are being considered in terms of early access to pension savings are in relation to enforced workplace retirement due to ill health. Contrast that with existing company pensions, where you can access a pension from age 50, or even PRSAs, the benefits of which can be drawn down from age 60.
  5. The implementation of auto-enrolment in Ireland appears optimistic. Consider this statement from the government’s announcement: “Services will be provided and supported through an easy-to-use online channel where participants will see their savings pots grow quickly and substantively”. Has the government uncovered a secret sauce for investing? They might do well to remember that investments can go down as well as up!

More seriously, considering the average value of each account is likely to be in the low thousands of Euro, it is difficult to believe that an entire government agency, custodianship, fund management, account management, banking, onboarding and ongoing customer service and communications can be delivered for the intended maximum cost of 0.5% of fund value.

If it cannot, then exactly who will foot the bill? If those who join have an average salary of €42,749 (the estimated average salary in Ireland based on 2020 CSO data), that suggests all of this work can be done at a year-1 cost of €16.03 per member. Yes, there will be scale advantages, but it is hard to believe that 750,000 people can be enrolled in pensions for the price of three pints. In the UK and elsewhere by contrast, fixed monthly account fees for auto-enrolment are the norm.

Where does auto-enrolment leave employers?

What is clear is that the government expects employers to do the heavy lifting when it comes to auto-enrolment in Ireland. Employers will contribute at a rate three times that of the State.

Although the phasing in of contribution levels from 1.5% to 6% over a decade will soften the blow, auto-enrolment represents a significant extra cost to businesses, at a time when there is already significant wage pressure and a high overall tax burden.

What’s more, it applies to employers of all shapes and sizes. When auto-enrolment was introduced in the UK back in 2012, only companies with 250 or more staff were required to operate it. Small businesses were not brought into the fold until five years later.

No such approach is being considered in Ireland. Aside from the costs, this has the potential to make 2024 a very busy time as 750,000 people join a pension scheme for the first time!

Will it work?

Ultimately, it’s great the government has finally fired the starting gun on auto-enrolment in Ireland. Many people stand to benefit. But the government has created some big expectations. The countdown to launch in 2024 is on, and there is a lot of work in terms of fleshing it out, engaging workers and businesses, and building infrastructure to make it happen.

In the meantime, there are better alternatives for employees and business owners to secure their financial future and save tax via company pensions. Either way, the train has left the platform. By this time next year, we’ll know if it was all hot air, or if the journey is really underway.

Ralph Benson is co-founder and head of financial advice of online investments and pensions advisor Moneycube.ie and co-founder of PensionsAwarenessWeek.ie