Following the recent publication of the long-awaited national framework on pensions, attention remains focused on the question of income in retirement. PwC's Alan Bigleyexplains the principal changes as outlined by the framework and the challenges that lie ahead
OVER THE last 18 months rarely has a week gone by without concerns regarding pensions featuring prominently in the media and following the publication last month of the long-awaited national framework on pensions clearly this focus is not going to relent.
Irish people rely on a wide variety of arrangements to provide them with an income in retirement. These range from non-pension vehicles such as property investment through a range of pension arrangements – public sector pension schemes, company-sponsored arrangements, personal pension savings and PRSAs – with many solely relying on the State retirement pension for their income in retirement. The challenge for the State (as a significant employer and funder of the State pension) and employers is getting the balance right – what is an appropriate level of post-retirement income to target and what is the balance of responsibility between the employer, the State and the individual in delivering this income in retirement?
For most employees they will rely on either the State or their employer to provide a pension arrangement. Given the challenges of funding retirement both the State and employers are reconsidering how and what type of retirement income they will be in a position to fund.
The Department of Social and Family Affairs published the National Pensions Framework on March 3rd. It sets out a framework for the future provision of pensions. The framework is scheduled to be implemented over a five-year period and the principal changes in the area of pension provision include: a mandatory approach to pension scheme membership; increasing the state pension age and a new public service pension scheme.
Mandatory approach
By 2014 the framework envisages a new regime for private sector employees who are not currently members of adequate employer-sponsored pension schemes and aimed at those earning between approximately €18,000 and €50,000. The pension contributions will be invested to provide a private pension, supplementary to State retirement benefits.
The mandatory contributions to the pension schemes will be:4 per cent of pay by the employee;2 per cent by the employer and 2 per cent by direct State top-up.
The State contribution of 2 per cent is akin to tax relief at 33 per cent of contributions. Employees may opt out of this scheme but will be automatically re-enrolled every two years (the Minister believing that inertia may eventually play a part in employees remaining in the scheme). Even if the employee opts out of the scheme the employer will still be required to pay 2 per cent.
With regard to age, clearly increasing longevity puts significant strain on the ability of the State to fund the State pension.
The framework seeks to address this by proposing that the State pension age will be increased to 66 years by 2014, to 67 by 2021 and to 68 from 2028.
It is interesting to note that this rate of change is far quicker than the measures announced in the United Kingdom where their deferment to age 66 does not start until 2026.
The value and benefit of the State pension is often overlooked by employees in considering their retirement income. For many employees on low to medium incomes the State pension will be a significant element of their post-retirement income and indeed for many it will provide all their post-retirement income.
A public service pension scheme will be introduced for new entrants from this year. It is intended that all civil and public servants will have the same basic scheme. Key elements of the scheme include: A minimum public service retirement age of 66 and henceforth linked to the state pension age; a maximum retirement age of 70 and pensions are to be based on career average earnings rather than the current final salary arrangement.
The details are to be finalised by Government in consultation with public service employers and unions.
For existing and future public service pensions consideration is to be given to using CPI as the basis for future post-retirement increases compared to the current linkage to salary at retirement grade. Time will tell how effective these changes are – much of the technical detail needs to be worked out.
Employers’ provision
For employers there is a real challenge around pension provision. The actual provision of a pension scheme is time consuming and expensive. While defined contribution (DC) schemes do not carry significant investment and longevity risks for employers they do create significant administration costs, including costs of meeting a wide range of regulatory requirements. Regulatory requirements appear set to expand as more of the National Pension Framework document comes to implementation.
Two things are becoming evident with regard to the corporate view of pensions. The golden age of defined benefit (DB) plans has passed. Few businesses can afford to or are willing to take on the risk and costs associated with the provision of DB pension arrangements and indeed given the weak defined benefit regulatory regime, employees would need to be cautious around relying on them.
The existing DC model is also coming under pressure. Employers are questioning the value of the employer contribution in an environment where there is a plentiful supply of highly qualified labour. Employees are also questioning the value and benefit of their employee contribution particularly where they have suffered significant investment losses on their contributions and wonder why bother? I think employers have two choices. They can abandon employer-driven pension provision. This will leave employees on their own perhaps using PRSAs or relying on the supplementary mandatory scheme to be introduced. Such a scenario I believe will be a real challenge for employees as I would expect that without some form of pension savings structure most employees will not engage with the process.
For employers who do not operate a pension scheme the 2 per cent employer cost is going to add to the cost base and as such is seen as unwelcome. Some employers who wish to provide some form of pension arrangement to employees may see the mandatory scheme as an attractive model with significantly lower employer contributions than provided by many DC schemes.
Or, many employers will see the provision of a pension scheme as key to attracting and retaining staff and indeed providing a retirement age appropriate to their business and will be looking to reshape their schemes in a manner that is easily understood and seen by employees as an important part of the remuneration package.
Reshaping arrangements
In reshaping pension arrangements I believe employers need to invest the time in ensuring that the scheme meets their strategic and business needs and in particular consider the following steps:
q Develop guiding principles. Is the scheme important in managing the workforce through recruitment, retention and management of the retirement age? Is cost certainty important and are there consistency issues with other group companies?
q Company decision on alternatives. Based on the guiding principle, filter the options to a small number of credible alternatives and support with recommendations. Steer options through company approval process, recognising that this may require iteration.
q Stakeholder engagement. Stakeholders should be grouped into those who make decisions, those who will need to take action, those who need to be informed and potential barriers. Engagement with these groups is crucial to buy in to the proposals.
q Implementation and Communication. A project plan should be developed for implementation of the final model. Communications should convey the company rationale and imperatives so that changes are understood and ultimately buy in achieved.
The key to success is for the employer to carefully consider the model appropriate to its business, how it integrates with State arrangements and introduce it coupled with effective communications.
