Heading towards the mandatory pensions route

Pensions. The word alone is enough to put a large proportion of the population to sleep, with discussions of intricacies such as tax relief or product structures almost guaranteed to trigger a full-on snooze fest, at least among younger people.

The problem is one of timing, with few people keen on considering retirement provision (or lack thereof) at a time when the prospect of retirement remains a couple of decades away.

The consequent difficulty is that by the time this youthful bias wears off, at around the age of 45 or 50, it will be far too late for most to make adequate financial provision in time for retirement.

It is for this reason that the Government is very keen to encourage all of us to sort out our retirement finances as early as possible. As well as seeking to ensure that its citizens can maintain a high standard of living as older people, the State is also worried that, before long, it will be left with a generation of pensioners who are too reliant on public resources.

The specific goal in this regard is to raise pensions coverage within the workforce from 50 to 70 per cent before 2007.

A key pillar of the strategy is the Personal Retirement Savings Account (PRSA) - a kind of portable pension that was introduced with much fanfare a year ago.

The basic appeal of PRSAs was meant to be that they would be a simple and workable pensions option for those who were, for one reason or another, excluded from other pensions plan.

The latest figures on PRSA sales, released a week ago, show that just shy of 27,000 of the products had been taken out by the end of March. The Pensions Board described the total as "encouraging" and said "steady progress" had been made.

Even with this positive spin however, the board's chief executive, Ms Anne Maher, is realistic on the limited dent that PRSA coverage to date will make in the 70 per cent goal.

Pensions coverage stands at about 53-54 per cent and rough calculations from the Pensions Board suggest that more than 300,000 workers will need to take out a pension in the next two-and-a-half years if 70 per cent coverage is to become remotely achievable.

Ms Maher acknowledged last week that, if the target is to be met according to the Government's timeframe, the business of persuading us to take out pensions may have to be revamped to include an element of force. This is why some observers have described the five years of testing PRSAs as "the scenic route" to compulsion.

At the moment, PRSAs must be made available by employers who do not offer another pensions alternative to staff, but the decision to take one out is at the discretion of the employee.

This notion that pensions coverage should be made mandatory - thus forcing both employers and employees to ensure retirement provision - is a thorny one.

Many employers, for example, will immediately argue that forcing them to make pension contributions for their staff could be enough to push them under financially. The small business lobby ISME is known to be firmly against the notion, for example.

Ms Maher takes this point, accepting that the competitiveness implications of such a move would obviously have to be considered. There is a growing sense however that if the Government is really to take its pensions strategy seriously, something will need to be done.

Mr Diarmuid Kelly, chief executive of the Professional Insurance Brokers Association says that it is not at all surprising that younger people choose to allocate their cash to needs that are more immediate than pensions provision, such as mortgages and creche costs.

"People will have a tendency to focus on the short-term rather than on long-term horizons."

He also points to the existence of the Special Savings Incentive Accounts (SSIAs) as a ready sponge for our savings, and one that leaves very little over for other forms of saving.

While recognising that this is not necessarily a bad thing because the tax benefits of pensions are more or less matched by the free money element of SSIAs, Mr Kelly says it will be important at the end of the SSIA scheme in 2006 and 2007 to encourage people to roll their accounts over into a pension.

Coincidentally, the end of the scheme will accord almost exactly with the Government's target date for increasing pensions coverage. "Personally, I don't see a way of reaching the 70 per cent coverage without making it mandatory," says Mr Kelly.

The danger of this kind of forced approach however is that it could lead employers and staff to make just the bare minimum of contributions to their pensions, thus making a mockery of the very idea behind compulsion. The introduction of mandatory pensions overage in Australia had exactly this effect.

The basic rule of thumb in pensions cover is that, if a worker wants to retain half their salary at retirement, they will need to invest about 15 per cent of their income in a pension, starting from their late 20s or early 30s. While this is not a hard and fast position, it is clear from calculations by actuarial firm Life Strategies (see panel) that a lesser approach can leave retirees open to problems.

Mr Ray McKenna, a partner with KPMG's human capital division, says the mechanism of the PRSA and the necessity for employers to nominate a provider is "probably right".

He is worried about the level of contributions however, pointing to evidence among existing PRSA holders that they are only contributing, on average, 5 per cent of their salaries to the accounts.

Mr McKenna suggests that this could be improved by looking at the accounts from another angle and making a few small changes.

He believes, for example, that the existing situation, whereby employer contributions to a PRSA are treated as a benefit-in-kind requiring tax disclosure on the worker's part should be changed for simplicity purposes. Mr McKenna also recommends that the tax relief on the structures should be given at 42 per cent rather than 20 per cent.

The Pension Savings Gap: scary stories

Jane (35): retirement shortfall euro7,441 p.a.

Jane, a professional, earns €75,000 per annum and owns an investment property worth €250,000. She plans to use this as her main source of retirement income but also has other assets worth €25,000. She pays €3,000 into an SSIA each year. Jane's required income at retirement is estimated by Life Strategies at €36,750 each year in today's money. When her State pension, investment property and other savings are taken into account, her shortfall will be €7,441 per year.

Ann (35): retirement shortfall €6,731 p.a.

Ann, a 35-year-old supervisor, earns €35,000 per year. She has no pension plan but has been saving €1,000 each year for several years. With other investments, she has €25,000 in savings. She also has an SSIA to which she contributes €100 per month. Life Strategies reckons Ann will need annual income of €22,400 in today's money when she retires. Even when her State pension and her savings are taken into account, her annual income shortfall as a retiree would be €6,731.

Michael (35): retirement shortfall €1,772 p.a.

Michael, a 35-year-old public servant, earns €40,000 each year. He will receive a public-service pension when he retires after 32 years of service. He also pays €2,000 per annum in additional voluntary contributions and saves €1,000 each year through a savings plan. His financial assets, including €2,000 per year to an SSIA, amount to €30,000. He does not qualify for the contributory old-age pension because, as a public servant, he pays the lower rate of PRSI.

Life Strategies estimates that he will need annual income of €25,600 when he retires. His public-service pension would be €16,000 at current earnings and he would get a lump sum of €48,000, so his annual shortfall would be €1,772.

Paul (45): retirement shortfall €2,444 p.a.

Paul, a 45-year-old administrator, earns €30,000 each year. He has no savings or assets and has an outstanding loan of €10,000.

Luckily for Paul, his employer provides him with a defined-benefit pension scheme.

If he retires after 30 years of service with the company , he will receive €8,904 each year from the scheme.

Life Strategies has estimated that Paul's required annual retirement income will amount to €20,700 in today's money.

When the pension from his employer is added to the full State pension that he will also be due, his annual income shortfall will be €2,444.