How safe is your State pension? Five ways the benefit may be cut

With the number of over-65s in Ireland projected to increase from 570,000 to 855,000 in the coming decade, the pension time bomb is ticking

Life’s a beach: the problem facing countries all around the world is how will they continue to pay for pension benefits at a time when the population is living longer than ever before

Life’s a beach: the problem facing countries all around the world is how will they continue to pay for pension benefits at a time when the population is living longer than ever before

 

It is a time bomb that has yet to detonate, but all the evidence seems to suggest that it’s a case of when, not if, it will go off.

The problem facing countries all around the world is how will they continue to pay for pension benefits at a time when the population is living longer than ever before. And if they can’t, will someone joining the workforce today have to wait until they are 75 before they can retire?

Longevity is the key issue. Department of Social Protection figures suggest that the number of people in Ireland aged 65 and over will increase from 570,000 in 2013 to 855,000 in 2026. By 2055, just two people will be working to support every pensioner, down from about five today.

Given that one in every two workers in the private sector doesn’t have private pension coverage, the importance of the State pension is clear – and cutting it may have a huge societal impact.

“I don’t think it’s fair on the next generation,” says Michael Culligan, a principal with actuarial firm Milliman, who was commissioned by the Society of Actuaries in Ireland and Publicpolicy.ie to assess the financial sustainability of the State pension last year. (To see the full report, ).

One issue with the way Ireland’s State pension scheme is constructed is that it operates on a pay-as-you-go model. This means that PRSI contributions made by those working today go towards paying State pensions for those who have already retired. However, as the population ages, the balance, or ratio, of those who are working and paying for those are retired is set to change dramatically.

Ireland is not alone in its current approach. Many other European countries set aside almost nothing, funding benefits instead out of tax revenues as they come in. But the cost of servicing the State pension is set to rocket, jumping from 5.6 per cent of GDP in 2015 to 7.9 per cent in 2045 and 8.9 per cent by 2065, according to Culligan’s figures. And the shortfall between PRSI contributions and the amount being paid out is expected to widen from 2.6 per cent at present to 4.9 per cent by 2045 and 5.9 per cent by 2065.

“When you look at these numbers, something’s got to give,” says Culligan. “You have a situation where you have projected costs increasing very substantially.”

And there are no easy solutions, he adds. “You can cut pensions or you have to increase contributions. There’s no other way around it”.

It’s also a challenge for individuals.

“They must decide, if they are currently relying on the State pension [to fund their future retirement], do they expect that it will be payable when they retire, or if it will be at a level which is sufficient to provide them with a realistic lifestyle in retirement,” says Aisling Kelly, senior associate with Mercer Ireland.

There have been efforts to address this shortfall. In 2001, then minister for finance Charlie McCreevy established the National Pension Reserve Fund to build up a war chest to deal with the future pension funding issue.

The financial crash, of course, meant the fund was later raided to recapitalise the banks. And while there have been some calls of late to reinstate it, it is not clear where the money to fund it would come from.

A Universal Retirement Savings Group is also working on a review of the issues involved, but discussion of a looming pensions crisis was noticeably absent from recent election manifestos.

Putting it on the long finger may no longer be an option.

From 2017, under new EU rules, the Irish government will be obliged to calculate the total amount they must pay current and future pensioners. This will put the pension time bomb firmly on the agenda, but what will happen is not yet clear.

“It’s ultimately a political/societal choice: if society feels it wants to maintain the State pension, or increase it, that means we need to increase contributions,” says Culligan, adding: “On the other hand, if society can’t afford it, then we should go in a different direction.”

So if it is unsustainable, what measures might future governments take to defray the costs and put the benefit on a more secure footing?

Option One: Cut the value of the pension

The State pension currently pays out a top rate of €233.30 a week, thanks to the €3 increase last year. Qualified adults may get a further €209 a week, while those on a non-contributory pension get up to €222 a week.

By cutting how much it pays pensioners each week, the government could, in one fell swoop, significantly reduce the burden of the State pension.

A report from the Department of Public Expenditure and Reform in 2014, for example, said that cutting the rate must be considered as an option to ensure the sustainability of the State pension. A €1 reduction in the weekly contributory and non-contributory rates, for example, could generate savings of €19.7 million. If this cut was applied on a pro-rata basis to the qualified adult payment, a further €3.1 million in savings could be achieved.

Another suggestion put forward by the department was to scrap the €10 a week top-up pension payment for the over-80s.

Politically, however, Culligan says that such a move would likely be “very difficult”.

Option Two: Increase the retirement age

It’s already been done, but that doesn’t mean it can’t be done again. It’s possible, in theory, to keep on increasing the age at which people qualify for the State pension.

Since 2014, the qualifying age for the pension has risen to 66. That will rise to 67 by 2021 and 68 by 2028 under current plans. But it could rise again. After all, delaying the age at which people qualify for the State pension – and thereby reducing how much they’re entitled to over their lifetime – could offer some relief to the exchequer. Moreover, the higher the number of people working, the higher the number of those who are making PRSI contributions.

Over in the UK, the government has just launched a radical review of the pensions regime to assess whether or not their system is sustainable and affordable for future generations.

The UK already expects to link its pension age to general life expectancy after 2028. The Office for Budget Responsibility, the financial watchdog, has forecast that the pension age will have to rise to 69 by the late 2040s before increasing again to 70 by the early 2060s.

For Culligan, it’s “the most credible approach”, provided that life expectancy continues to rise. Today, a 65-year-old male is expected to live until he is 81.3 years, and a female until she is 84.8 years. Fast-forward 30 years, however, and by 2045 life expectancy may have increased to 86 years for a man and 88.9 years for a woman. Push out the dial to 2065 and a man may be expected to live until 88.6 years and a woman until 91.4 years.

As such, Culligan suggests in his report that the pensionable age should increase again to 69 years by 2038 and by one year every 10 years thereafter. In practice, this would mean that the State pension age would have risen to 70 years by 2055, and to 71 years by 2065. So, anyone born after 1969 wouldn’t be entitled to a pension until they were at least 69, while those born after 1994 wouldn’t get their pension until they were 71.

While it might reduce the period of pension payments for the State, and therefore ease the burden, this won’t offer a solution of itself. As Culligan notes in the report, “using this lever in isolation would not put the State pensions system on a sustainable footing”.

Moreover, increasing the pension age can be a bit of a “distraction” from the real issues at hand. After all, people retiring at 65 now have to wait until they are 66 before they can claim the State pension – but they are entitled to jobseeker’s benefit, albeit at a lower rate of €188 a week. This means that there is still a cost to the exchequer, whether people in this category are getting the pension or not.

While employers have been loath so far to increase their own pension age to match the new State pension age of 66, Kelly says that new legislation will make it more difficult to prevent employees from working longer.

“It will become an area under increasing pressure,” she says. “Employees will want to work beyond age 65 or their contractual age, and employers will be grappling with that.”

Another option, suggested by the OECD, in its review of the Irish pension system in 2014, is that “increments and decrements of the State pension could be introduced for late and early retirement”. This means that the later you retire, the more you would be entitled to get in your weekly pension.

Option Three: Cut eligibility for the pension

If fewer people qualify for the State pension, and fewer people are entitled to get it, the cost of servicing it will drop significantly. Already eligibility has tightened. People are now required to have 520 full-rate social insurance contributions, up from just 260 prior to April 2012. The actual pension paid is then determined by the annual average number of contributions since you first joined the system. An average of 48 a year will give you the maximum weekly pension payment, while you will need a minimum of 10 a year to get the minimum contributory State pension of €93.20 a week, with an additional €61.80 for a qualifying adult dependant.

This could introduce the possibility of means-testing the payment, or simply introducing an arbitrary threshold, such as €100,000, and deciding that no one earning more than that should be entitled to the State pension. However, this would cut the link between social insurance contributions and benefits for higher earners, which could lead to considerable resistance.

If that was to be introduced, it would have an impact on about 5 per cent of the population, according to statistics from the Revenue Commissioners. However, according to figures prepared by Culligan, it would deliver only a “slight reduction” in the cost of the pension to the exchequer, with the cost of pension provision as a percentage of GDP dropping to 6.5 per cent, from 6.8 per cent, by 2035 under tighter eligibility rules.

Another option would be to allow certain types of workers, such as manual workers, to retire earlier than those who are office-based.

If auto-enrolment – whereby employees have to opt out, rather than opt in, to a private occupational pension scheme, and employers are obliged to contribute – was to be introduced in Ireland, this could also be factored into how much someone gets in their State pension.

Option Four: Increase PRSI contribution rates

This is perhaps the simplest solution, and the one that will keep benefits as they are. But increasing taxes is always a contentious move.

At present, employees and the self-employed currently pay PRSI at a rate of 4 per cent, with employers paying a further 10.75 per cent. However, while the system might just about work now, with fewer and fewer people working and paying PRSI to support those in retirement in future, it won’t be enough to cover the level of benefits the State pension offers.

As Kelly points out, there are currently five employees working for every person in retirement; fast-forward to 2055, however, and that ratio drops to just 2:1.

To fill this contribution gap, Culligan suggests that the State could increase the level of PRSI people pay. However, to make a real difference, it would need to increase by 20 per cent over the next couple of decades, and by about 25 per cent thereafter.

This would mean that people paying PRSI at a rate of 4 per cent now would need to be paying 6 per cent, while their employers would need to pay more too, up from 10.75 per cent to 15.6 per cent.

Option Five: Change pension indexation

The stated goal in delivering pensions in Ireland is to maintain the minimum value of the pension at about 35 per cent of economy-wide average earnings. In 2011, this stood at about 36.5 per cent, up from about 30.5 per cent in 2002.

This is done by indexing the State pension with the rate of inflation in earnings, so that, as earnings rise, the State pension must rise too. But this is expensive. A better alternative could be to link the pension with price inflation. Doing so would bring down the percentage of GDP that the pension burden would account for, to 5.2 per cent by 2025, down from 6.2 per cent otherwise, and to 4.9 per cent, down from 7.9 per cent, by 2045, according to Culligan’s report.

Opting for an average of the two would reduce the benefit to the exchequer but could still be helpful, as could delaying the switch to price inflation until 2040.

There has been some move along this path already, with public sector pensions already linked to price inflation.

However, changing indexation would ultimately result in a decrease in income for those on the State pension, and would reduce that 35 per cent ratio to the average earnings for which the government is aiming.

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