Some things are worth protecting Background Existing Pension tax relief benefits 900,000 workers in Ireland 1 In the run-up to the 2011 Budget, there has been much debate on the issue of the cost of tax reliefs available on private pension provision. We believe that this debate has not recognised the fact that the existing tax relief incentives for private pension provision primarily benefit hundreds of thousands of middle income earners, rather than just the wealthy. If the Government s aim is to encourage saving for retirement, then changing tax relief is not the answer. Reducing pension tax relief will cut the income of middle income earners Reducing pension tax relief will significantly cut the take home pay of these 900,000 workers. For an example married couple, with one income of 50,000 per annum, the cut in take home pay will be 45 per month. 2 It has taken many years to build up pension provision The existing private pension system has succeeded in building up the number of people with pensions over many years 3. The tax reliefs available are essential to encouraging private pension provision, because longterm pension savings only make sense if the tax expected to be paid in retirement is lower than the rate at which tax relief is claimed. Tax paid by pensioners reduces the cost of the tax reliefs The actual cost of the current tax relief regime has been overstated. In reality, the tax relief offered is tax deferral, as pension income is taxed at the normal rates in retirement. If we allow for the tax revenue gained from pension income in retirement, 40% of the actual annual cost of pension tax reliefs on personal contributions is covered by tax on pension income 4. This % will increase quickly as the population ages. There are better ways to raise revenue and curb abuse We recognise that the Government has an immediate need to increase tax revenues. It is essential that the method of the contribution is designed so that the revenue achieved is certain, and so that incentives for private pension savings are maintained for middle income earners, who make up the vast bulk of the 900,000 workers who benefit from the current tax relief system. We need a debate We believe that the Government can meet its revenue requirements whilst also maintaining its commitment to long term pension saving. Over the four year plan, the Government should use the flexibility of a temporary fund based contribution from pension funds, as well as allowing limited taxed withdrawal from pension schemes. This approach would provide sufficient space for a debate on the development and implementation of a fair and sustainable long term strategy. 1 Source: Revenue Commissioners Statistical Report 2008 2 See Appendix 1 3 See Appendix 2 for build up of Zurich Life s pension numbers over time 4 Source: Revenue Commissioners Statistical Report 2008
Different approaches to increasing revenue contributions from Pension Funds There are a number of approaches which could be implemented in 2011, so that private pension funds can make a contribution to the Government s current need to increase tax revenues. 1) Tax relief of 33% on Pension Contributions Revenue raising potential: 85 m per annum 5 Tax avoidance incentive/potential for the wealthy: Some Negative This proposal is part of the National Pensions Framework, and was intended for introduction in 2014 as part of a comprehensive review of pension planning in Ireland. It benefits low income earners, who gain from a higher rate of tax relief than their 20% marginal rate. The revenue raised from this measure is quite limited, and comes with some uncertainty as higher paid employees will be able to avoid the tax change by moving to employer pension contributions. 2) Tax relief of 20% on Pension Contributions Revenue raising potential: 360 m per annum 6 Tax avoidance incentive/potential for the wealthy: High Highly Negative This proposal has been mentioned in the media as a simple means of generating extra revenue for the State. The expected revenue raised from this measure is significant. However, the actual revenue raised is highly uncertain as company directors and higher paid employees will be able to avoid the tax change by moving to employer pension contributions. This approach will have a hugely negative impact on private pension provision because, for many workers, the tax paid in retirement will be higher than the relief gained on contributions. Therefore, it will close down private pension provision to a very large segment of middle income earners. 3) Annual Contribution from all Private Pension Funds Revenue raising potential: 215 m per annum 7 Tax avoidance incentive/potential for the wealthy: Limited Limited This proposal will involve a contribution from all Private Pension Funds. It is designed as a temporary measure, linked to the four year plan, to allow time for a long term sustainable approach to be developed. The rate of the contribution can be set based on the Government s revenue raising requirements. The wealthiest individuals with the largest pension funds will make the highest monetary contribution, as the contribution will be a % of their fund. Most importantly, the incentive for private pension provision is maintained, as tax reliefs continue to be available. If introduced for a limited time, the proposal will have a relatively small negative impact on the funding position of defined benefit pension schemes. 5 See Appendix 3 6 See Appendix 3 7 Based on contribution of 0.25% of Private Pension Funds See Appendix 3
4) Allowing members to access funds early to meet their current liabilities Revenue raising potential: 100 m per annum 7 Tax avoidance incentive/potential for the wealthy: Limited Some It is currently only possible for members to access pension funds on retirement. In the current economic conditions, many people are struggling with large mortgages and other liabilities Allowing members to access a limited part of their pension funds early would give them a source of cash, to reduce their liabilities and help restore their financial position. Pension plan holders should be allowed to withdraw a maximum of 2.5% of their fund each year, or 10% over 4 years. The withdrawals made will be taxed as income. This option could not easily be made available to members of Defined Benefit pension schemes but could be implemented quickly for Defined Contribution pension schemes. 5) Encouraging members to access funds early based on the ARF deemed withdrawal model Revenue raising potential: 300 m per annum 7 Tax avoidance incentive/potential for the wealthy: Limited Some The tax relief provided on pension contributions is simply tax deferred, usually deferred until retirement but that could be brought forward under this option. In the current economic conditions, the Government could copy the existing ARF model and introduce a 2.5% per annum deemed withdrawal over the four year plan period which would be taxed as income. As with ARFs, the vast majority of pension plan holders would likely elect to take a withdrawal of their own money so the net of tax income could also boost the broader economy. In effect, this would be bringing forward the reclaim of part of the prior year tax reliefs which the pension plan holder had received on their original pension contributions. This option would reduce existing private pension provision by 10% so it would be even more important that the Government also committed to using the four year plan period for the development and implementation of the long term pension strategy. This option could not easily be made available to members of Defined Benefit pension schemes but could be implemented quickly for Defined Contribution pension schemes. 7 See Appendix 3
Thinking ahead - A strategic approach to private pension provision As the population ages, there will be an increasing need for private pension provision. It is essential that private pension provision continues to be encouraged, and that middle income earners continue to see the benefits of private pension provision. The stated aim of National Pensions Framework is to deliver security, equity, choice and clarity for the individual. It also aims to increase pension coverage, particularly among low to middle income groups and to ensure that State support for pensions is equitable and sustainable. In order to meet the aims of the National Pensions Framework, we believe that the future approach to private pension provision should have the following key elements: 1) Savings Incentives for low and middle income earners As pensions savings involves funds being tied up for many years until retirement, low and middle income earners must be provided with significant incentives to provide for their future pension needs. Tax relief at the marginal rate of income tax is an efficient means of delivering these incentives. 2) Restricting the wealthy from benefiting from excessive tax reliefs The cost of the private pension system will not be sustainable if the wealthy can benefit from excessive tax reliefs. The most effective way to stop excessive benefits is to restrict the contributions that can be paid into a pension plan on behalf of an individual each year and limit the total fund that might be accumulated. This is the process that was arrived at in the UK and is logical if the aim is to encourage pensions provision over and above the basic state provision. 3) Encouraging the lower paid to make pensions provision Tax relief has not been a major driver in encouraging the lowest paid to make contributions into pension plans. For the lowest paid the state pension will be the major form of provision. For the next tier of the population we believe that the provision of safe simple plans which are operated on an automatic enrolment basis, with a state contribution, will be the most effective method for providing pensions.
Appendix 1 Pay reduction for middle income earner This example assumes that pension tax relief is reduced to 20% Married - One Income - Private Sector Standard Rate pension tax relief + PRSI/Health Levy Relief Gross salary 50,000 Pension contribution 2,563 Subject to PRSI/HL 47,437 Less Income Levy 1,000 Income Tax 5,476 PRSI 1,633 Health Levy 1,897 Net 37,430 Add back Pension Tax Credit 513 Net 37,943 Tax credit rate 20% Current net income with marginal rate relief 38,481 Monthly loss 45 Appendix 2 Build up of Zurich pension coverage numbers over time Number of pension plan holders 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year The chart graphs the number of current Zurich Life pension plan holders who started their pension plan in each year.
Appendix 3 Exchequer yield from alternative approaches 33% tax relief Source: Minister for Finance reply to Parliamentary Question 22281/10 (26th May 2010) Saving from 41% tax relief: Cost of 33% relief to 20% tax payers: Net Exchequer yield 185 million - 70 million 115 million Assuming a 25% reduction in pension contributions since 2007, the expected current yield is 85 million. 20% tax relief Saving from 41% tax relief: 185 million times (41%-20%)/(41%-33%) = 485 million Assuming a 25% reduction in pension contributions since 2007, the expected current yield is 360 million. 0.25% annual contribution Total value of Irish Pension Fund Assets (as at 31/12/2010): 72.2 billion* Average Managed Pension Fund Growth (to 31/10/2010) 5% Total value of Irish Pension Fund Assets (as at 31/10/2010): 75.8 billion PRSA assets RAC assets Total Private Pension Fund Assets 2.3 billion** 8.0 billion*** 86.1 billion 0.25% contribution 215 million Allow pension funds to be accessed early Total Pension Fund Assets: Less Defined Benefit Schemes: 86.1 billion 50.8 billion**** 35.3 billion 2.5% withdrawal rate each year 0.9 billion Revenue yield at 33% tax rate (33% = assumed average marginal rate) 0.3 billion The revenue yield will be 0.3 billion if the deemed withdrawal rule is applied, or 0.1 billion if there is no deemed withdrawal rule and 1 in 3 pension plan holders avail of the option. * Source: Irish Assocation of Pension Funds ** Source: Pensions Board Q2 2010 *** Based on estimated Zurich Life share of RAC assets = 10% and Zurich Life RAC assets = 0.8 billion **** Source: IAPF 2010 67% of IAPF 75.8 billion in pension funds is Defined Benefit Zurich Life Assurance plc Zurich House, Frascati Road, Blackrock, Co. Dublin, Ireland. Telephone: 01 283 1301 Fax: 01 283 1578 Website: www.zurichlife.ie Zurich Life Assurance plc is regulated by the Central Bank of Ireland. Intended for distribution within the Republic of Ireland.