Ireland
compiled by Allianz Global Investors
Pension System Design
Ireland’s pension system consists of a pay-as-you-go financed public pension pillar supplemented by a voluntary 2nd pillar scheme and private pension plans. However, there is a substantial group of people without adequate supplementary pension coverage; just about 50% of the population only receives the state pension. This is one reason why there is an ongoing discussion to reform Ireland’s pension system. In October 2007, the government issued a green paper and made several reform proposals discussing the ‘big picture’ options for the system while addressing topics such as:
- The demographic challenge
- How to ensure the sustainability of the pension system
- Reform Options for the Social Welfare Pension
- Possible approaches to pensions development
- Funding standards for defined benefit schemes
- The role of regulation
The paper addresses in deep detail any issue that relates to the structure of the pension system in order to stimulate debate on the challenges and options for the future development of pensions in Ireland. The publication of the Green Paper is followed by a period of consultation until mid-2008. All individuals and organisations are invited to give their views. The goal is to develop a framework that comprehensively addresses the pensions agenda over the longer-term.
Ireland is one of the few European pension markets where investment assets are prevailing. Since individual life insurances do not attract tax incentives, and Personal Retirement Savings Accounts (PRSA) have been only established in 2003, the pension market predominantly consists of occupational pension schemes although PRSA saw a strong growth since their introduction. Compared to the European average pension schemes are predominantly investment instead of insurance oriented. Given the comparatively young population and the high equity exposure of Irish pension funds we expect the pension market to grow at an annual rate of close to 5.6% to EUR 333 billion in 2020.
Public Pensions
The public pension pillar comprises both a contributory and a non-contributory element. The latter is a means-tested pension, which is paid to individuals without adequate means at the age of 66.
The old-age contributory pension system is financed on a pay-as-you basis and provides flat-rate benefits depending on the contribution period. All employees in the private and public sector as well as the self-employed are insured under the system. Contributions are unequally shared between the employer and employee; the contribution rate for wage earners amounts to 4% of earnings up to a ceiling of EUR 46,600. The employers’ share depends on the income of the employee and is not limited to the ceiling applicable for employee contributions. For employees with weekly earnings of EUR 356 or less the employer pays 8.5%, but 10.75% in case weekly earnings exceed that amount. The self-employed whose income is less than EUR 22,800 pay 3% of gross income and 5% for earnings above that threshold.
The statutory retirement age is 66 and early retirement is not possible under current conditions. Pension benefits from the public pillar are not considered to be overly generous with a replacement rate of 32.5%, which is obviously lower than the OECD average at 56%.
Occupational Pensions
Almost all major employers operate a pension scheme and it is estimated that about 50% of the workforce can expect to receive occupational retirement benefits in addition to their basic state pension.
Occupational pension plans can be defined benefit or defined contribution in nature. According to the Pensions Board’s annual report for 2006, there were round about 542,000 members in defined benefit schemes and approximately 235,000 members in defined contribution schemes. Compared to 2005, the number of people in defined benefit pension plans has increased by circa 5% whereas the membership in DC schemes has been constant.
There is a significant difference between large and small employers: large companies offer defined benefit plans whereas small companies favour defined contribution plans. The largest defined benefit plans with more than thousand members each cover 72% of the members of defined benefit schemes. Half of them are public sector schemes.
The Pension Board thoroughly monitors the funding situation of the pension schemes. Schemes that do not meet funding standards have to deliver a funding proposal for acceptance by the Board.
It is obligatory to fund private sector pension liabilities externally. The following funding vehicles are legally recognised and attract tax advantages:
- Qualified pension funds established under trust law,
- Retirement Annuity Contracts (RACs), which are insurance contracts,
- Personal Retirement Savings Accounts (PRSAs): PRSAs are low-cost pension products with fixed charges based on the defined contribution approach.
1. Pension funds
Pension funds are defined in the Pensions Act of 1990. They are normally established under trust, that is the assets are separated from the assets of the employer. The trustee usually appoints investment manager and custodian. Pension schemes have to be registered with the Pensions Board.
Tax treatment of contributions and benefits
Employer and employee contributions are receive tax relief up to 15% of salary at age 30 and younger. The maximum contribution rate that attracts tax relief increase with age and adds up to 40% for those aged 60 and over. Investment income received by the pension fund is also tax-free. Income tax becomes payable upon the time the pension is paid.
Investment regulation
There are no investment regulations regarding asset classes or geographical allocation of assets, hence the Prudent Person Principle applies. However, if the scheme invests in employer shares or lends property to the employer, this has to be disclosed in the annual report.
As in the UK, Irish pension funds were traditionally mostly invested in equity with the highest equity investment ratio throughout Europe.
2. Personal Retirement Savings Accounts (PRSA)
Through the introduction of low-cost, flexible PRSAs in 2003 the government aimed to increase occupational pension coverage from 51.5% at present, which is considered to be insufficient, to around 70%. It is a defined contribution type pension plan offered by investment managers, insurance companies and credit institutions.
PRSAs saw strong growth throughout 2006 and 2007. The Pension Board has recently published the third quarter results for 2007, which reported that until September 2007 approximately 120,000 contracts had been taken out. This was an increase of 70% compared to March 2006. Assets in these accounts amounted to EUR 1.12 billion up from EUR 552 billion 18 months ago.
Since September 2003, employers who do not provide access to an occupational pension scheme are obliged to allow access to a group PRSA arrangement and establish a payroll deduction facility for employees who wish to participate – although neither the employer is obliged to contribute, nor the employee to join. Personal Retirement Saving Accounts generally offer several investment options, of which one must be a default investment option.
Individual PRSA contracts must be approved by the Pensions Board and by the Revenue Commissioners. Only private companies registered in Ireland – either financial institutions or insurance companies – that are licensed by the Pensions Board are allowed to offer PRSAs. There is no legal distinction between group PRSAs and individual PRSAs although the distinction may be drawn by providers as a marketing tool and people typically refer to PRSAs arranged by the employer as “group PRSAs” even if there is only one employee.
The purpose of the introduction of PRSAs was to increase the level of supplementary pension coverage. In case the desired level of coverage will not be achieved, the government considers to make occupational pensions compulsory. This option is discussed in the Green Paper in detail.
Tax treatment of contributions and benefits
Contributions receive tax relief up to 15% of salary at age 30. The maximum contribution rate that attracts tax relief increases with age and adds up to 40% for those aged 60 and over. An earnings cap of EUR 262,000 applies. Benefits are taxable as normal income.
Unused tax relief can be carried forward to subsequent years. The transfer is subject to the annual limits. This concept could be described as being quite modern, paying attention to interrupted employment records and therefore containing some kind of life-cycle approach.
3. Retirement Annuity Contracts
Retirement Annuity Contracts (RAC) are insurance contracts approved by the Revenue Commissioners. RACs are defined contribution schemes, which offer different investment options. A Retirement Annuity Contract can only be taken out by individuals without access to an occupational pension plan.
The same tax treatment as for PRSA applies. The earnings cap of EUR 262,000 is a combined limit that covers both, contributions to PRSA and Retirement Annuity Contracts.
Outlook
The Irish pension system is already well equipped to meet the demographic challenges it faces, which will be fairly modest in Ireland given a birth rate of still close to 2.0 children per women. In 2001, the National Pensions Reserve Fund was set up under the National Pensions Reserve Act 2000 to shoulder future financial burdens due to demographic changes. From 2025 onward, this fund is to finance part of state pension spending. Up to 2055, 1% of GDP a year is to be contributed to the fund. Funded with EUR 10.6 billion mid-2004, the fund value should easily outpace EUR 50 billion by 2015. It is managed by international asset management companies offering considerable opportunities for the time to come.
Further growth in occupational pension assets can be expected if the government decides to make occupational pension coverage mandatory. This option is discussed in the current green paper and is considered as an option within the range of discussion. The income poverty for the elderly is relatively high by international standards and a noticeable percentage of households will be solely dependent on social welfare. Making occupational pension mandatory is a realistic option as tax incentives are not efficient as a significant part of the population earns below the tax threshold.