SINCE April 2021, Trustees, employers, and their Financial Brokers have been reacting to and dealing with a plethora of new pension regulations which have seen dramatic changes to the pension landscape in Ireland.
The implementation of IORP II by the Pensions Authority has resulted in a mass exodus to Master Trusts while the Finance Acts of 2021 and 2022 have begun the government’s objective to simplify the range of pension products available to clients and their advisors.
However, the long awaited arrival of Auto Enrolment (AE) in 2024 could have an even greater impact on the two challenges that have continued to frustrate the pension industry – pension coverage and pension adequacy.
The CSO figures from their Pension Coverage Survey in 2021 show that 56% of employees have active pension coverage while if the private sector is considered on its own, this figure drops to less than 35%.
This lack of coverage is due to a number of factors with many employers not offering a pension scheme and, in some cases, even where a scheme is offered not all employees opting to join. It is estimated that approximately 750,000 employees aged between 23 and 60 and earning over €20,000 will be auto enrolled.
The AE system will allow a number of opt out scenarios but, based on experience of similar schemes in other countries, the drop-out rate is expected to be very low.
This number will increase if the recommendations of the Social Protection Committee are taken on board. Their report, published in May 2023 put forward 21 different recommendations including that –
- The minimum age for inclusion is reduced to 16 to align with the age that employees start to pay PRSI.
- The lower income threshold of €20,000 is removed. Whatever the final rules are AE will result in a dramatic increase in the number of employees saving for their retirement – albeit at low contribution rates in the early years. Overall pension coverage will also increase within existing occupational pension schemes where membership to date has not been compulsory.
Most pension schemes operate on a voluntary basis and in many cases employees – particularly younger employees opt not to join when they become eligible.
Employers will need to either include these employees in their existing scheme or Auto Enrol them and administer two separate pension schemes.
For future hires, the answer is straightforward with pension membership being made compulsory and a condition of employment for new hires.
Dealing with existing employees is more of a challenge. Including existing employees who previously opted out, is likely to be seen as a change in their terms of employment and needs to be approached with caution.
If these employees still resist being included in the employers existing scheme, then they will have to be auto enrolled.
A separate AE section could be established within the employer’s scheme but the advantage of continuing with one scheme might be outweighed by an ongoing concern that investment returns under the employers “AE scheme section” may not match the AE investment returns and therefore the employees eventual retirement pot.
Pension Adequacy The proposed AE scheme is far from perfect and will take several years for the contribution levels to become meaningful.
Starting at a low base, with gradual increments is understandable – to a certain extent but, even allowing for the scheme to start in 2024, contribution rates will only broadly equate to existing occupational pension schemes after year 7 when the combined AE contribution rate increases to 10.5%.
However, from year 10 onwards, the combined total contribution of 14% will apply and this will be based on an employee’s total earnings, both features a significant improvement on a typical DC scheme based on a total contribution of 10% of basic salary.
As with pension coverage, the introduction of AE will have a big knock on effect for existing schemes that will want to be exempt from the AE scheme.
The details as to how an existing scheme can be exempt still need to be published but it seems likely that a comparison of the employee’s fund at retirement will be the answer.
I expect that this will need to be an individual calculation taking into account contribution rates (excluding tax relief), existing funds, and charges.
Will contribution rates for some employees need to change? Most existing schemes have a waiting period before an employee can join the scheme and this will need to change to immediate inclusion – resulting in more contributions being paid into the scheme by both employer and employee.
For future hires, it would appear clear that contributions from employers and employees (again ignoring tax relief) should mirror AE contribution rates but then the impact of charges needs to be taken into account with a maximum annual management charge of.5% applying to the AE scheme. As the AE rates increase, particularly from year 7 onwards new members are likely to be on higher contribution rates than existing members leading to demands for their contribution rates to be brought in line.
Auto Enrolment is to be welcomed and despite a number of shortcomings will start the journey to solve the pension coverage issue and in time will also improve pension adequacy.
Employers with existing schemes need to engage with their Financial Broker to see what change they need to consider as your typical scheme will change from
- a voluntary scheme that employees can join after 6 months service with contributions of 5% and 5% of basic salary to
- a compulsory scheme that employees are included from day 1 with contributions (from 2034) totalling 14% of total earnings.