Mandatory company pensions might not be as financially advantageous for average tax paying employees compared to current pension schemes, claims a high-ranking industry official. Auto-enrolment, which will see the State adding €1 for each €3 contributed by a worker, is seen as more appealing for those taxed at lower rates who might not be lured by the existing pension tax relief unlike their higher-earning counterparts.
The new system, which uses the straightforward “State top-up” method prevalent in exceptionally triumphant special savings incentive accounts (SSIAs) prior to the economic crisis, is favoured by advocates who argue that the existing pension tax relief structure’s complexity alienates many. Nevertheless, calculations produced by Irish Life suggest that the upcoming system, under scrutiny in the Oireachtas and due to be implemented next year, might offer diminished benefits to workers.
The company suggests that under auto-enrolment, a worker’s €1 contribution would be matched by their employer and the State would add 33.33 cent, thereby the €1 invested by the worker multiplies to €2.33, or 2.33 times their initial investment. Current tax relief rules for occupational pensions allow a 20% taxed worker who contributes €1 to their pension to effectively only pay 80 cents, as the amount is deducted before income tax. Their employer’s equal contribution results in a €2 pension investment, costing them 80 cents, or 2.5 times their actual outlay.
High tax payers currently see their pension pot investment at 3.33 times their net contribution under the existing set-up, as opposed to 2.33 times with auto-enrolment. This overlooks the fact that auto-enrolment will actually increase the total pension investment to €2.33 for each €1 the worker provides, compared to the current €2 investment under pension relief provisions.
Shane O’Farrell, who manages corporate partnerships at Irish Life, argues that the narrative positioning auto-enrolment’s 33 per cent bonus against the 20 per cent tax relief is overly simplified, hiding the fuller implications. Companies are exploring ways to avoid auto-enrolment by capitalising on pre-existing pension schemes, and O’Farrell highlights the absence of tax relief in such cases.
According to him, auto-enrolment takes a sizeable chunk out of the net income due to the lack of tax relief, which is much more than the current pension tax relief system. Using an individual earning €30,000 as an example, O’Farrell calculates a 6 per cent contribution rate, planned to be achieved by auto-enrolment over 10 years of phased implementation. This means the employee contributes €1,800 to the pension fund, directly deducted from the net earnings.
After considering today’s tax rates, income bands, social security deductions and individual tax credits, the worker’s net inc ome comes out to just above €26,000. Against this figure, the 6 per cent contribution amounts to nearly 7 per cent of the net pay.
O’Farrell feels auto-enrolment could seem deceptive, as it proposes simplicity but comes off less valuable to contributors compared to the defined-contribution occupational pension model adopted by many employers, including his own company. Its major drawback is that it severely impacts lower-paid individuals due to tax relief’s non-existence.