Pensions Update: The Architecture of Enrolment – The Auto-Enrolment Update and Questions that Arise

The Roadmap for Pensions Reform, published in 2018 by the Department of Employment Affairs and Social Protection (the Department), contains a commitment by Government to implement an automatic enrolment (AE) retirement savings system by 2022. In August 2018 a “strawman” proposal was issued. The purpose of this was to put forward a potential structure for AE and to initiate a consultation process on its key features.

Confirmed features

The AE features confirmed in the Department’s recently published update (the Update) will not surprise those who followed the consultation process. Some key aspects highlighted in the Update are:

• AE will use a defined contribution model

• Members will have the option to choose from a specified range of investment products

• The State will make a contribution, as yet unspecified, on behalf of each member, and

• Employer contributions will match those of their employees

Confirmed in principle

Some of the features are confirmed in principle, meaning they are still subject to change. Of particular note is an increase in the default contribution rate to 1.5% of qualifying earnings, or an increase of 0.5% on the rate initially included in the strawman proposal. This rate will increase by 1.5% every three years, leaving a maximum contribution rate of 6% at the end of the first ten years of enrolment. Employers will match that contribution within an overall qualifying earnings threshold of €75,000.

It is expected that contributions for the first six months will be compulsory with an opt-out window opening at that point. In principle, it is also confirmed that a Central Processing Authority (CPA) will be set up to source registered providers of the investment options. It is suggested that the annual charge for these providers will be capped at 0.5% per annum. Given prevailing fund charges in the DC industry, this rate is likely to be seen as unattractive as the charge does not factor in the cost of financial advice. It is assumed that the CPA will carry out distribution and contribution collection.

Remaining questions

State contribution?

The strawman proposal included a State contribution rate of €1 for every €3 contributed by an employee but this is not in the Update. Queries remain about how an alternative incentive can sit alongside the existing marginal rate of tax relief. Will two separate systems of tax relief co-exist and could this create opportunity for tax arbitrage?

Existing pensions and minimum contribution?

The Department confirmed that employees who are members of existing pensions will not be enrolled where their pension meets prescribed minimum contribution levels amongst other criteria, but these minimum standards are not available. It may be necessary for the trust deed and rules of existing pensions to be amended to achieve compliance with the minimum standards.

Death benefits?

The strawman mentioned that, on death, any assets that the member had accumulated in their fund would be payable to their estate. This would include the accumulated value of contributions plus investment returns less fees. However, the Update contains nothing further on the death of a member. If AE is the only pension available to many employees in the future we could see an effective end to death benefits for all except those that are members of an ever decreasing number of occupational pensions.

Specific investment?

Members that do not select a specific investment will be provided with a default investment from one of four registered providers. The potential that many AE members will not actively choose a fund or take any financial advice is an issue. It means that a large number of members will invest in one of perhaps four default investments provided on a carousel basis. Come pay-out, the required level of benefit may not be there to meet retirement needs. This is a heightened risk with a fee of only 0.50% where providers will be less likely to actively manage funds and take risks, leading to lower returns.

Retirement benefits?

There is also a question around the sufficiency of retirement benefits that AE will provide. If we take an employee earning €30,000; the maximum level of contributions from them and their employer is €3,600, or 6% each. We will also assume that the State is contributing €1,800 on behalf of that employee. This allows a total contribution rate of €5,200 per year less fees of 0.5% and a poor growth rate due to the selection of a default investment. Even after 20 years at this rate, it is hard to see how this fund would provide sufficient retirement benefits for a member that retires at 68 and lives until 90. Together with the potential removal or even reduction of the existing State contributory pension, the risk of a shortfall is very apparent.

Conclusion

The Update timeline anticipates draft legislation by late 2020 and enrolments to begin in 2022. Before this occurs, the State contribution will need to be agreed and its relationship with the existing tax relief system considered. The prescribed minimum standards for existing pensions will need to be established and a further consultation process with employers may be necessary.

The existence of functioning AE on a large scale could well lead to the reduction or complete removal of the State contributory pension. Arguments might be made in the future that the annual contributions made by the employee, their employer and the State for AE are sufficient and the very expensive State pension could be diluted in value over time as the AE system beds in.

It should also be noted that the proposed target membership of AE excludes a large portion of the working population. Any employee under 23 and over 60 is excluded, as well as those earning below €20,000 per year. While employees outside of the age limits and with earnings of under €20,000 per annum can opt-in they are automatically excluded from AE form the outset. The numbers of those excluded because of those parameters forms a very large portion of the workforce not currently contributing to a pension. It could be argued that the State pension provides a satisfactory replacement income for such individuals but this will be the case only if the State pension continues in its current generous form.

The Government should be applauded in pushing ahead with AE and for engaging in the consultation process but significant questions remain unanswered. Employers should begin to budget for the cost of contributions and those that offer a pension to employees should consider the potential costs in taking financial and legal advice for the review and update of such arrangements to make them AE compliant.

For more information on the prospect of AE and how it may affect your members, contact a member of our Pensions team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.