Wednesday, 19 August 2009

Current pension tax reliefs inequitable and unsustainable

Gerard Hughes: Reading Paul O’Faherty’s opinion piece in the Irish Times on 29 July one would not suspect that it is the private pension system rather than the State pension system which is in crisis.

In 2008 Irish pension funds lost €27 billion as the value of the average managed fund fell by almost 35 per cent. This was the greatest relative loss in value of 37 OECD and non-OECD countries. The loss of over one-third in pension assets resulted in an estimate by the Minister for Social and Family Affairs that up to 90 per cent of defined benefit schemes were underfunded at the end of 2008. Rubicon Investment Consulting estimates that returns on group managed pension funds in the ten years up to the end of 2008 amounted to 0.2 per cent per annum on average, or well below the annual rate of inflation of 3.7 per cent. This is an abysmal performance. Contributors to pension funds would have been better off if they had put their money in the Post Office.

Recent pension surveys indicate that up to half of all defined benefit schemes are closed to new members and that over 40 per cent of firms which have defined benefit schemes are considering reducing member benefits. Some employers and employees are considering reducing their contributions to defined contribution schemes even though the government’s Green Paper on Pensions points out that the average contribution to these schemes is too low to provide an adequate income in retirement. There is a long-term change from defined benefit to defined contribution schemes which is shifting the risk of poor pension returns from employers to employees.

None of these weaknesses of the private pension system are mentioned by O’Faherty. Instead he argues that pension tax relief, which cost €3.2 billion in 2006, amounts only to tax deferral because the tax forgone will be recovered during retirement when pensions are paid. His argument ignores the more favourable tax exemption limit for people aged over 65, the fact that up to ¼ of the value of the pension is taken as a tax free lump sum, and that a great many taxpayers who pay tax at the higher rate during their working life only pay tax at the standard rate when they retire. In its country report on Ireland in 2008 the OECD concluded that the overall effect of our favourable tax arrangements for pensions “ … is in effect fairly close to being … [a] system where income channelled through pensions is unlikely to be taxed at any point of the life-cycle.” An earlier report in 2004 by OECD researchers Yoo and de Serres showed that the tax deferral argument of the pensions industry is wrong as the long-term budgetary cost of pension tax reliefs in Ireland, on a present value basis, amounted to nearly 2 per cent of GDP.

O’Faherty argues that tax relief for private pensions should not be curtailed because private pension provision “offers the only prospect of alleviating the burden [of an ageing population] on the State.” The evidence which is available from a study by Hughes and Watson for the ESRI of the performance of the State and private pension systems shows that the private pension system does a very poor job of delivering pensions except for higher income earners. Over 90 per cent of pensioners receive an income from the State compared with about one-third who receive an income from a private pension. The State pension is also by far the most important source of income for 80 per cent of pensioners. The top 20 per cent of pensioners is the only group for which the private pension system provides a significant share of their retirement income. This is hardly surprising as around two-thirds of the tax relief on employee and self-employed pension contributions accrues to higher rate taxpayers.

The inequitable distribution of the tax relief for pensions, the low level of the State pension and the challenge of providing adequate pensions for an ageing population are the main reasons why the TCD Pension Policy Research Group, TASC and others have argued that the tax relief for pensions should be given at the standard rate of tax and that the revenue which would become available should be used to increase the State pension above the poverty level. As an ESRI study by Callan, Nolan and Walsh showed in 2008, this policy would eliminate the risk of poverty for people who are already retired. If it were adopted it would provide protection against poverty in retirement for the increasing number of people in the future who are likely to receive lower private pensions relative to pre-retirement earnings than current pensioners and it would contribute to a sustainable basis on which to pay for State pensions as the population ages.
Gerard Hughes is a Visiting Professor in the School of Business Trinity College Dublin and a member of the TCD Pension Policy Research Group


Mack said...

Gerard -

Under your scheme, would you equalise private and public sector pensions. I.e. Discontinue the public sector pension and allow public sector workers to purchase their own Defined Contribution Scheme, with standard rate tax relief on their contributions?

Otherwise, are you not advocating that those with lower quality pensions further subsidise the superior pensions of the public sector? I note you work at TCD, am I correct then, in assuming that you will be a beneficiary of a superior, taxpayer subsidised, Defined Benefit State pension?

Gerry Hughes said...


See my blog "Paying Twice for Public Service Pensions" (, posted on 22 February
2009 on this site, for how I would adjust public service pay to take account of
the cost of an increase in higher rate taxpayers contributions to private sector
pensions following standard rating of the tax relief.


Mack said...

It's politically difficult to adjust public sector pay downward, although I guess that would be fairer than doing nothing - if it could be done transparently and fairly.

I note you estimate the value of a public sector pension to be 12% of salary, presumably this would also have to be taxed as a benefit in kind.

I still think it would be fairer if we're going down this route to scrap the public sector pension and allow public sector workers to purchase their own pensions, like the rest of us.

Proposition Joe said...


Please tell me you're not seriously claiming that the 12% pension discount applied by the Benchmarking II body had any basis in reality?

But if you are making this claim with a straight face, you're either monumentally misinformed or simply being dishonest.

The only way the Benchmarking II could have really applied this discount without cutting pay rates, after Benchmarking 1 having supposedly already equalized pay rates between the sectors, would be for the public sector to fallen a *further* 13-14% behind the private sector between 2002 and 2007.

All, and I mean *all*, the data says otherwise. In fact the gap widened in the opposite direction during this period.

Anonymous said...

Mack writes: I still think it would be fairer if we're going down this route to scrap the public sector pension and allow public sector workers to purchase their own pensions.....

Which in effect means that public sector workers, alongside those private sector workers who can afford to, hand over billions each year to the private pensions industry to gamble; and industry which in the most economically propitious period in our recent history only manages to generate abysmal returns of 0.2%, as noted in Gerard's piece. As an aside, of course, Pension fund managers remuneration reflected this and over the course of ten years their only rose by 2%, such ascetics!

No, the fairest thing to do is to take the current public sector pension as the benchmark against which all pensions should be pegged. This will hurt employers, business and the rich... but they'll live. To stop subsidising the pensions of senior management, company directors and others.

Incidentally, as Gerard is a "Prof." he's probably paying almost 25% of his gross salary in pension contributions and PRSI. He's making more than fair provision for whatever pension he, deservedly, receives - as are all public sector workers.

Mack said...

Anon -

PRSI contributions count towards state wide social security provisions only (i.e. state pension not the public sector pension). That higher earners pay more (up to a point, it's still capped, right?) is, em, whatchacallit again - progressive?

Proposition Joe said...


Can we please keep the discussion rooted in actual reality?

As opposed to the madey-uppy version where a tax-deductible 6.5% superannuation contribution and 9% pension levy somehow morphs into "almost 25% of gross salary".

That's "almost" in the sense of oh I dunno, less than half of what you claim, when the tax deduction is taken into account. Shure that's close enough, wha'?

His PSRI contributions cannot be counted as contributions to his pension, because there are most certainly not that. Everyone's PRSI contributions pay for *current* benefits paid out to recipients who made PRSI contributions in the past (which paid for the previous generation of welfare benefits). That's how a pay-as-you-go system works.

And don't even get me started on the health levy, that has absolutely nowt to do with anyone's pension.

If the Prof is paying any more than 10% of his gross in actual pension contributions excluding AVCs, I'd be very surprised. But 10 and 25 both have two digits in, so I guess that makes the two numbers sortta the same, right?

Anonymous said...

@ Mack, public sector pension IS state pension plus the premium for public sector workers. Ergo, PRSI payments by PS workers are de facto pension contributions. Agree with you: higher earners should pay more.

@ Prosposition Joe, see above point re: PRSI.

OK, so let's go real slow: 6% PRSI contribution plus 6.5% "PENSION" (that what it says on my pay slip) plus 10% "PENSION RELATED DEDUCTION" (again what it says on my payslip) equals..........almost 25%.

That's the formula every Public Sector worker is paying against; although the rates vary.

Thanks for the lecture though on how pay-as-you-go works.

Proposition Joe said...


Seems we shall have to slow it down a tad further.

Are you familiar with the idea of a tax-free deduction?

Have another look at that payslip of yours. Now is the PAYE applied before or after the 6.5% "PENSION" and 10% "PENSION RELATED DEDUCTION"?

After, right? That means these pension contributions amount to less than 4% and 6% respectively of "gross salary" (to use your original characterization).

Then we have the slightly more difficult concept of a progressive deduction. In the case of your 10% "PENSION RELATED DEDUCTION", the first 15k earned is exempt, and the next 5k is levied at only 5%. Taking this into account, the pension levy deduction on *gross salary* for an average public servant would amount to only 4%, even for a principal officer on 100k it wouldn't go above 5%.

Then to deal with PRSI, which as I said before isn't a pension contribution. But even it was, it doesn't amount to anything near 6% of gross for a university professor. The first €127 a week is exempt, and then only 4% is applied to the balance, up to a ceiling of €75,036. So a Professor on say 100k (which is low-ball estimate of earnings) would only pay €2737 per annum in PRSI or equivalently less than 3% of gross.

So how far are we away from 25% of gross? Even half way there?

Your attempt to plump-up the pension contribution to make it look "more than fair" is downright misleading.

Mack said...

@Anon -

The state pension is included in the total pension paid to public sector workers. It's a stretch though to count 6% PRSI as a 6% contribution towards your pension - I pay 6% PRSI too + whatever else I can into my Defined Contribution Pension.

I would love a Defined Benefit Pension, but that isn't what Prof. Hughes is agitating for. (Incidentally wouldn't a state provided DB pension is regressive not progressive as it would favour higher earners?)

He likely earns a multiple of what I do, and has a gold plated pension too boot but yet wants to make it harder for me to save for my own retirement. Champagne socialism indeed...

Incidentally, we could also boost the state pension by scrapping final-salary related public sector pensions and taxing any contributions to private pensions across the board - that would also be progressive would it not? And at least, be fair as well.

Proposition Joe said...


Anon also artfully fails to mention that any public servants employed more than 14 years ago pay no PRSI at all, and those employed since are paid on a higher scale so as to exactly compensate for the PRSI deduction.

So the payment of PRSI is totally notional in this case, the state simply upped their salary then took away the difference in PRSI.

It would be like getting a pay-rise from your employer to compensate for the new income levies, then proceeding to whine about the imposition of said levies, despite the fact they make no difference to you.

Anonymous said...

@ Proposition Joe.

Just revisited the payslip and all pension related deductions including PRSI which is, no what way you try to spin it, a form of pension contribution and I pay 16.5% of my gross salary towards pension contributions. I'm well below the salary of the good Prof who kickstarted this discussion, but I'm sure he's paying a few percentage points more.

So, we're both wrong, but you're more wrong than I as I think 16.5% is a good deal more than half way. Taking 12.5% as your presumed calculation of all PS pension related deductions.

Interestingly, neither Proposition Joe nor Mack seem all that concerned with the performance of the private pensions industry as noted in the original post. Despite this you still want to scrap current PS pensions and instead throw tens of billions to an industry that is, being more charitable than is warranted, crap at fulfilling it's obligations to holders of private pensions (that's not when it's actively defrauding them, but that's another days work).

So, I admit some of my calculations were inaccurate (done from memory) but the rebuttals here are less than convincing and skip over, entirely, the point of how expanding even further the private pensions industry would be fairer or more equitable to workers.

And you both fail to explain how a private industry - governed by performance related pay - managed to grant huge salaries to pensions exectives (with all requisite perks etc) for a lousy .2% average return. If that were a public sector body there'd be murder, but since it's a private industry and, so, "obviously" more efficient, it gets a pass and is not subjected to the same level of critical scrutiny that minimum wage earners, public servants and social welfare recipients are currently getting.

Mack said...

Anon -

Your concern for the performance of my pension fund is appreciated - there is indeed less in it than I have contributed after 10 years of working.

You will of course join us in protecting what little benefits private sector workers are entitled to with respect to pensions provisions and reject this obscene proposal from a cosseted group which would penalise those with inferior pensions to yours.

Proposition Joe said...


Your calculations weren't just "inaccurate", they were off by a country mile.

Even to get to 16.5% of gross including PSRI, I suspect you've thrown in your health levy contribution. This may be listed under PRSI on your payslip, as these payments often are lumped together for administrative reasons, but in no way can the health levy be counted as anything to do with anyone's pension.

You might want to consult this ready reckoner from the Department of Finance to get a quick estimate of what actual percentage of gross you pay in PRSI:

And your assertion that the Prof pays a "few percentage points more" on his gross than you because he earns more, betrays a complete misunderstanding of how PRSI actually works. Because anything above the 75k threshold is exempt from PRSI, the Prof is likely to be paying significantly *less* PRSI as a proportion of gross. This would easily offset the proportionally higher pension levy he pays, assuming you're an average public servant (as opposed to an outlier on 22k, in which case you'd be paying virtually nothing in pension levy). And of course if the Prof has more than 14 years standing, he wouldn't be paying any PRSI at all. So any which way you cut it, he's paying a smaller percentage of gross than you are.

Now even if your revised estimate of 16.5% held any water, which I doubt as I suspect you're including the health levy in that, what's this about me being "more wrong" than you? Please get out your calculator and check this one very carefully ... is 16.5% closer to all of 25% or half of 25%? Extra credit question: how much closer is it to the latter? Whoops I think I just gave away the answer to my first question!

I'm also bemused that you sandwich public servants between minimum wage earners and social welfare recipients in your troika of those afflicted with "critical scrutiny". The most privileged, protected and secure workers in this economy make strange bed-fellows with the worst-off and most insecure. The only common thread is all three groups receive significant transfers from the state, though the amounts involved differ to a huge degree.

But to return to your main point on how badly the private pension system is performing. When the markets tank, the pension funds tank with them. Private sector workers don't have the luxury of assuming that future generations of workers will fund their occupational pension, thus their only option is to invest in something, and when that something goes south so does their pension fund. That's the risk borne by the private sector, and the fact that the public sector is insulated from this risk is an enormously valuable perk. Not that any serving public servant would willingly acknowledge this fact.

And on the subject of badly performing pension funds, have you any idea how far in the red we as taxpayers are with respect to future public sector pension liabilities? The total accumulated liability is currently 100 billion euros, and this is growing at a rate of over 5 billion a year. As a financial time-bomb to drop on our children and grandchildren, this will put NAMA in the shade. They will be working to 70 at least to fund the current generation of public servants who can ride off into the sunset at age 50 or 60.

Anonymous said...

@ Proposition Joe: you're right my figures were inaccurate. I've just rechecked them and it's actually 17.5% of a salary that's just about keeping the wolf from the door.

I was being polite, and trying to overestimate in favour of your position, when I reckoned on 12.5% being your estimate of total PS pension deductions. Re-reading your initial comment it's clear that you were skeptical that it would even reach half of 25%. So, if you didn't believe they would reach 12.5% and it's reached, on re-calculation, 17.5% I think would should just agree to differ.

Your final three paragraphs were interesting, however.

So, your solution to the public pensions problem is to scrap it altoghter and replace it with private pensions which Mack acknowledges are worth less (and probably worthless) than the total amounts contributed over the years. You want to ensure that everyone loses money, not just some. This is the sickening element of this whole debate - the desire to equalise risks and exposure to the vagaries of the market and corporate fraud.

The only fair option regarding pension is some form of generous state pension that does not discriminate between public and private sector and that equalises out, in retirement, whatever income differentials existing during active participation in the workforce. If the government were to introduce another levy/tax that would ensure every private sector worker got the same pension that I will get, I'd have no problem with that. You'd be better employed advocating something like that than shilling for an utterly useless pensions industry.

My last comment: this is too depressing to continue but I'm sure you'll both derive some satisfaction by thinking you've "won".

Proposition Joe said...


Please stop repeating such an obvious falsehood.

You pay nowhere near 17.5% of gross on pension contributions, even allowing for PRSI (which I don't accept as a pension contribution, but for the sake of argument will include for the purposes of this calculation).

So here's an illustrative range of contributions worked out for a representative sample of salary levels. I used the Department of Finance's own figures for PRSI which I linked to above. The health levy is not included for obvious reasons.

As you'll see, the contribution peaks at less than 12%. So in which alternative universe does your contribution amount to 17.5% of gross?

Salary: 25k
6.5% superannuation (tax-free @ 20%): 5.2%
3.0% pension levy (tax-free @ 20%): 2.4%
2.9% PRSI
total: 10.5%

Salary: 50k
6.5% superannuation (tax-free @ 41%): 3.835%
6.0% pension levy (tax-free @ 41%): 3.54%
3.5% PRSI
total: 10.875%

Salary: 75k
6.5% superannuation (tax-free @ 41%): 3.835%
7.5% pension levy (tax-free @ 41%): 4.425%
3.7% PRSI
total: 11.96%

Salary: 100k
6.5% superannuation (tax-free @ 41%): 3.835%
7.7% pension levy (tax-free @ 41%): 4.54%
2.8% PRSI
total: 11.2%

Salary: 150k
6.5% superannuation (tax-free @ 41%): 3.835%
8.8% pension levy (tax-free @ 41%): 5.2%
1.9% PRSI
total: 10.9%

Anonymous said...

That's not what it says on my payslip. I'm around the second category that you list above and if what you're saying is true I'm being seriously screwed by my employer?!

I've re-checked it now three times on Excel and the precise figure I'm getting is 17.56217% of gross salary going on pension, pension related deductions and PRSI.

Maybe I'm unique in the public service and the subject of a dastardly plot.... Or, maybe, what I'm stating is a more accurate reflection of reality than the notional Dept. of Finance ready-reckoners with their "Pat & Mary" examples that bear a limited relation to people's actual experience.

Look, I'm not a personal finance expert or an economist or accountant. So, calculating tax reliefs is not how I like to spend my spare time. The only data I have to work on is my pay slip as a middle ranking public servant; and that states clearly and unequivocally that I pay 17.56271% of my gross salary in pension related deductions and PRSI (which pays for others' pensions just as future PRSI payers will fund my pension). I obviously have an ideological axe to grind and you'd be right to dismiss my point of view, because short of faxing you a copy of my payslip (which I'm not prepared to do), you've no way of definitively verifying what I'm saying.

But I think this debates illustrates the gap between those who desparately want to believe that, amongst other things, Irish workers are overpaid; the Irish public service is wildly overstaffed and underworked; that we've the most generous social welfare benefits in Europe, and a hundred other assorted myths; and the actual verifiable facts as discussed by, to take the shining example, Michael Taft but also others. Slowly, tortuously, some semblance of the truth is beginning to emerge and, maybe, just maybe, policy will be guided by facts rather than the all to common prejudices that implicitly inform what both Joe and Mack have contributed above.

This debate is going nowhere; really leaving this time.