Saturday, March 6, 2010

Economics 06/03/2010: Pensions Plan that confirms my worst fears

Per comments to my blog posts on pensions:

Article 4.2.3. of the National Pensions Framework states (emphasis is mine):


"The individual will be provided with a range of investment choices reflecting different levels of risk, accompanied by suitable, easily understood information about the level of that risk and the benefits expected. The range of funds will include very low risk options
to provide members with a high level of security on their savings. The Government will not, however, provide any guarantees on investment returns."

This resolves the issue of asymmetric nature of returns: we will be compelled to invest, but Government is not compelled to guarantee.


At the same time, provision of very low risk option plans – traditionally fixed income only funds – does not disqualify these funds from purchasing Irish Government bonds, implying that the funds are not shielded from the Government ‘borrowing’ against our pension savings. This, coupled with direct State oversight over the approved funds (see next quote) means that it will be difficult to create functional Chinese walls between the State and our cash.


“The limited
number and types of funds (which will be required to have life-styling built in) available under the scheme will be provided by the private sector through a competitive process run by the State.”

So rationing is the State objective, making the funds subject to potential State interference and influence.


“Members will have the option of choosing between these approved funds or providers, or else they will be enrolled in one of the low risk default options
. Charges will be kept to a minimum as marketing expenses and investment advice are minimised."

How is this automatic enrollment into ‘one of the low risk default options’ be determined – who will select a specific provider option? The State? Some proportional competitive formula? Either way, someone else will decide what to do with the money some of us will be compelled to part with. It is, therefore, a tax, especially absent guarantee of a return.


The last sentence above is beyond any belief. This the State pushing on a retail client a major financial undertaking, while promising to keep advice to a minimum?!



Per my concern with contractual aspects of the plan, the entire NPF makes no mention of any contractual arrangements under the proposed plans. This means that either the authors of the document did not understand the importance of securing pension holders’ rights, or they omitted this consideration to exempt the state from committing to any sort of a scheme-related obligations. My questions regarding the legal validity of this ‘pension’ arrangement in the future are, therefore, correct and justified.


There are no references to any value-for-money frameworks within the document, which puts it in direct contrast to the green paper on pensions (the latter being full of cheerful promises of delivering this golden fruit of all public sector schemes).

There is no economic impact assessment, and there is no actuarial evaluation of the new plan, which means that the Government has promised not to guarantee returns which may or may not resolve the problem of the pensions funds shortfall in 2030-onward. If this still qualifies as a well thought-through proposal, I am off fly-fishing for the rest of my life.



Page 19 of the NPF states: “…the Government will seek
to sustain the value of the State Pension at 35 per cent of average weekly earnings and will support this through the PRSI contribution system.”

This clearly states that the Government does not contractually guarantee the benefit for which it imposes a tax. I would love to 'seek to sustain' my tax contributions to the State at the current rates, but hey, I am actually obliged to do so. The opposite is not true for the state's duties to me. Again, asymmetry inherent in the rights and obligations of taxpayers vis-à-vis the State are re-affirmed here.

Even more insulting is the NPF statement concerning the State employees Defined Benefit pensions which reads (page 46): “However, only these core benefits granted plus revaluations to date would be guaranteed
, and this would be underpinned by regulation.” So while not guaranteeing ordinary taxpayers anything at all, the State guarantees a large proportion of the Defined Benefit Rolls-Royce pensions to its own employees.


With respect of tax relief ‘reform’ NPF states (page 30) that “Another reason is that people are often unsure about the value of the incentives provided by the State to encourage pension provision. By providing a matching contribution equivalent to 33 per cent tax relief, the Government will introduce more transparency to the system – allowing people to see the exact value of the Exchequer support.”


This is pure hogwash – if people are unsure about the speed limit on the road being in miles or kilometers per hour, does the state change the number on the speed signs? And why not provide relief at 41%, or better yet – at 50%, since the Government is now taking half of the paycheck for many employees in this country?


With respect to opt-outs:


Section 2.3.2 page 17 states: “If people decide that retirement saving is not feasible, they can opt-out but there will be a once-off bonus payment for people who contribute to the scheme for more than five years without a break in contributions.”


In other words, the State will restrict competition in pensions provision by subsidizing the ‘approved’ plans mentioned earlier. In effect, to discourage people from undertaking purely private pension provision.


Page 32 states: “Employees will be permitted to opt out of the auto-enrolment scheme after a period of three months. Employees can opt in again whenever they wish but, in any event, they will be automatically
re-enrolled every two years... Once a person remains in the scheme for six months, their contributions will be held in a pension account and no withdrawals will be allowed.”

So I am right to state that there can be instances of double payment into pensions funds by individuals who opt-out for a private pension. And that there has not been any thought given to how this can be avoided and how duplication of pensions will be prevented.


Page 34: “To ease administration costs, contributions will be collected through the PRSI system. In addition, the opting in/opting out arrangements will be made as straightforward as possible. The Government recognises, however, that any additional labour and administration costs will have an impact on small firms, particularly in the current economic environment.”


So it is a tax that will impact more smaller firms. And it will be the State who will collect the funds and then, somehow (how – remains to be determined) disburse these funds to ‘approved’ providers and to the ‘low risk option’. The latter, of course, being some new state quango managing the new retirement tax windfall. How will our choice of provider be entered into? How can we switch from one provider to another? How can we carry our pensions out of the state if we move places of work, including with the EU? Which open up another question – is this proposal actually in compliance with EU directives on portability of benefits?



There is an amusing table 4.1 on page 32 that illustrates just how dire is both the analytical part of the NPF is and how dangerous the Government promise to provide minimal advice can be. The table calculates replacements and returns on pension savings under the new scheme using an assumption of, hold your breath, 7% investment returns
per annum! This, in the view of the report authors represents a safer type of investment…

I really rest my case here. Good luck to anyone who still believes this proposal to be a well thought-through idea.
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