Challenges in Irish Pension System: Intergenerational Income Transfers

1. Economics of Policy IssuesEC3060Autumn 2015Case Study: Irish Pension System and Challenges Michael King

2. Additional Readings Supplementary • National Pensions Framework (2010) http://www.oecd.org/site/iops/research/45563546.pdf • OECD Review of Irish Pension System http://www.welfare.ie/en/downloads/oecd-review-of-the-irish-pensions-system.pdf

3. The Entitlement to Income during Old Age • Entitlements provided during old age are important for: • Older people who benefit • Younger people who pay • An intergenerational social contract: We begin from conditions of a hunter–gatherer society • The old can survive only if the young give them food

4. Unborn generations are not present when the social contract is set out • The intergenerational contract is Pareto-improving • Abrogating the contract of intergenerational transfers would make every generation worse off

5. A government collectivizes the intergenerational income transfers: • Most Common: Under a pay-as-you-go scheme, taxes paid by working generations finance the consumption of retired generations • Ideal Situation: Fully funded systems each individual covers own future cost • Without compulsory payments collective transfer from the young productive population to retired people introduces free-riding incentives • Compulsory taxes during productive years preempt such free-rider behaviour.

6. Sustainability of intergenerational income transfers • The dependency ratio excluding children • The number of people in the retired generation = nR • The number of people working = nW • The dependency ratio is:

7. Case Study: The Pension Crisis • How will your generation solve the looming pension crisis? • How will you vote? • Short Video: Elderly Fuel Povertyhttps://www.youtube.com/watch?v=v7tQLTMExFs

8. Elderly Poverty in Ireland (2011) • Elderly poverty in Ireland did fall significantly in the boom years – greater social expenditure. • Elderly poverty in Ireland is real. In 2011: • 10% suffer from low incomes • 11% suffer from deprivation • 19% suffer from low incomes or deprivation.

9. Future: The Perfect Storm • The greying of Ireland • Increased life expectancy • Lower birth rates • Cost of elderly care • Increasing medical costs • Increasing costs of old age care • Failure of private pension provision • Insufficient pension coverage • Lack of private savings Increased old age dependency rate α

10. The greying of Ireland • Increased life expectancy • Lower birth rates • The number of people in the retired generation = nR • The number of people working = nW • This dependency rate excludes children Increased old age dependency rate α

12. Old Age Dependency Rates

13. Cost of elderly care • Increasing medical costs • Increasing costs of care

14. Failure of private provision • Insufficient pensions coverage

15. Long term fiscal implications • Note: By OECD standards Ireland already has a low minimum government pension rate but it will be costly to maintain.

16. The Battle of the Generations: What will you vote for? • What will you vote for: • Increase significantly taxes on working age population (to maintain state pension or massively subsidise private savings) • Reduce significantly other expenditure: social expenditure (health, education) or expenditure on infrastructure • Reduce significantly state pension • Increase significantly eligibility age • Combinations of the four.

17. How long will you live? http://gosset.wharton.upenn.edu/mortality/perl/CalcForm.html Results • Life Expectancy: 85.72 years • Lower Quartile: 78.00 years (75% chance you will live longer) • Upper Quartile: 95.16 years (25% chance you will live longer) Resources Needed 20 years @ €30,000 p.a. = €600,000 Only have 30 years to raise this – assuming minimal growth need to save approx. €18,000 per year.

18. How long will you live? http://gosset.wharton.upenn.edu/mortality/perl/CalcForm.html Results • Life Expectancy: 85.72 years (RIP: April 2065) • Lower Quartile: 78.00 years (75% chance you will live longer) • Upper Quartile: 95.16 years (25% chance you will live longer) Resources Needed 20 years @ €30,000 p.a. = €600,000 Only have 30 years to raise this – assuming minimal growth need to save approx. €18,000 per year.

19. How long will you live? http://gosset.wharton.upenn.edu/mortality/perl/CalcForm.html Results • Life Expectancy: 85.72 years (RIP: April 2065) • Lower Quartile: 78.00 years (75% chance you will live longer) • Upper Quartile: 95.16 years (25% chance you will live longer) Resources Needed 20 years @ €30,000 p.a. = €600,000 Only have 30 years to raise this – assuming minimal growth need to save approx. €18,000 per year. • Consider how you will provide for you golden years early and often! The Life Cycle Hypothesis!

20. Irish Pension System Overview:The Three Pillars Pillar III: Non-pension wealth earnings, investment income etc Unequally distributed 70% of net personal sector wealth in UK Pillar II: voluntary private pension system - Occupational and private schemes ½ the workforce 72bn in 2011. Pillar I: Flat rate partly funded PAYG system In 2005 €219 per week represents

21. 2015 State Pension Rates

22. Pillar 1 Income Replacement Rates

23. Summary of Irish System • Pillar 1 comprises of two parts • a basic minimum safety net based on needs assessment • a contributory pension, where value is linked to the level of PSRI paid • Pillar 1 pensions provide low income replacement rates - defining characteristic of the Irish system

24. Pillar 2: Private Pensions • At the end of 2005, only 52.6% of the labour force possessed private pensions. • considerably below the target set out in the 1998 NPPI report of 70%. • Projections of the coverage rate indicate that without policy action the private pension coverage rate will only rise from 52.6% in 2006 to 54.5% in 2056. • Favorable tax arrangements to encourage the growth of the private voluntary pension system. Tax reliefs are currently available on: • employers and employees contributions • on the investment income • the capital gains of the funds • lump sum on retirement

25. Failure of private provision • Lack of private savings • Replacement Rate of 0.5: There is also widespread pension savings insufficiency with an estimated shortfall of €3,300 per annum per worker (2004).

26. Evolution of retirement age

27. Summary of Challenges

28. Irish Pensions Framework 2010: Highlights • Seek to maintain the value of the State Pension at 35 per cent of average weekly earnings. • Apply credits rather than disregards to homemakers and backdate these to 1994 for new pensioners from 2012. • Introduce a standard age of 66 for the State Pension from 2014 and gradually increase state pension age to 68 by 2028.

29. Irish Pensions Framework 2010: Highlights • Proposed new auto-enrolment system private pensions scheme are as follows: • Employees (aged 22 or over) will be automatically enrolled unless they are a member of their employer’s scheme (which provides higher contribution levels or is a DB scheme). • Employees will be required to make a fixed percentage contribution. • There will be a State contribution equal to 33 per cent tax relief and employer contributions to match the State contribution. • Once-off bonus payment for people who remain in the scheme for more than five years continuously. • Current tax relief for contributions to existing occupational and personal pension arrangements will be replaced by a State contribution equal to 33 per cent tax relief.

30. Budget 2011: Private Pensions • Private pension contributions will no longer be able to claim relief from Pay Related Social Insurance (PRSI) and the universal social charge. (Savings = €150 million in a full year) • Signaled further reductions in the tax relief on private pensions. • In 2015 • There is a limit on the earnings that may be taken into account. The limit is €115,000. • The older you are the amount of your earnings that qualify for tax relief increases.