Dr. Barra Roantree:

I thank the Cathaoirleach and members for inviting us to the committee today. We are both economists at the ESRI. We work primarily on tax, welfare and pensions policy. We are delighted to be here to talk to the committee about automatic enrolment. The introduction of an automatic enrolment pension scheme has been long mooted as a response to low levels of private pension coverage, particularly outside the public sector. The reason for this is that automatic enrolment is an effective way of raising private pension coverage. Evidence from countries such as the US and the UK, where similar schemes have been introduced, suggests that private pension coverage can be substantially increased by simply defaulting individuals into plans, with the long-run rise in pension provision largest for those who would otherwise have saved least. We will focus our comments today and in this opening statement on three features of the draft heads and general scheme we think are worth particular consideration by the committee during this period of pre-legislative scrutiny.

The first aspect of the proposed legislation on which we intend to focus is the proposal to change the tax treatment of contributions made through an automatic enrolment scheme. Instead of applying the existing "exempt-exempt–taxed", EET, regime, whereby income is exempt from tax when first received and paid into a pension, is exempt from tax as returns accrue and is taxed when funds are withdrawn from the pension, it is proposed that the State will pay €1 for every €3 saved by an individual in a private plan. This amounts to a move away from the provision of marginal rate relief and towards what is in effect a flat 25% rate of relief. The general scheme justifies this on the basis that "the benefits of tax relief [are] not at all well understood by ordinary workers", with "a different approach [being] needed to incentivise" lower-to-middle income workers who do not currently have a private pension. However, evidence from other countries suggests no change in the structure of tax relief on pensions is required for automatic enrolment to achieve its aim, as the policy works by shifting the default behaviour of individuals and firms. It is the default and change in default that has the effect, rather than anything to do with the tax treatment. Given this, it is unclear that such radical reform, which would add substantially to the complexity of Ireland’s pension tax regime, is needed to support the initial roll-out of automatic enrolment. Instead, if after the initial roll-out of automatic enrolment, certain groups are still thought not to be saving adequately for their retirement, the Government could then look at targeted incentives to further raise savings rates among these groups. We previously published some ideas of how one might do that, which are referenced in the opening statement.

As well as adding complexity to an already quite complex system, the creation of a different, parallel system of tax relief for automatic enrolment pension schemes raises questions of horizontal equity. I refer to circumstances in which two individuals with the exact same earnings profile over their lifetime would receive different levels of support from the State, depending on whether their employer operates an auto-enrolment scheme or a more traditional private pension scheme. There are also more practical questions, which the committee has considered previously, about the portability of funds accumulated through an auto-enrolment scheme to a more traditional private pension should an individual change employer, as is likely over the course of a working life.

A second important feature of the draft general scheme that is worth considering is the facility for people who are auto-enrolled to opt out after an initial six-month period. Research led by my colleague Dr. Keane has examined whether such a period of compulsion may lead to issues of affordability by simulating the distributional and poverty impacts of the scheme in these initial six months. Her research found that the largest impact on incomes will be felt by those around the middle of the income distribution, while the bottom two income quintiles, or bottom two fifths, of the distribution will see the smallest fall in disposable income. These results are driven by two factors. First, only around 1% of those in the lowest income quintile and 7% in the second lowest income quintile will be affected by auto-enrolment. That is because most of the people down at the bottom of the income distribution are less likely to be in paid work and have lower levels of earnings. Second, while we know that lower earners are more likely to be auto-enrolled, these individuals are often higher up the distribution of household income due to the presence of a working partner. We therefore see little impact of the scheme on the at-risk-of-poverty rate, even in the short run, based on the research that has been done.

The final feature of the scheme that we wish to highlight is the proposed cap on charges on the funds of those participating in an automatic enrolment scheme. For many people, paying for the management of a private pension is the biggest purchase they will make in life after buying a house. It is clear from the research that unlike estate agent fees or those associated with many less important purchases, pension management fees are not very salient and savers appear to face large switching costs. There is a good case for ensuring that the fees associated with the schemes into which individuals are defaulted are capped at the minimum level required to cover costs, especially as automatic enrolment is specifically designed and targeted at those who we know do not pay particular attention to their pension savings and are particularly unlikely to pay attention to charges that are often complex. At the moment, head 65 of the draft Bill says the Minister will set a limit on the charges made to the assets of an employee’s auto-enrolment fund by regulation. The Department of Social Protection has previously suggested that this cap would be set at 0.5% per year as an annual management charge, which, while lower than that applied in some other countries, is higher than, for example, the 0.3% annual management charge levied by the British National Employment Savings Trust, which is the fallback option there as auto-enrolment. That may serve as a useful benchmark or idea. The key point we make in this regard is that it is about making sure the costs are as low as possible while sustaining the programme. It is important to get that exact figure right.

We thank the committee for its time and look forward to discussing these or other aspects of automatic enrolment.