The Government has announced plans for a new compulsory pension savings scheme for workers that do not currently have a private pension. They expect up to 750,000 people will be affected. But what does it mean for you and how will it work?
What exactly does auto-enrolment mean?
Auto-enrolment means that if you are not already a member of a pension scheme – most likely through your employer – you will automatically be signed up to start saving for your retirement.
Will everyone be signed up?
Not everyone. It applies only if you are aged between 23 and 60 and you have an income of at least €20,000. But there is nothing to stop you opting in at a younger (or, less likely, older) age or on lower earnings. As a general rule, the earlier you start pension saving, the better.
But what about the State pension? I’m already paying for that with my PRSI.
You are in a sense but there are two things to note. First, the State pension amounts only to €13,425 a year even if you include the Christmas bonus. That can be a stretch financially for people. If you were earning at the average industrial wage – around €45,000 – as a single person, you would have been bringing home €34,668 a year up to retirement. Suddenly, your income is dropping by over 60 per cent. Especially in a world where more people might be renting in the private sector into old age, that sort of money is not going to suffice.
Second, your PRSI payments are paying the current generation of old age pensioners, not being salted away for your benefit. With people living longer and a falling birth rate, there is no certainty that when you come to retire, the State pension as we currently know it will be available to all.
How much is this going to cost me?
Initially you’ll be paying 1.5 per cent every month. Although that money will come from your after tax income, it will be 1.5 per cent of your gross salary. So, if you are a single person on €45,000 as above, you will pay €675 in the first year or €56.25 a month. Your employer will pay the same and the Government will chip in €18.75 monthly, or €225 in that year.
That doesn’t sound like it is going to build up a big pension pot?
Well, no. But the contribution rates will rise over the first 10 years of the scheme. From the start of year 4, you and your employer will pay 3 per cent of your gross earnings into the fund, with the State adding in 1 per cent of your earnings. In year seven, that will rise again – to 4.5 per cent each from you and the employer and 1.5 per cent of gross earnings from the State. And from the start of year 10, you will be paying 6 per cent of your gross earnings €2,700 a year in our example, or €225 a month – as will your employer. The State will pay 2 per cent €900 a year on a €45,000 salary – which means the total contributions will amount going into the pension fund will be 14 per cent of your annual earnings.
What if I simply cannot afford it, or I am likely to be moving elsewhere in the near future?
There is an option to leave the scheme, if you choose. You’ll have to pay into the fund for six months anyway. At that point, you can choose to walk away but only if you decide to do so in months seven or eight. If you do, you will get your own contributions back, but not the money put in by your employer or the State.
During that first decade, as contributions are ramping up, you’ll also be able to walk away (with your own contributions to date repaid to you) in a window after the payments increase – the start of years 4, 7 and 10.
If you are still working here two years after you choose to opt out, the scheme will automatically sign you up again. The thinking – and the experience with such schemes in other countries – is that once you are signed up, people get used to the idea and stick with it. Making the decision to start retirement saving is the biggest hurdle: auto-enrolment does that for you.
I’m okay with the idea of a pension fund but once I start, am I obliged to pay in every month?
We all have financial emergencies – a sick child, a damaged home that needs urgent repair for instance. The Government says employees will be able to suspend contributions at any time while remaining part of the scheme. Obviously, while contributions are suspended, you won’t be getting the benefit of the employers’ payment or those from the State.
Does this auto-enrolment guarantee you a certain pension?
How much of a pension you will get will depend on the investment return on the combined contributions that go into your fund. You will have a choice between a number of funds offering different levels of risk and you can move between these funds. If you don’t choose a specific fund, you will be put into a default fund. This is not like the old defined benefit pension where you get a certain proportion of your salary on retirement.
So what sort of pension pot can I expect to build up in this scheme.
Let’s look at two scenarios. If you are 23 and earning the €45,000 average industrial wage and the fund you are investing in delivers an annual return, or growth, after charges and fees of 5 per cent every year, you will retire with a fund of almost €577,000. If, however, in the same position, your annual return is only 2 per cent, the fund will grow to just shy of a more modest €340,000. In bother cases
Yes, you’re unlikely to be on the average industrial wage at 23 and, in any case, your earnings will increase (hopefully) as you progress so this is not necessarily a realistic scenario but it does give you some sense of how your fund might accumulate. As you can see, the return after charges is critical.
In both of these examples, you will have personally paid €116,650 towards your pension, and the total contributions to the scheme – including the money added by your employer and the State – would be €248,850.
And how much would that pay me in retirement?
Again, you have choices. First off, if you choose, unless the rules change by then you will be able to take a chunk of the funds as a tax free lump sum. After that you can choose either to buy an annuity or an approved retirement fund (ARF).
In very simple terms, an annuity is a policy you take out with an insurer that sees you hand over your pension fund to them and them paying you a guaranteed income for life. At the moment, depending on age and health, a €577,000 would yield an annuity of about €17,310.
An ARF means your money continues to be invested and you can drawdown whatever you choose each year. You will have to take a minimum of 4 per cent of the fund until the age of 71 and 5 per cent thereafter. On your €577,000 fund in our example, that means annual income of just under €23,100 in the early years and then around €28,000. Of course that depends on the investment continuing to grow at 5 per cent: otherwise the amounts will be lower. And it also assumes you take no tax free lump sum which is unrealistic, but it gives you some idea.
On our poorer performing fund, the annual income would be about €10,000 lower in each case – or about €7,000 lower on the annuity.
What’s the rush? We’re just recovering from the Covid shutdown, everyone’s cost of living s rising sharply and the Ukraine war is adding to uncertainty. Now doesn’t seem like a good time to take more money from my pack packet.
It’s hardly a rush. Auto-enrolment has been on the radar in Ireland as far back as 2006. SO, by the time you start paying contributions – assuming there are not further holdups – it will have been “planned” for 18 years. By the time we get to a reasonable level of pension contributions under the scheme in 2034, a further decade will have passed. That’s more than half a working life. There’s never a “good time” to bring in something that will take money from workers’ pay, even if it is for their own longer terms benefit. That’s why successive ministers and governments have bottled the issue.
Dominic Coyle
