Senior Financial Consultant at SYS Group Paul Heverin penned this article to demystify the pension auto-enrolment system set to be put into place by 2024
When I became a financial consultant over 11 years ago, one of the first things that was mentioned to me was the reform of the pension system in Ireland. After four or five years, I thought this reform would never materialise. We now have a date for the introduction of the proposed Irish Auto-enrolment system – 1st January 2024. Many of the clients I meet are unsure what this means for them as an employer or employee. Let’s break it down.
Pension Auto-Enrolment
The auto-enrolment system will apply to all employees aged between 23 – 60, earning over €20,000 and there is an upper limit of contributions for salaries above €80,000. This is across all employments sectors, and for employees who are not already members of an occupational pension scheme. Eligible employees will be automatically enrolled in the scheme but will have the choice after six months of participation to ‘opt-out’ or suspend participation. Those who opt out will be automatically re-enrolled after two years. Department of Social welfare anticipate approximately 750,000 workers to be enrolled into a new workplace pension scheme. When fully established, a worker earning €35,000 p.a. will accumulate a fund (excluding investment returns) of €293,000 over their working life.
Pension Contributions – Phased
Although this is an additional expense for employers paying into a pension scheme. The good news for them, is the level of required auto-enrolment contributions will gradually increase every 3 years over a 10-year period as illustrated below table. This should help employers to budget for this new benefit for their employees.
In years 1 to 3, every €3 the employee saves their employer would match this €3 and the Government will top up with an additional €1. So, their €3 will turn into €7 before even being invested on the employee’s behalf. This is a brilliant return.
| Year 1 to 3 | Year 4 to 6 | Year 7 to 9 | 10 plus |
Employee | 1.5% | 3% | 4.5% | 6% |
Employer | 1.5% | 3% | 4.5% | 6% |
Government top-up | 0.5% | 1% | 1.5% | 2% |
Total Contribution | 3.5% | 7% | 10.5% | 14% |
Tax Incentives
The Government have announced that the new system is an additional pension scheme and will run alongside the existing tax relief system available to pension savers participating in occupational pension schemes, PRSA and Personal pension products.
When comparing the new incentive system to the existing tax relief system it will be more favourable for members who pay 20% income tax rate on all their earnings and less favourable for 40% income tax rate payers.
The cost per €1 to member summarised in the table below for both systems:
| Standard Rate @20% Current Pension Scheme | Auto Enrolment Proposed New Pension Scheme | Higher tax rate @40% Current Pension Scheme |
Every 1 Euro Contributed | €1 | €1 | €1 |
Cost to Employee | €0.80 | €0.75 | €0.60 |
Employer Planning and Considerations
The table above outlines that the auto-enrolment state tax incentives are less generous than the current tax relief incentives available for higher rate taxpayers. If the majority of an employer’s workforce are higher rate (40%) taxpayers, then it is potentially difficult to justify adopting the new auto-enrolment system. With that in mind, the auto-enrolment incentives are more generous for a standard (20%) taxpayer. Companies may want to consider the tax profile of their workforce when considering the optimum way forward.
Employers and trustees who have employees on the lower tax rate do not need to take immediate action as the system is not due to be implemented until late 2023/early 2024. However, employers with high-rate tax employees need to consider which scheme is better for their employees.
Employee Changing Jobs
Individuals would remain in the auto-enrolment system when they change employment and therefore under the ‘pot-follows-member’ approach, individuals who move jobs will not have to change or join a new pension scheme. In addition, individuals with multiple employments will have their pension savings consolidated into one pot. In certain circumstances, it may prove more tax efficient for people not to merge all their pension into one pot. Once you access your pension after turning 61 revenue rules state that you must take 4% of your pension pot out every year. Even though it may not be tax efficient for you to do so.
When I meet employers who do not have a pension scheme in place, I use the following example to show the benefit of setting up a pension for an employee on 50k looking for a pay rise of 10%. This table outlines the difference for both parties of getting a pay rise and starting a pension.
Salary Increase v Employer Pension Contribution
Example | Percentage | Figure |
|
Basic Salary |
| 50,000 |
|
Increase Under Discussion |
| 5,000 | 10% |
Employer Offers to set up an Employers Scheme
Employer Saving |
|
|
|
No extra employers PRSI | 11.05% | 553 | Assumed higher rate |
Tax relief on pension contribution | 12.50% | 625 | Assumed company tax rate |
Employee Saving
Tax | 40% | 2,000 |
USC | 8% | 400 |
PRSI | 4% | 200 |
Net pay if taken as salary |
| 2,400 |
Pension contribution to scheme |
| 5,000 |
Employers pay 8.8% Class A employer PRSI on weekly earnings up to €410 over this amount it’s 11.05%.
The Benefits
Employee benefits
- Tax efficient saving for retirement needs
- Greater compounding on investments due to larger net contribution
- Pension schemes can provide death in service for dependents
- Tax free growth on pensions
- May help some employees to qualify for Government schemes like SUSI grants, Single family payment etc.
Employer benefits
- A more satisfied employee saving for their future
- A good alternative to pay increase avoiding higher wage growth
- Improved retention: Contribution schemes lock staff in for 2 years as employee would lose employer contribution.
- Reduces recruitment and training expenses. The average cost to a business replacing an employee is €30,000.
