What level of retirement income will the Government’s Auto Enrolment Scheme provide?

What level of retirement income will the Government’s Auto Enrolment Scheme provide?

There has been lots of commentary concerning the Government's new Auto Enrolment Pension Scheme (“the AE Scheme”) with legislation to put in place the AE Scheme now signed by the President. Its main purpose is to provide supplementary retirement income to the approximate 800,000 workers who do not participate in an employer pension plan. The AE Scheme will be branded ‘My Future Fund’.

However, what level of retirement income is the new AE Scheme expected to provide to members?

The answer is that the projected retirement income is €15,200 a year for an individual earning the Average National Wage (€50,000) who joins the AE scheme at age 23 and retires at age 66. When this is combined with the State Pension the total retirement income is approximately €30,000 p.a. The table below summarises the projected retirement income for individuals joining the AE Scheme at various entry ages, who are earning the Average National Wage. All figures are in “current day” terms so the projected pension amount can be compared against current earnings. The Replacement percentage is the total projected retirement income as a percentage of each individual’s earnings (€50,000 in all cases).

Summary of projected retirement income

Observations

If our projection assumptions are borne out in practice then:

• The AE Scheme will provide a meaningful level of additional retirement income for the younger generation of savers.
• For older workers with, say, only 10 years to go until retirement there is insufficient time for the AE Scheme to produce a meaningful level of additional retirement income. This arises because the initial level of contributions are quite low (e.g. 1.5%, 1.5% and 0.5% for first 3 years etc) and there is not enough time for the magic of investment compounding to take hold. Of course having some retirement savings is better than having none!
• For other individuals the outcome is somewhere between these results as can be seen in the table.
• Details of the main projection assumptions used are set out in the Q&As at the end of this document. We believe perhaps the biggest unknown here, is whether the very significant increases in future contributions due over the next 10 years, will proceed as planned as we expect there will be significant pushback by employees and employers.

What if these employees are eligible to join an employer DC pension plan?

Many companies already provide retirement benefits through employer schemes such as Defined Contribution (DC) arrangements. The average level of employer contribution payable to DC pension plans in Ireland is 7% of salary. In the table below we show the corresponding amounts of projected retirement income assuming that the same individuals earning the Average National Wage could join a DC Plan with this level of employer contribution and with the individual making the same level of member contributions as they would make to the Government AE Scheme (in terms of reduction in take home pay).

Projected retirement income with a DC plan

The chart below compares the supplementary retirement income that is projected under the AE Scheme and the assumed DC Plan. The results show that in this scenario and under these assumptions the DC Plan provides significantly higher levels of projected retirement income.

Comparison of retirement income

Supplementary retirement income projected under AE Scheme versus assumed DC Plan.

Under the above scenario, if the individuals can join an employer DC Plan they should seriously consider the offer and avoid being defaulted into the Government’s AE Scheme! Of course, individuals will need to carefully analyse the terms of any employer pension scheme that is being made available to them and consider their own circumstances before deciding on whether any employer DC Plan available to them is more or less beneficial than the Government AE Scheme. It will therefore be imperative that employees that have such options receive comprehensive communications to assist them in their decision making.

Some interesting Q&As on our projections!

Pension projections are long-term; remember that when the AE Scheme goes live in September 2025 employees (not in an employer plan) will be automatically enrolled once they are age 23 (and earn more than €20,000). The funds set aside then become available 43 years later (when the employees reach State Retirement Age)! That gives plenty of time for the magic of investment compounding to take effect and savings within the Scheme will grow tax-free. So we need to make some key assumptions which are covered in the questions below.

1. 01

   What level of Contributions will be paid to the AE Scheme?

   We have assumed total contributions (as a % of total earnings) will be as follows:

   Level of Contributions to be paid to AE Scheme

   Level of contributions paid to the AE scheme as a % of total earnings

   Years	Employee	Employer	Government top-up	Total
   2025 to 2027	1.5%	1.5%	0.5%	3.5%
   2028 to 2030	3.0%	3.0%	1.0%	7.0%
   2031 to 2033	4.5%	4.5%	1.5%	10.5%
   2033 +	6.0%	6.0%	2.0%	14.0%

   Even here we need to point out that there is no certainty that contributions will increase to these levels. In particular, the final targeted contribution levels of 6% (employee), 6% (employer) and 2% (state top up) are ambitious. The UK’s AE Scheme has been in place for over 10 years and it requires minimum contributions of 5% from employees and 3% from employers.

2. 02

   What investment return have we assumed?

   We are projecting retirement income relative to each individual’s projected earnings. The key assumption is therefore what level of investment return (net of expenses) will be earned in excess of the growth in the individual’s earnings. For this we assume a 2.0% excess return. This is consistent with, for example, earning investment return of 5.0% (net of expenses) with the individual’s earnings increasing at 3% p.a.

3. 03

   What amount of capital is required at age 66 to provide €1 of retirement income?

   If we allow for the retirement income to increase in line with price inflation in retirement the Society of Actuaries projection basis* tells us that we need between €26.0 (if currently age 23) and €23.3 (if currently age 56) of capital to provide each €1 of retirement income from age 66.

   ^* Annuity factor assumptions used are in line with changes proposed by the Society of Actuaries in Ireland for DC pension projections in July 2024.

4. 04

   What about the €80,000 earnings cap for AE?

   We have assumed that over time this will revalue in line with average earnings.

5. 05

   Have you allowed for any break in employment or unpaid periods of leave?

   No, our projections assume no break in service. Earnings are projected to equal the National Average Earnings Amount in every future year. We have not allowed for any breaks in employment or periods of unpaid leave.

6. 06

   What about the state pension?

   We have assumed that it will be paid from age 66 in the future and each individual will qualify for the full state contributory pension and that the pension will remain a stable percentage of National Average Earnings.

7. 07

   What additional assumptions were made for the Employer DC Plan projections?

   We assumed that the level of investment return net of expenses will be the same as that under the AE Scheme. We have assumed annual employer contributions of 7% of salary and we have allowed for the same level of member contributions (on an after-tax basis) as would have otherwise been paid to the Government's AE Scheme. We have assumed that the individuals are higher rate (40%) income tax-payers.

^*Annuity factor assumptions used are in line with changes proposed by the Society of Actuaries in Ireland for DC pension projections in July 2024.

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