We are pleased to provide a copy of our submission to the Department of Finance’s consultation process on the Standard Fund Threshold (Consultation paper dated 14 December 2023).
WTW is a leading global advisory, broking and solutions company. In Ireland we provide insurance brokerage, risk advisory, pension and actuarial consultancy services. We are long-standing administrators of, and consultants to, an extensive range of occupational pension schemes provided by both multinational and indigenous employers.
Our financial consultants work on a daily basis with companies to provide their employees with a better understanding of the benefits that are provided and how they interact with their financial needs and objectives.
WTW has a long history of working with government agencies, trade associations, and regulators on important reform projects.
Please note that comments in our submission are made not only from our perspective as a provider of occupational pension scheme services but also based on our experience in advising current and future pensioners on wider financial planning and our understanding of their expectations and concerns.
In this submission, we address some of the terms of reference outlined in your public request for submission titled “Consultation on the Standard Fund Threshold” dated 14 December 2023. Over the course of our submission, we will lay out why we are in favour of an increase in the Standard Fund Threshold (“the SFT”) and also why we are in favour of reducing the chargeable excess tax rate and reviewing the capitalisation factors used to value defined benefit pensions.
Tax relief on pension contributions and investment returns is a significant, and necessary, incentive to encourage a culture of retirement saving. In our view, this must be maintained and enhanced.
It is in everyone’s interest to further develop a stronger culture of saving for retirement. Benefits in retirement fall into the tax net so the tax receipt is deferred rather than lost to the State. Ultimately the long-term cost to the State could be far greater if people do not have sufficient savings to enjoy a reasonable standard of living in retirement. We are also of the view that the current system of full marginal income tax relief should continue as otherwise there would be a disincentive for higher rate tax payers to save for their retirement (receiving less than 40% income tax relief at the time of contribution but paying 40% income tax at the time of drawdown).
We would support a significant increase to the current Standard Fund Threshold level recognising that tax approved pension saving is one of the few tax incentivised saving mechanisms available to individuals. We note in other jurisdictions there are further tax incentivised savings mechanisms outside of approved pension products such as Individual Savings Accounts (ISAs) in the UK.
We believe that it is appropriate to benchmark against an appropriate and fair level of retirement income and we would recommend that this level of income is indexed over time so that a consistent level of retirement income as a percentage of earnings at retirement can be targeted. For example, many defined benefit occupational pension schemes are designed to target a pension of 2/3rds of final salary assuming a full-service career. The limits imposed on the level of benefits provided under occupational pension schemes by the Taxes Consolidation Act 1997 as applied by the Revenue Commissioners are also based on a maximum pension of two-thirds of Final Remuneration.
Our view is that the actual level of the SFT is a matter which concerns public policy. However, in this submission we consider what a revised SFT level should be in 2024 and beyond if €2m was considered the right level in 2014.
We note that as well as the lifetime limit on tax approved pension savings through the SFT there is also an annual funding limit that applies to employee contributions to occupational pension scheme (and to total contributions for self-employed individuals). Placing restrictions on the level of individual contributions that a self-employed person can make significantly reduces retirement planning flexibility. Many individuals are not in a position to contribute towards a pension until later in their careers. It seems unfair that they be restricted from funding up to the SFT in comparison to an individual fortunate enough to have been able to contribute to pension provision throughout their working careers. If the employee / individual contribution limits is to remain in place we think there are strong arguments to also review the €115,000 earnings cap (which was last reviewed in 2011).
We note that there is a concern regarding the immediate impact on tax revenues were the SFT to be increased, but we would highlight as outlined in section 1 that pension income in retirement falls into the tax net, so the tax receipt is deferred, rather than lost, to the State.
To illustrate this point, we examine the tax benefit an employee who pays higher rate income receives from paying a voluntary member contribution.
Under the current tax system, the contribution does not receive relief from USC and PRSI at the time of payment. In the analysis we have assumed that:
In this scenario, there is in fact a tax loss relating to this marginal additional contribution if we ignore any potential benefit from the “gross roll up” environment. This analysis illustrates that when allowance is made for the prospective tax and USC receipts that can be expected on drawdown there really is not a significant tax benefit, if there is any at all, to individuals who make additional contributions which bring them above the current €2m SFT amount even before the chargeable excess tax is levied.
We note that at the time this consultation is taking place there is press coverage that there are difficulties recruiting for senior public sector roles due in part to the SFT regime significantly reducing the value of the overall package. This highlights that the SFT is having an adverse effect on the recruitment of senior public sector staff and this needs to be addressed.
Significant rises in both price and wage inflation over the period from 2014 to 2024 underpin a large part of our belief in the need for a significant increase in the SFT level. The Consumer Price Index has increased by approx. 21% from 1 January 2014 to the current time.
Over the last 10 years National Average Earnings have increased by approx. 33% (based on Q3 2013 to Q3 2023 published statistics). Given the purpose of a pension as income replacement then there is a very logical argument for an increase in the SFT when a greater pension is required at retirement to provide for the individual and any dependants in their old age.
We also note that the State Pension has increased by 20.4% over the same period.
It is also worth considering the typical level of investment return made on retirement funds since 1 January 2014. We consider the position of an individual with a defined contribution fund who ceased making any further tax relieved contributions to an approved pension product in 2014 (at the time the SFT was reduced from €2.3m to €2.0m). In this example, the individual’s fund was worth €1.5m on 1 January 2014 leaving some headroom for the fund to grow while staying within the €2m limit.
Over the period since 1 January 2014 the average investment return on Managed Pension Funds in Ireland was 7.25% p.a. or a circa cumulative 100% increase over the period. This means this individual’s fund, if invested in the managed fund, would now we worth approximately €3m and would therefore be subject to very penal SFT taxation at retirement (see further analysis included under Section 6 below). Further investment returns into the future will exacerbate the issue. In order to manage this tax exposure, the individual is likely to have been advised to disinvest from Growth Seeking funds until they have the opportunity to process their pensions pot (i.e. trigger a Benefit Crystallisation Event). This has a real economic cost for the individual. Arguably this dynamic is very punitive given that:
The table below summarises the revised level of SFT if the current €2m was indexed in line with CPI, Average Earnings Growth and Average Managed Pension Fund returns since 1 January 2014.
| Indexation | Increase | Revised SFT Level |
|---|---|---|
| CPI | 21% | €2.42m |
| Average Earnings | 33% | €2.66m |
| Average Pension Managed Fund Returns | 100% | €4.00m |
We are of the view that the minimum level of escalation should be at least in line with Average Earnings Growth (to maintain income replacement ratios). For the reasons outlined above, we believe that Average Pension Managed Fund returns are also relevant. Therefore, a replacement SFT level might fall in the range between €2.66m and €4.0m (on the basis that €2m was the right SFT level in 2014).
WTW’s view is that the current 40% SFT tax rate is excessively penal when account is taken of the fact that any funds in excess of the SFT are not only subject to this 40% SFT tax penalty but are also taxed on drawdown, creating an effective tax on excess funds of 68.8%.
The table below examines the total marginal tax rate (SFT, Income tax and USC combined) on excess funds under the current 40% chargeable excess tax rate and if alternative SFT tax rates of 20% and 25% were to apply*.
| Current Scenario | Alternative SFT tax rates | ||
|---|---|---|---|
| Current chargeable excess tax | 40% | 20% | 25% |
| Income Tax | 40% | 40% | 40% |
| USC* | 8% | 8% | 8% |
| Effective tax on funds exceeding the SFT | 68.8% | 58.4% | 61% |
While we accept that there should be a chargeable excess tax applying, we would suggest that the chargeable excess tax rate could be significantly lower than 40% and still disincentivise individuals from excess funding. For example, a 20% chargeable excess tax still results in an effective tax on excess funds of 58.4%. This would make the regime less penal for individuals who inadvertently exceed the SFT level.
| Age | Existing SFT Capitalisation Factor | Non-escalating pension value | % difference | Increasing pension value | % difference |
|---|---|---|---|---|---|
| 50 | 37 | 23.5 | 36.5% | 35.1 | 5.3% |
| 55 | 33 | 21.8 | 33.9% | 31.3 | 5.1% |
| 60 | 30 | 19.9 | 33.5% | 27.5 | 8.2% |
| 65 | 26 | 17.2 | 33.7% | 22.9 | 12.0% |
| Average difference | 34.4% | 7.6% | |||
In capitalising the value of €1 of pension we have used the SORP mortality basis, an interest rate of 3% (broadly in line with current long term Eurozone sovereign bond yields) and assumed the pension is single life. For the increasing pension we have allowed for increases of 2.25% p.a. in-payment (which is in line with current market long term price inflation expectations). This analysis would indicate that the current capitalisation factors at each age are on the high side particularly considering that a large proportion of private sector DB pension schemes do not provide for pensions to increase in payment.
Application of age-related multipliers to portion of pre-2014 DB pension
The current SFT regime applies a fixed multiplier of 20 to a DB pension accrued up to 1 January 2014 and age-related multipliers to a DB pension accrued after 1 January 2014. The capitalisation factors being on the high side is exacerbated by the fact that increases to a pre-2014 DB pension due to salary increases or revaluation in the period up to retirement, are subject to the higher age-related capitalisation factors rather than the fixed 20 times multiplier.
We have looked at a simple example of an individual who on 1st January 2014, had 20 years to go to retirement and who’s pre-2014 DB pension increases in line with 3% p.a. salary increases over this 20 year period.
Our analysis indicates that, for this example, applying the age-related multipliers instead of the factor of 20, has the effect of increasing the SFT value of the pre-2014 portion of their DB benefit:
In our view salary linking or revaluation attaching to the pre-2014 DB benefit should be subject to the fixed 20 times multiplier as this component of benefit arguably relates to service accrued up to 1 January 2014.
We are of the view that it should continue to be possible to have any chargeable excess tax settled directly from an individual’s pension fund assets.
Given the large scale of the change in the economic landscape from the last time the SFT was changed in 2014, it is our belief that the SFT should be reviewed much more regularly going forward. This will serve not only to ensure fairer limits but will give greater certainty to allow individuals plan for retirement without incurring large tax liabilities.
