Reducing tax relief on pensions could have negative impact
11 June 2008

Written by Sophie Baker

Reducing or eliminating the tax incentivisation of pensions and diverting the current cost into providing a higher State pension is “fundamentally unsound” in terms of the economy, says a report by Life Strategies.

The actuarial consultancy firm carried out the report on behalf of the Irish Association of Pension Funds (IAPF).

According to the study, the annual cost of tax and other reliefs on private pension provision is €2.5bn, or some €400million less than suggested in the Government’s Green Paper on pensions and that this also fails to recognise the structure of the system which relies on a deferral of taxation. The report questions whether this cost could be diverted in whole to the State pension.

Commenting on the results, Patrick Burke, chairman of the IAPF, said: “It should not be forgotten that the so called cost of tax relief is really tax deferred rather than tax foregone and any serious analysis must quantify this point taking into consideration Irish demographics.”

The Life Strategies report finds that extreme proposals are fundamentally flawed on grounds of sustainability and relativity. Projections show that the strategy of diverting approximately €2bn of funding could increase the State pension from 34 per cent of average earnings to 50 per cent. However, it says that this proposition is fundamentally unsustainable as “although cost-neutral in the current year, it would result in a substantial worsening of the overall budgetary position as the population ages.” It states: “In summary, it would result in a net additional cost of over two per cent of GNP by the middle of the century.”

The report suggest that, even if this change does not happen, the annual spend on the State pension is set to increase from its current level of roughly three per cent of GNP to in excess of ten per cent by the middle of the century.

According to the report, the effective rate of tax benefit for high earners is significantly lower than for those earning €45,000. “We find that the current system gives the highest benefit to those earning just above the average industrial wage and that the benefit falls as one moves up the earnings scale and/or as one increases the level of pension contributions,” commented Michael Culligan of Life Strategies.

The study also highlights the knock on effects on the cost of public sector pensions if tax reliefs are reduced, estimating that the total employer and employee contributions to public sector pensions if funded would be in excess of €3bn per annum. It says: “In order to ensure equitable treatment of private arrangements would also need to be mirrored in the public sector. This would have to be done by imposing a benefit in kind tax on the notional employer contribution,” it adds.