It’s a seismic change, and one that not enough of us seem to be aware of.
In days gone by, it was enough for members of defined benefit (DB) schemes to make their monthly contributions safe in the knowledge that when they retired, they would be heading off into the sunset with up to half of their final salary deposited into their bank account each month.
Now however, the move to defined contribution (DC) schemes has put the responsibility very much on the individual. But how are employers responding to the new environment and are people ready for the change? And is the DC model itself primed for a shake-up?
“It’s a huge change for people – now it’s your responsibility,” says Sean Egan, DC product manager with Irish Life Corporate Business, of the move away from DB schemes, which promised a certain level of benefits in retirement, towards DC schemes, which will force individuals to take control of their own retirement.
It’s a move that is steadily gaining pace. According to figures from the Irish Association of Pension Funds (IAPF) just 11 per cent of DB schemes are taking on new entrants.
Some might bemoan the move. As Brendan Walsh, head of pensions for Bank of Ireland Life notes, DB schemes were completely hands-free: employees didn’t have to be concerned about investment issues because if a fund performed badly it had no impact on them personally. The reality however is that the guarantees offered by DB schemes are not necessarily watertight.
“We thought they were guaranteed but they’re not; it’s more of a promise,” says Egan. “If it works out it’s great, but if it doesn’t you’re snookered.”
So DCs can offer employees a real alternative. Unlike DB schemes, the assets in the fund are ringfenced, which means that even if the company collapses, your pension funds are safe.
And there’s no cross-subsidisation, so your contributions won’t be propping up the benefits of retired members of the pension scheme – leaving you at risk of there being nothing left in the pot when the time comes for you to retire.
'Safer model' for employers
"It's all yours and no one else can come near it. In times of uncertainty it's a much safer model, as the risk is with the employee rather than employer," says Egan.
However, as Walsh notes, “The move into the DC world means much greater individual involvement and a far greater level of personal responsibility is required”.
Egan agrees. “The underlying commitment – and risk – is with the individual. The employer will say ‘I’ll give you a certain amount but how that works out at retirement is up to yourself’.”
But how much will an employer contribute? Bank of Ireland recently renegotiated its pension benefits, offering employees up to the age of 44 a contribution of 12.5 per cent, rising to 20 per cent for those aged over 44.
Not all employers offer such generous terms however, with multinationals, for example, typically making contributions on a matching basis.
A typical scenario might see an employer pay about 5 per cent on a matching basis – so you put in 5 per cent and the employer matches this to give you an annual contribution of 10 per cent of your salary. In addition to the employer contribution, you’ll also get tax relief, so a pension contribution of €200 might actually just cost you €59, if you pay tax at the higher rate.
“It’s a very good deal with employer matching,” notes Egan.
Walsh also recommends that people consider makimg additional voluntary contributions outside of the matching arrangement to boost their pension benefits.
Remember, however, as a report from the Department of Social Protection showed in 2012, pension fees and charges can eat away at the benefit of this tax relief, so be sure that your employer/pension trustees are picking the best option for employees.
You might also need to be aware that issues can arise with DC schemes, and the Pensions Board is running a consultation on the future of such schemes.
Walsh notes that one flaw is the low level of engagement DC schemes tend to engender among employees, while the cost of certain benefits offered under DC schemes – such as death in service – can eat away at contributions as employees age.
In praise of simplicity
Niall O'Callaghan, partner and DC leader with Mercer, is in favour of radically changing the current DC pension system so that there is only one type of scheme, governed by one set of rules, "and not the nine types of scheme with a myriad of different rules that currently exist".
“This will have the double positive effect of making pensions easier to understand and significantly reduce the cost of administering/advising on them,” he says.
For employees not entitled to join a DC scheme, another option is a PRSA, or personal retirement fund. Employers are obliged to offer a PRSA scheme to employees – but not to contribute into it – although Walsh notes that employers typically do. However, such a contribution is liable for the universal social charge, which can diminish the benefit to an employee.
And, given that about half of the working population do not have any pension, and will rely on the State pension, O’Callaghan is in favour of the introduction of auto-enrolment.
Already introduced in the UK,Australia and New Zealand, this automatically enrols employees into a pension scheme.
He says when the economic environment supports it, the Government should introduce a soft mandatory system to nudge people towards increasing their savings for retirement.
“It is time for Government to take positive action and implement them,” he says.
