Government’s new pensions roadmap spells an uncertain future for AMRFs

Last year, the government set sail on an ambitious overhaul of the Irish pensions landscape with the launch of its ‘Roadmap for pensions reform 2018-2023’. Like all journeys towards pensions reform, it’s likely there will be a few bumps along the way.

In any case, the five-year roadmap addresses the three types of retirement funding:
•    State pension
•    Occupational pensions
•    Personal pensions

Within this framework, the State pension continues to form the bedrock of retirement savings for Irish people. In this article, we look at the implications of reforming the State pension and the future of Approved Minimum Retirement Funds (AMRF).

Ageing Ireland and the State pension

Like most countries, Ireland’s population is getting older. Over the next 40 years, it’s estimated that the ratio of people of working age to pensioners is likely to fall to approximately 2:1. Faced with this challenge, the government already increased the State pension age in 2014, with further increases planned as follows:

Table 1: State pension qualification age:

Of course, there’s a limit to how long people can realistically continue working, and the current five-year plan includes an assurance that there will be no further increase to the State pension age before 2035. Furthermore, any future increases will be linked to life expectancy, to be reviewed every five years.

For most people, these changes to the State pension age mean that (a) you will be working for longer and (b) you will be making more Pay Related Social Insurance (PRSI) contributions. Those are salient facts when we look at how the State pension will be calculated in future.

‘Total contribution approach'

The new system for calculating the State pension will be based on the total number of PRSI contributions a person has paid over their working life. 

To qualify for a full State pension, you will be required to have contributed a full 40 years’ worth of weekly PRSI contributions (2,080 in total).  Those who have contributed less than the required amount will have their State pension reduced on a pro-rata basis. 

Within these boundaries, the government has said it will make allowances for certain ‘gaps’ in PRSI contributions, for example giving credits in lieu of periods of illness or where people have taken time off to look after children.

The new Total contribution approach (TCA) will dovetail with the current average test method until 2020, and whichever calculation yields the highest result will determine what rate of pension a person will receive.  

Interestingly, those who received their State pension from 1st September 2012 are entitled to have their allowance recalculated based on the new method. If this qualifies them for a higher amount, their payments can be back-dated to 30th March 2018.  

This may well increase the State pension for many people, in particular mothers who would not have been in a position to contribute PRSI while caring for their kids.  This potential bonus will be further bolstered by the €5 per week increase in the top rate of State pension announced in Budget 2019 (scheduled to begin on 25th March 2019).

Benchmarking rate of State Pension

As part of the changes, the new roadmap also aims to take the guesswork out of how much people can actually expect to get from their State pension. Going forward, the government plans to set the State pension at 34% of average earnings.  All future increases would then be linked to the consumer price index (CPI).

Let’s look quickly at how that stacks up. The average wage in 2018 was €38,878. If we take 34% of that figure, the State pension rate would be €13,219 per annum or €253.34 per week, which is slightly above the new current rate of €248.30 which started on 25th March 2019.

What does this mean for AMRFs?

This increase will also affect anyone who holds AMRFs, or ringfenced vested Personal Retirement Savings Accounts (PRSAs).  Those who receive the highest rate or second-highest rate of State pension will now have incomes above the guaranteed specified income requirement of €12,700.  

Table 2: Increase to State pension contributory on a pro rata basis for a single person with no dependants:

By meeting the specified income requirement, AMRFs and ringfenced amounts held in vested PRSAs will automatically convert to Approved Retirement Funds (ARFs) and standard vested PRSAs. These funds will be subject to income taxes on deemed distributions of either 4% for those under the age of 71, 5% for those over 71, and 6% for anyone whose ARFs or vested PRSAs are valued at over €2m.

How will this affect me?

As with all income, everything boils down to that great certainty in life: tax.  Previously, the money within an AMRF or ringfenced portion of a vested PRSA was not subject to the deemed distribution regime with no income tax liability arising unless an actual distribution was drawn.  Once these AMRFs convert to ARFs, however, they will be subject to the deemed distribution regime and are subject to tax.

Let’s take the example of someone who is 66, receiving the full State pension with AMRF and ARF funds of less than €2M and with €63,500 in an AMRF. This individual now meets the specified income requirement through the State pension increase, but they do not wish to make a withdrawal from their AMRF. So, they must pay tax on a deemed distribution of 4% on these funds once they convert their AMRF to an ARF (or the ring-fenced portion of their vested PRSA is no longer ring fenced). This distribution will be €2,540 per annum (4% of €63,500).  Assuming their marginal rate of tax is 40% and the applicable rate of Universal Social Charge (USC) is 4.5%, then distribution will result in tax payable of €1,130 in the €63,500 held in the AMRF or ringfenced portion of the vested PRSA.  While this allows the individual to receive a distribution from the AMRF, the tax on the distribution exceeds the increase in the state pension. See Table 3 below:

Table 3: Example of additional tax payable on AMRF

Of course, this is only an issue for those who do not want to take a distribution from their AMRF and have the extra tax liability.  The current rule of being able to drawdown 4% from your AMRF per annum still remains in place for those who do not meet the specified income requirement. 

Is it the end of the line for AMRFs?

It certainly looks that way. Increasing the State pension age means that people can work longer and pay more PRSI, while receiving credits for periods of time when they are not working means that more people will qualify for the higher rates of State pension. 

This, coupled with the government’s commitment to benchmark the State pension at 34% of average earnings, means more people will meet the specified income requirement of €12,700 via the State pension, meaning less people will require AMRFs or ringfenced PRSAs in the future.

Against that, the new TCA means that individuals must have 40 years’ worth of full PRSI contributions to qualify for the State pension. Given the modern mobile workforce, with people increasingly living and working in other countries during their careers, reaching this number of PRSI contributions may prove difficult.  

Ultimately, we may not see the end of AMRFs or ringfenced vested PRSAs until the government decides to remove the specified income requirement. Given the potential tax revenue this move could generate, it’s a distinct possibility.