2.1 Introduction to Occupational Pension Schemes
Pension provision in Ireland has evolved since the introduction of the old age pension over 100 years ago. It comprises of two main Pillars. The First Pillar is the Social Welfare system which provides a minimum income in retirement for all, and the Second Pillar consists of voluntary supplementary pensions. (Hutch, 2001:263) For the purposes of this study, focus will be on the latter Pillar. The Second Pillar comprises of three main types of pension arrangement:
Public service pension schemes run on a pay-as-you-go basis;
Funded occupational schemes set up by employers to provide benefits for their employees.
Personal pensions arranged by individuals, generally aimed at the self-employed.
All of these above arrangements are voluntary in the sense that there is no legal obligation for an employer to establish or maintain a scheme, or for individuals to provide for their retirement. (Hutch, 2001:264)
Occupational pension schemes is the name given to employer sponsored schemes for employees, which are approved by the Revenue Commissioners under various Finance and Income Tax Acts. The Pensions Act, 1990 recognises two distinct types of scheme, Defined Benefit and Defined Contribution. (Kenny, 2004:1)
2.2 Entry Requirements of Occupational Pension Schemes
Occupational pension schemes must be set up as trusts in order to qualify for tax relief. Schemes must be first approved by the Revenue Commissioners or comply with restrictions imposed by legislation. Therefore each scheme must be first approved by the Revenue Commissioners who will supply a Revenue reference number for the scheme, before it can start. In order to gain approval by the Revenue, the scheme must comply with restrictions on:
The level and type of benefits the scheme can provide.
Who can be admitted to the scheme?
When and how the benefits can be taken. (Hutch, 2004:251)
2.3 Defined Benefit Schemes
2.3.1 Outline of Defined Benefit Schemes
Defined Benefit Schemes (also known as final salary plan) are pension schemes where the risk for the individual is minimised and pension benefits are less strictly related to contributions paid. In most defined benefit schemes, pension benefits guarantee a certain percentage of reference earnings rather than taking contributions paid as the base for pension benefits. The risks associated with the investment of the contributions paid are now borne by the pension plan funder instead of the retiree. The majority of first pillar pensions in Europe consist of the defined benefit scheme. (Schils, 2005: 82)
A significant number of Defined Benefit plans make an allowance for the State Pension when providing a pension. Typically this is achieved by using an offset from salary in respect of the State Pension. Many plans that aim to provide 2/3rds of a member's basic salary after 40 years' pensionable service calculate the pension entitlement on the member's basic salary less 11/2 times the State Pension. (The Pensions Board, 2008: 9)
For the individual, the advantages of defined benefit schemes are commonly understood as increased predictability of benefits and insurance from investment risk, which lies in the first instance with the employer offering the benefits. However, defined benefit schemes often suffer from a lack of portability between jobs; as such schemes are frequently designed to improve workforce retention. In addition, workers face the risk of premature employment termination which can significantly reduce the value of benefits based on final salary values. (Glennerster, 2003:152)
2.3.2 Main Features of a Defined Benefit Scheme
Contribution rates of Defined Benefit schemes can vary, depending on the outcomes of the regular actuarial reviews. Members of these schemes may be able to predict the benefits they will receive as a proportion of their earnings just before retirement.
The higher the investment return achieved by the scheme, the lower the contribution rate will be. However, if investment returns are poor, contribution rates have to be increased to provide for the agreed benefits.
The cost of buying a pension at retirement affects the contribution rate. Defined Benefit schemes are considered to be best suited to those who stay until retirement, particularly those who experience above average salary growth.
Those who decide to leave their employment before retirement can expect to receive much lower benefits with this scheme. (Department of Social and Family Affairs, 2007:132)
2.4 Defined Contribution Schemes
2.4.1 Outline of Defined Contribution Schemes
A Defined Contribution Scheme is also referred to as a Money Purchase scheme as the money accumulated at retirement from contributions and investment returns is applied in purchasing the pension. The final pension is dependent on the interest rate and on the capital market return. The risks associated with this are borne by the employee. (Schils, 2005: 82)
Defined contribution schemes are deemed generally more portable than defined benefit.
Some companies now operate hybrid schemes with both defined benefit and contribution elements.
2.4.2 Main features of a Defined Contribution Scheme
One of the advantages for employers with Defined Contribution schemes are that contribution rates are fixed in advance therefore employers know what they have committed to.
However, members of the scheme will not normally know until very close to retirement what their benefits will be.
The higher the investment return achieved by the scheme before retirement, the better the pension benefits will be. On the other hand, if investment returns are poor, especially in the years just before retirement, retirement benefits will be lower than expected.
In a Defined Contribution scheme, the member builds up a fund by retirement age which is used to buy a retirement pension. The cost of the pension is unknown in advance, and it is to the member's advantage if the cost is low, but detrimental if pension cost at retirement is high.
If a member's earnings increase rapidly throughout their working life, and especially towards the end, their Defined Contribution benefits may be low relative to their earnings just before retirement; and contributions are usually allocated uniformly across all members as a percentage of pensionable earnings. Thereby allowing no discrimination between those who stay until retirement and those who leave early. (Department of Social and Family Affairs, 2007:133)
2.5 Public Service Pensions
Irish public service pension schemes generally have their origins in the early part of the 19th Century, which predates the formation of the Irish State. The formative legislation, the UK Superannuation Acts of 1834 to 1919, still provide the basis or foundations and inform much of the terms of Irish public service pension schemes. These foundations have of course been built on by legislative developments during the 20th Century and indeed most notably in the last few years. However, the structure of Irish public service schemes still rests solidly on the foundations of the 19th Century. There is no overall single pension scheme covering the entire public service. There are in fact many schemes. Each area of the public service, the civil service, local authorities, the health service, judiciary and security services, and indeed individual organisations tend to have their own schemes. As a general rule, public service pension schemes are enabled under specific legislation.
As a result of the Public Service Superannuation Act 2004, the minimum age at which pension benefits are payable to most public servants appointed from 1 April 2004 is 65 years and, for most such staff, there is no compulsory retirement age. For most staff appointed before 1 April 2004, pension benefits are generally payable from age 60, and a compulsory retirement age of 65 applies. In a few areas, where the nature of the work places special demands e.g. Gardaí, Permanent Defence Forces and firefighters, arrangements for pension payment and retirement at an earlier age are in place. (Department of Social and Family Affairs, 2007:200)
2.5.1 Funding of Public Service Pensions
Most public sector schemes, with the exception of some Commercial State Bodies, are funded on a "pay as you go" basis. Recognising the increasing costs of social security benefits and public service pensions, the Government decided in 1999 to establish a National Pensions Reserve Fund. Specific legislation provides that at least 1% of GDP must be transferred to the Fund on an annual basis and that the proceeds of the Fund can be used from 2025 onwards, but not before then, to assist in meeting ongoing costs of social security and public service pension costs which are not otherwise met from Exchequer funds.
There are a number of schemes in the Commercial State sector which are "funded Schemes", where the company and the employees contribute on an ongoing basis to ensure that the fund is sufficient to meet the pension needs. (O'Leary, 2006)
2.6 Regulation of Pensions -The Pensions Board
Irish pension regulation is underpinned by the Pensions Act 1990. The supervisory framework, which specifies the legislative requirements to guarantee the key objectives of security, portability and accountability for occupational pension schemes, was established in Ireland under the Pensions Act, 1990. A statutory body, the Pensions Board was established which comprises representatives of the social partners, the pensions industry, trustees, pensioners, consumers and Government. (Hutch, 2004: 248)
The functions of the Board are according to the Irish Statute Book are:
To monitor and supervise the operation of this Act and pensions developments generally;
To advise the Minister either at his request or on its own initiative on all matters relating to the functions assigned to the Board under this Act and on matters relating to pensions generally;
To issue guidelines on the duties and responsibilities of trustees of schemes and codes of practice on specific aspects of their responsibilities;
To encourage the provision of appropriate training facilities for trustees of schemes;
To advise the Minister on standards for trustees of schemes and on their implementation;
To publish an annual report and such other reports as it may from time to time consider necessary;
To perform such tasks as the Minister may from time to time request.
Occupational pension schemes must register with the Board and most schemes must pay an annual fee to meet the Board's administrative costs. The Board can act on behalf of pension scheme members who are concerned about their scheme: it can investigate the operation of pension schemes; it has the power to prosecute for breaches of the Pensions Act and to take court action against trustees for the protection of members and their rights. (Hutch, 2004:250)