Auto-enrolment could deliver pension pots of up to €890,000 for young workers

This was originally published in the Irish Times on Wednesday 10th April by Dominic Coyle.

EY numbers suggest workers could retire with strong savings for retirement under new compulsory pension scheme.

Compulsory workplace pensions could deliver a pot of close to €890,000 for a 23-year-old worker on the average industrial wage being signed up for the scheme when it comes into force, according to Big Four accountants EY.

Numbers crunched by EY tax partner Michael Rooney show that the auto-enrolment scheme pension, which the Government intends to put in place early next year, could deliver a guaranteed annual payment of around €36,000 a year at today’s annuity rates for a single person even after they had taken a lump sum of €200,000 from the scheme tax free in line with current pension practice in Ireland. Allowing for a spouse would reduce that to around €33,500 and, if allowing for annual increases of 3 per cent in retirement, to more than €22,000 at the age of 66.

The pension would be payable in addition to the State pension, assuming that is still in operation at that time. It is currently paid at €14,420 annually before any Christmas bonuses, living alone payments or household benefits package.

The Government intends to automatically enrol everyone earning over €20,000 who is between the ages of 23 and 60 into a workplace pension scheme from next year, if they are not already members of an occupational pension scheme.

Initially, the employer and employee will pay 1.5 per cent of the worker’s gross income into the scheme, with the Government adding an amount equal to a third of the employee’s contribution – 0.5 per cent.

This will rise to 3 per cent for worker and employer (1 per cent for the State) after three years, 4.5 per cent and 1.5 per cent after seven years and to 6 per cent for each of the worker and the company from year 10, with the State paying 2 per cent from then on.

EY crunched the numbers of the basis of someone being signed up next year at the age of 23 and earning the average industrial wage of €47,200 at that time. It assumes wages will rise by 2 per cent annually and that the pension fund will secure an annual return of 4.5 per cent.

In reality, wages and investment returns will not be smooth across the lifetime of the pension fund, and in any case, contributions are likely to be invested in higher-risk assets in the early years in search of stronger returns, while returns will be lower as people approach retirement and the risk of their investments is reduced.

Inflation will also eat into the value of that fund 43 years down the line when this notional worker retires so that the €888,576 fund will not be worth the same as it is in today’s money and nor will the annuity that it can be used to buy.

Auto-enrolled workers will not be obliged to invest in annuities on retirement. They will also likely be able to keep the money invested in an approved retirement fund-type product and draw it down as they need. Annuities may not be as good value as some other options, but they are risk free to the pensioner.

Many of the workers being auto-enrolled will not, of course, be just starting work and some of those younger workers will not yet be on the average industrial wage. Mr Rooney said that, adjusting the figures to show a 23-year-old worker signing up when they earn €30,000 could have a pension pot of around €590,000 by the age of 66.

Someone who will be 38 when the scheme comes in and earning the average industrial wage could accumulate pension savings of €344,000-plus by 66 on the same investment and wage growth basis as the other examples.

“The calculations are a clear indicator of what the scheme will mean for employees up and down the country,” Mr Rooney said.

“Recent figures show one in three private sector workers do not contribute to a private pension. I think this is going to be very popular with a huge percentage of the population.”