Mixed feeling on pensions

5^th March 2006

The Malta Independent on Sunday

The announcements made by government this week on pension reform left me with mixed feelings.

I felt good that at least after a lot of talk, studies, white papers and other forms of consultations decisions have been taken to reform the current pension system (generally referred to as a first column PAYG – pay as you go – system). This is the first real comprehensive reform of the pension system since 1979, a well overdue exercise, which attempts to make state pensions more affordable and less inadequate.

I felt bad because the chosen tempo for shifting to the new system is too slow and over-cautious, even slower than that included in the final recommendations of the Pensions Working Group which had suggested a rise to the maximum pension-able salary from the present Lm6750 to Lm9000 in 2007 whereas the government has extended this process to 2014 lest it would suffer any political unpopularity.

Those who go on pension in the meantime are facing the prospect of receiving a state pension which at its maximum is nowhere near sufficient to keep the standard of living achieved during their working career; at a time when it is too late for persons in this category to build sufficient savings to generate additional sources of income to top up the state pension.

I felt even worse as the decisions to introduce state sponsored or fiscally assisted supplementary pension funded schemes (generally referred to as second pillar for occupational funded pension schemes and third pillar for personal funded pension schemes) has again been postponed to the future.

The conclusion is therefore that whilst the announced changes to the pension system are good in so far as they go in making the present first pillar more sustainable and less inadequate, they certainly do not go far enough.

Let me explain what I would have expected to pass my test for a real comprehensive review of the pension system.

In think firstly we need to give attention to those over 55 that will not be affected by the proposed changes. Not being affected does not mean that their prospective pension will be rendered any more adequate. Many of these people are facing the prospect of inadequate state pension and unless they have already built supplementary savings they could even face poverty during retirement.

I would expect that this category be offered the option to continue working beyond 61 years without losing entitlement to their state pension at 61 provided they continue to pay social security contributions till age 65 or till they stop working whatever comes first. In addition I would expect this category to be given the facility to enter into annuity type of contract with licensed institutions to generate tax-free revenue streams by selling equity in their residence while continuing to live there if they so desire.

Then I think we have to be more categorical about the introduction of second pillar – occupational pension schemes. The prospect of introducing such schemes on a compulsory basis could act as a disincentive for attracting foreign investment. The government is right in arguing that present economic conditions are not conducive to the introduction of such schemes on a compulsory basis. I would add that economic conditions will probably never be right as such introduction will inevitably dent the competitiveness of our productive base and therefore I would prefer an outright statement that such second pillar will be on a permanent optional basis. In order to promote their take up on an optional basis, government could then offer fiscal incentives to employers who fund such schemes for which nationally sponsored and protected funding should be considered to give a choice of underlying investments but not such a wide choice (as in Sweden) as to make the selection process too complicated.

Rendering the second pillar permanently optional will also give the opportunity for government to render private sector employment more attractive and thus facilitate the process of slimming down the public sector. With heavy commitments to maintain our health system government should be extremely wary of adding to its own payroll expense particularly as unlike private employers, government will have no tax rebate to gain for contributing to such second pillar schemes.

Lastly I think that government must not delay much further the announcement of fiscal incentives for individuals who take on third pillar privately funded pension schemes. To be fair probably government is leaving this component for incorporation in tax system review that has been promised by next June. It should however not be allowed to drag on as it is clear that state pension, no matter how reformed, will on its own not be sufficient to offer adequate pensions down the line and those who are still in time must start thinking as of now to build alternative savings which can provide supplementary income during retirement.

The announcements of this week can only be considered as a necessary but too small a step in pension reform. Other steps must follow and soon.