Tax relief on pension contributions mainly benefits high-income households

New ESRI analysis finds that high-income households gain the most from tax relief on pension contributions in Ireland, compared with a regime in which pension contributions are fully taxable. Under Ireland’s current system, most pension contributions by employers and employees are exempt from income tax at the individual’s marginal rate of tax. The new study examines changes to the current tax treatment of pensions in Ireland in order to quantify the cost and distributional impact of widely discussed potential reforms.

Potential reforms include equalising the value of tax relief for low and high earners. This could be done by restricting tax relief to be at the standard rate of tax (standardisation) or at some other single rate of tax (relief at a hybrid rate). This report examines the implications of each of these approaches, taking into account employee and employer contributions in the private sector and employee and implicit government contributions in the public sector.

The research finds that moving to a system of a standard rate tax relief (20 per cent) or a hybrid rate relief (30 per cent) could save the State up to one billion euro, which equates to half of the current cost of tax relief. High-income households would lose some of their gains from tax relief on pension contributions while low-income households would not. However, if individuals chose to reduce their contributions due to such a reform, this would have implications for individuals’ retirement income.

“A key challenge for any reform to the pension regime is to provide incentives to save for retirement for low income earners”, commented Dr Karina Doorley.