With the start of 2024, people will have the opportunity to apply to raise funds for their personal retirement account, instead of the current regime of 2% (of gross salary) + 4% (from state social tax), also It is based on the 4+4 or 6+4 scheme. The increased pension payments will start from the year following the submission of the application, i.e. from 2025. Who and why should increase the payments of the second pillar?
First some background. The second pillar cumulative pension system was created in 2002 with the aim of getting people to save together with the state for retirement age, so that the transition to pensioner’s income at the end of working life is not so painful. 2% of the gross salary was transferred to a personal pension account, and the state transferred 4% of the salary’s social tax money there. A very right step in itself. Especially when you consider Estonia’s demographic trends, small state pensions and high poverty rate among pensioners. The only negative is that the additional 2% of the salary accumulated over 40-45 years of work cannot have a significant effect on improving the quality of life over the 20-year period of using the pension. This 2% is simply too small a figure. And it actually became clear relatively quickly.
In addition to 2+4, now also 4+4 and 6+4
In 2014 I wrote in the article “How to do well in retirement?” that the 2%+4% system is not enough for Estonia. In the 2015 article “Moody’s warns: Baltic population is aging and pension system is vulnerable”, I repeated the same message together with the rating agency Moody’s. In 2016, I directly said that “too little is saved for pensions” and that the 3%+6% pension payment system, in force temporarily in 2014-2017, should be transformed into a permanent solution. Unfortunately, the State did not have the financial means to increase its contributions, nor did it consider it necessary to increase the savings rate of the people themselves, since in the 3rd pillar you can still save voluntarily. You can. But in this case the reporting is important: not everyone knows how to think about their future finances in such detail, and giving everyone a simple choice when it comes to the size of their pension improves the ability of many Estonians to cope with old age. Even today, almost 450 thousand people pay contributions into the II pillar, just over 100 thousand into the III pillar.
In the following years I had dozens of meetings with various ministers, parliamentarians, officials, interest groups, researchers and parties in the pension system. More and more people realize the need to change the situation. In December 2022, the sustainability analysis of the Estonian pension system prepared every 5 years by the Ministry of Social Affairs and Finance also highlighted in its 140-page document the need for rapid implementation of positive changes.
On page 14 of the same analysis cited there is the sentence: “Broad communication is needed: the current I and II pillars only guarantee the necessary sustenance in retirement, for better financial well-being a person must save more on his own or with the help of his employer”, sentence from page 22 in turn “Compared to European Union countries, Estonia has the greatest difficulties in ensuring the pension replacement rate and, as a result, the relative poverty rate of elderly Estonians is the highest in the EU” and a simple summary from page 140: “It is important that people understand what the state offers them in old age and what the person’s responsibility is.”
Think for a moment: if today the state does not have enough money to pay teachers’ salaries, then you cannot hope that sooner or later, when you retire, the tiny pensions will become larger as if by magic.
What pension do you want?
Those who have so far withdrawn money from the 2nd pillar should bear in mind that their income will only amount to around 30% of their current salary, because both the 2% paid by themselves and the 4% paid by the state have been withdrawn, and therefore their pension will also be lower than those who have never joined the second pillar. Those who have paid 2%+4% contributions to the 2nd pillar during their lifetime can expect a pension of around 40%. By starting to pay 6% of your salary every month instead of 2%, your future pension will already rise to the range of around 45%-50%, depending on the number of years left to accumulate.
To exceed the 50% limit it is necessary to pay an additional contribution to the 3rd pillar or convince the employer to also contribute to the pension fund. Indeed, “Estonia should not put up with poor pensioners,” as I wrote in the spring of 2023 in Äripää. This year, according to the coalition agreement, the Estonian government is also analyzing the possibility of introducing an occupational pension. If sooner or later employers’ contributions were linked to the amount of employee contributions and the so-called 6+4+6 savings pension system was created, with this step the incomes of our future elderly people would really move to the standard Western world , i.e. 60%-70% of the last salary.
To increase the contributions of the 2nd pillar it is necessary to submit the application between 01.01.2024 and 30.11.2024. The application takes effect from the following calendar year, i.e. January 2025, and is valid until you submit a new application to change the payment rate. You can submit inquiries for free in your fund management company’s online environment – you can do so here on LHV. Since the largest Pillar 2 contributions come from today’s gross salary, this immediately means a 22% income tax benefit for you, making it one of the best long-term financial decisions anyone can make for themselves. I have already submitted my request to increase the payment installment from 2% to 6% at the beginning of January, you too.
Joel Kukemelk
Member of the board of directors of LHV Varahaldus
LHV pension funds are managed by AS LHV Varahaldus. Fund share values may rise or fall, and the performance of funds in prior periods is not a promise or indication of performance in subsequent periods. The preservation of the value of the invested amount of the fund is not guaranteed. View the LHV pension fund prospectus and basic information documents at lhv.ee and consult an expert.
2024-01-02 15:13:34
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