Estonia Parliament Plans to Amend Taxation of Pension Funds
Mon, April 19, 2021

Estonia Parliament Plans to Amend Taxation of Pension Funds

The Estonia Parliament Riigikogu has already accepted for consideration a bill that will amend the current taxation of pension funds in their country, including the 10% tax pension fund transfer and tax-free pension fund withdrawals / Photo by: Ypsilon from Finland via Wikimedia Commons

 

The Estonia Parliament Riigikogu has already accepted for consideration a bill that will amend the current taxation of pension funds in their country, including the 10% tax pension fund transfer and tax-free pension fund withdrawals. This is based on a report by Bloomberg Tax.

The Pension System in Estonia

The pension system in Estonia consists of three pillars: the first pillar (state pension), the second pillar (mandatory funded pension), and the third pillar (supplementary funded pension). The state pension is based on redistribution, which means that the current workers are covering the pensions of future pensioners through their social tax payments. The second pillar is dependent upon the person’s income. Joining the second pillar requires that 2% of the person’s gross wages will be transferred to their personal pension account every month. The third pillar enables everyone to make supplementary contributions to their retirement years, explains Estonian bank SEB Pank.

Riigikogu is considering a bill to amend the taxation of the pension fund. The bill proposes to (1) allow a tax-free pension fund withdrawals under the second pillar, (2) impose a 10% tax for pension fund transfers, (3) expand the tax-advantaged investment options for people in the second pillar, (4) amend the conditions set for employers in claiming the 13% tax rate for social contribution, and (5) enable the Minister of Finance to index the tax-exempt minimum yearly, which will be applicable for the third pillar pension system.

The pension system in Estonia consists of three pillars: the first pillar (state pension), the second pillar (mandatory funded pension), and the third pillar (supplementary funded pension) / Photo by: wir_sind_klein via Pixabay

 

Pension Sector and Its Role in the Economic Growth

In a 2018 study published in the journal Springer link, authors Michiel Bijlsma from Tilburg University (Netherlands) and their team said that pension saving may fuel economic growth in a direct way by providing more funds for investment. By studying the dataset of 69 manufacturing industries in OECD countries for the period of 2001 to 2010, the authors found that pension savings bring a positive effect on various sectors in the economy that rely on external finance in relation to industries that have less external finance.

Both life annuities and life insurance are also important parts of the activities of the pension companies. The reason why the pension sector is an important element of the economy is that its transactions have major implications for the citizen in terms of the pension saving schemes used among the self-employed and wage earners and the volume of assets that are managed by the sector itself. This was previously explained in a conference by Nils Bernstein, Chairman of the Board of Governors of the National Bank of Denmark.

In a 2018 study published in the journal Springer link, authors Michiel Bijlsma from Tilburg University (Netherlands) and their team said that pension saving may fuel economic growth in a direct way by providing more funds for investment / Photo by: Guillaume Speurt via Wikimedia Commons

 

Plan to Reform Estonia’s Second-Pillar Pension System

Last August, the Estonian coalition party or the center-right Estonian government agreed on the pension reform bill that would enable people to opt-out of the mandatory second-pillar pension system. 

Currently, employees are paying 33% social tax and 20% of which goes to pensions, such as the state pensions. In the second pillar, the individual pays a 2% tax for their personal pension account. If the second pillar will be optional, Conservative-nationalist political party Isamma believes that it would improve the competitiveness because the second pillar has the tendency to underperform if they base on returns.

The International Monetary Fund, however, expressed its concern about the said reform because it may increase the burden on future generations. It may lead them to cash out more of their savings. The IMF has recommended the coalition to assess their country’s current pensions system in-depth before they embark on the reform. The IMF also said that although cashing out the savings may boost fiscal revenue, current consumption, and economic growth, it will only be for the short term. The long term result would be a reduction in future pension entitlements.

Pension Funds of Estonia From 2002 to 2018

The Organisation for Economic Co-operation and Development, an intergovernmental economic organization founded to stimulate economic progress and world trade, shared the pension funds of Estonia measured in millions of US dollars: 2008 (1,023), 2009 (1,372), 2010 (1,431), 2011 (1,467), 2011 (1,467), 2012 (1,953), 2013 (2,443), 2014 (2,676), 2014 (2,676), 2015 (2,844), 2016 (3,264), 2017 (4,365), 2018 (4,511).

OECD economies with the highest funded pension in 2018 include the United States (16,178,148), United Kingdom (2,809,112), Australia (1,883,127), Netherlands (1,536,269), and Canada (1,372,822). All units indicated are measured in millions of US dollars.

Recently, the Bank of Estonia also recommended that the country not make the second pillar of the pension system voluntary because it may bring pressure to increase taxes in the future with it and result in lower old-age pensions. Bank of Estonia’s Governor Madis Müller mentioned to the Ministry of Finance that the more the planned pension changes reduce the pension savings accumulation into the pension pillar, the greater the pressure it will bring to increase taxes and also increase the pension paid from the first pillar. 

A relatively generous provision of income for the elderly is an achievement for modern economies. However, pension budgets can also be challenged by financial developments, the governments reforming the system, and the demographic. It remains a question in the case of Estonia whether the number of people to opt-out for the second pillar will be able to cover the full cost of their pension hikes.