News

From July 1 this year people will have a new opportunity to save for their old age – it will be the starting date of the mandatory funded pension or the so-called “second pillar” of the system.

The system has been designed as mandatory, which means that it will cover the whole population of Estonia in the future, but in the start-up phase most of the taxpayers can choose whether to subscribe to the new funded pension or not.

The first decision – to subscribe or not to subscribe?

What are the main benefits of subscription to the funded pension, depends on several circumstances, the most important ones of which are:

• The age at the moment of subscription determines the duration of making contributions to a pension fund. For example, a person subscribing at the age of 20 could, when retiring, receive state pension amounting to 21% of the average salary, but if such person chooses also the second pillar, his or her pension would already constitute 64% of the average salary. For those who start subscribe at the age of 50, the respective figures would be 32% and 37%.
• The salary, or to be more exact, the amount of taxes paid on the declared salary influences the results to a great extent. The attached table indicates the potential pension amounts of a person of 35 years of age for different salaries that are set out in the columns.
• Rate of return of funds directly affects the growth of the contributed amounts. For example, if the annual net rate of return increases by one percent (the total increase, from which inflation has been deducted) and the length of employment is 40 years, the final amount will increase by 20-30%. At the same time, it is very difficult to predict the rate of return of funds, In Estonia, calculations are made primarily on the presumption that the net rate of return will be 5%.

Ratio of pension to average salary if a person starts to make contributions at different ages

The figures in the table have been calculated for a person with the average salary. Under each age, the first column sets out the pension amount if the person relies only on the state pension, and the second column indicates the pension if the person chooses to subscribe to the funded pension.

Ratio of pension to average salary if contributions are made on different salaries

As indicated by the data in the tables, irrespective of the age or salary of a person, it is still more beneficial to subscribe to the funded pension. Certainly, the bigger the salary and the younger the age, the greater the benefit from subscription. Why? The rate of return of funds has an important role to play in this – the higher the rate of return, the higher the pension will be. But even if the rate of return of funds covered only inflation, it would be more beneficial to subscribe. The reason behind this lies in the formula of contributions, where the state adds 4% to the 2% contributed to a fund by a person himself or herself.

Persons over 50 years of age, whose income is lower than the average salary in Estonia, are probably the ones who should contemplate whether it is reasonable to subscribe to the funded pension. For them, it would be more beneficial to depend on the state pension.

The second decision – which fund to choose?

Having decided to subscribe to the funded pension, the next question is – which fund to choose? After registration, the pension funds of the second pillar will publish their fund rules, i.e. their differences in investment policy, etc. which will help to make the decision. Nobody should worry about the reliability of funds, as all applicants are carefully controlled before issue of an activity license, and the new merged Financial Supervisory Authority will exercise continuos supervision over them.

The third decision – how to subscribe?

Having chosen a fund, the next step is submission of a subscription application. In order to submit an application, one should (after 1st May of 2002):

• fill out the choice application form set out on the website www.pensionikeskus.ee under the heading “My Account”;
• go to any bank office and fill out the choice application there;
• fill out the choice application form through the Internet bank;
• fill out the choice application form provided by an agent of a fund.

If the application is submitted before 1 June this year, money will be received in the pension account from 1 July, and if the choice application is submitted before 1 November, money will be transferred to the pension account from 1 January 2003.

The fourth decision – how to collect money?

Nothing more has to be done for making contributions – the employer will withhold 2% of the salary and transfer it to the Tax Board together with the social tax. The Tax Board will allocate 6% of the total amount received and transfer to the registrar of the Estonian Central Register of Securities, which shall transfer the amounts received to the pension funds.

During the funding period, one may start making contributions to a new fund by directing the contributions to the new fund on the basis of an application to the Estonian Central Register of Securities. In such case all the units acquired so far can be left in the previous fund(s). Likewise, all the units of fund X can be replaced for the units of fund Y. These procedures are subject to certain restrictions as to the timing and quantity.

The units of a pension fund are heritable. Upon the death of a person, his or her successor will be able to demand redemption of the inherited units in a certain period of time or add them to his or her own pension account.

Although the funded pension system may seem a bit complicated at first, it is actually simple and flexible, it involves several choices and last but not least – it will help you enjoy your retirement.

Kadi Oorn
Chief Specialist of the Financial Services Department
Ministry of Finance