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Estonia: Proposed amendments to make individual retirement accounts voluntary from 2021

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November 26, 2019

For individuals choosing to suspend participation in retirement accounts, employer contributions would go toward funding social security pensions.

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The retirement benefit from social security is a defined benefit pension composed of a flat amount and service-related benefits. The pension is supplemented by compulsory individual defined contribution retirement accounts (for employees born after 1982) funded by an employee contribution of 2% of pay and the diversion of 4% of employer social security pension contributions; for older employees, the accounts were optional. First established in 2002, the individual accounts were intended to increase domestic savings and diversify individual retirement options. In that respect, the plans succeeded as over 738,000 individuals have accounts (roughly 55% of the population) and total assets were 4.4 billion euros at the end of June 2019 (according to Financial Supervision Authority [FSA] data); however, the plans have suffered from high fees and low investment returns with a –0.2% real annual average return after fees (3.0% in nominal terms) in the first 15 years of the plans’ existence according to the Organisation for Economic Co-operation and Development. The median account balance is around €4,500 (according to Financial Supervision Authority [FSA] data).

In response to these issues, the government is proposing to end the mandate, making the accounts entirely voluntary, and using the additional funds to increase social security pensions, assuming a large number of account holders suspend participation.

Key details

  • New employees joining the workforce for the first time would continue to be enrolled in an account by default, but they could choose to opt out; participation would no longer be mandatory. In a similar vein, individuals born before 1983 would have the option to participate voluntarily, subject to a minimum of 10 years of participation. (The option for voluntary participation by older workers ended in 2010.)
  • Existing participants would have the option to suspend participation (contributions) to the individual accounts but would be able to restart contributions at the same time during the year when account holders are permitted to switch investment funds. While participation is suspended, employer pension contributions (20%) would go entirely to the social security pension.
  • Members would have the option to withdraw their savings from suspended accounts by transferring the balance to other individual retirement products or taking the money as a lump sum withdrawal subject to personal income tax. There would be no option for partial withdrawals. Individuals withdrawing from their accounts would be ineligible to open new accounts for 10 years. Currently, funds are payable only at normal retirement age (age 63 and nine months) or, in the event of permanent disability, in the form of a lifetime annuity, scheduled withdrawals or lump sum settlement.

Employer implications

The level of social taxes would not change, so the immediate impact on employers would not be material. The primary issue is the risk of lower retirement benefits for individuals withdrawing their savings before retirement. For its part, the International Monetary Fund recommends that the government maintain the individual accounts as compulsory. There are otherwise few alternatives as there is no framework for group pensions or practice of employers offering retirement benefits (due in part to a fringe benefit tax levied on employer-provided benefits).

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Michael Brough

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