"Pension systems in the Baltic States are often considered to be very similar, but similar systems do not always bring similar results. There are quite a lot of substantial differences - from the amounts of pension contributions and different tax policies to the overall mood of the population, and people’s willingness to plan savings for old age," comments Ilja Arefjevs, Management Board Member at Nordea Pensions Latvia.
With 2% state mandatory contributions to the 2nd pillar pensions it is unlikely possible to save up for a prosperous old age!
The first fundamental difference in the pension systems is that a total of 20% of gross wages and salaries are allocated to the Estonian and Latvian 1st and 2nd pillar pensions, while in Lithuania this figure amounts to a total of 26.3%. However, the highest average retirement pension in Estonia is around EUR 390 per month, whereas, in Latvia – EUR 295 and in Lithuania – EUR 265 per month.
It is important to note that in Estonia, 2nd pillar pension contributions amount to 6%, of which 2% is paid by customers themselves out of their gross salary/wage. In Latvia, the total amount of pension contributions is the same - 6%, which is fully funded from social insurance contributions. In Lithuania, however, contributions are set by the so-called "2% + 2% + 2%" formula. This namely involves a minimum contribution of 2% to be made when a person chooses not to pay an extra 2% out of his/her gross salary/wage. However, if the customer chooses to allocate 2% of his/her gross salary/wage in addition to the state-provided 2%, the state pays an additional 2%, bringing the total amount to 6%.
Admittedly, in Lithuania many people choose not to pay extra money, thus receiving a 2nd pillar pension of only 2%. For that reason, the existing Lithuanian 2nd pillar pension component is often criticised because the 2% contribution to the pension fund is unlikely to accumulate sufficient capital for retirement.
Tax policies significantly affect the amount of future pensions
Tax policies implemented in the Baltic countries also vary. Personal income tax in Estonia is 20%, while in Latvia - 23%. However, in Lithuania 1st and 2nd pillar pension capital is not subject to personal income tax. In addition, while in Latvia the non-taxable pension income is EUR 235 per month, in Estonia it is EUR 395, which even slightly overreaches the average pension.
Also, capital received from the 3rd pillar pension is taxed differently. For example, in Estonia, if a customer wants to withdraw his/her savings after having reached the age of 55 (and their contract has been in force for at least 5 years), all the accumulated capital is taxed at a rate of 10%. In Latvia, under similar conditions (with contracts having been in force for 2 financial years instead of 5), a rate of 10% is levied on profits, but private pension contributions are not taxed. Employer contributions, which in Latvia are not very popular (not more than 25% of all contributions), are subject to the full income tax rate - 23%. On the other hand, in Lithuania, provided that the relevant conditions are met, capital paid out of 3rd pillar pensions is not subject to personal income tax. It should be noted that in Lithuania, the personal income tax rate is only 15%.
It should also be noted that there are tax reliefs in relation to contributions to 3rd pillar pensions and life insurance: in Estonia it is possible to recover 20% of personal income tax levied on up to 15% of gross salary/wage, while in Latvia those are 10% of contributions to the 3rd pillar pensions and additional 10% of contributions to life insurance with accumulation of funds, which together account for 20% at the personal income tax rate of 23%. Lithuania offers the biggest tax reliefs, if we calculate against salary/wage - 25%. However, the personal income tax rate in Lithuania is the lowest among the Baltic countries - only 15%, which reduces this advantage in monetary terms. In addition, from 2017, a “ceiling” or contribution threshold of 2,000 euros is to be set for tax reliefs.
To sum up - the fact that Estonians receive the highest pensions is not down to the pension system, but rather it is the result of the country's economic development and tax policy. Namely, higher salaries and wages provide higher contributions to 1st pillar pensions. Moreover, the far more substantial amount of non-taxable income (EUR 395 a month, compared with EUR 235 in Latvia) and the lower personal income tax (20% compared to 23% in Latvia) inevitably contributes to the total pension amount in Estonia being higher than in Latvia. It should be noted that pension funding costs in Estonia and Latvia are the same - 20% of the gross salary or wage. It is also important to note that Lithuanian pensions are lower than in Latvia, while pension funding is more expensive (26.3% of gross salary or wage) and there is obvious room for improvement. In fairness, it should be noted that in Lithuania, 1st and 2nd pillar pension capital, when paid out, is not subject to personal income tax, which in turn means that the amount of future pensions in Lithuania can grow faster than in Latvia.
With regard to private pension funds or the so-called 3rd pillar pension, the situation in the Baltic countries is similar; perhaps even a little more favorable to Latvians in terms of tax reliefs. 3rd pillar pension capital withdrawals are most intensively taxed in Estonia, but in Lithuania, under certain conditions, personal income tax is not applied at all. This is certainly not a desirable situation, as withdrawals from 3rd pillar pensions constitute private income; withdrawals above a certain amount should be subject to tax in order to prevent unfair treatment of other taxpayers who derive income from other, similar sources, for example, income from other capital types.