Pension, an overview of the Dutch pension system.
Pension, an overview of the Dutch pension system.
The famous Dutch tax system is undergoing major reconstruction. This is because, among other things, the pension funds took a hit due to the financial crisis. The pension funds have insufficient buffers, and we are all living longer nowadays. The ceiling for the pension age is raised and pensions are not corrected in regards to inflation.
Through the AOW (general old age law) you are ensured a social minimum substance from the moment you retire. For additions to the AOW you, yourself, are responsible. Usually together with your employer.
The government believes that the Dutch should be more pension conscious. Therefore, articles concerning the transparency of the pension are added to the Pensioenwet (Pension Act). Among other things, it has been determined that new participants to a pension scheme have to be informed about the content of the scheme in clear and understandable words. All participants will also receive an annual overview of the pension agreements.
Pension funds and –insurers have an obligation to provide information. You, of course, should act upon this information on your own initiative.
To make it all even more transparent, the Stichting Pensioensregister (foundation of Pension Register) created the website www.mijnpensioenoverzicht.nl. Unfortunately, this website is only in Dutch. On this website, beside your AOW, you can see how much pension you have built up and with which pension funds or insurers you have done so. You can also see what your next of kin will receive in the case of your death.
To better understand your pension, it is important to know what the ceiling of your pension will be, but also what the investment risks such as market interest and longevity are and with whom and at what moment these risks come into play. Are these your risks or the risks of the pension provider?
What exactly is a pension?
A pension is really no more than a periodical benefit. You will receive this, usually, monthly benefit under certain circumstances. For example, if you reach a certain age and stop working (partly). In this case you will receive a retirement pension. However, there are other kinds of pensions. Your partner or child may be entitled to a dependant or orphan’s pension in the case of your death. Or you may be entitled to a disability pension if you are sick or cannot work for a long period of time. For as long as you work, you contribute to these pensions. You can also see your pension as a delayed wage. Generally, you can say that a pension is a provision in the form of a periodical benefit that ensures an income from the moment you are no longer capable of earning this income yourself because of your death, a disability or retirement. These provisions are the basis of the Dutch pension system.
This pension system is also designated as the three pillar system. Every pillar has its own responsible entity: In the first pillar the government provides the protection of the social minimum, in the second the employees and employers the protection on the level of welfare. And in the third pillar you, yourself ensure necessary or desired additions. In addition to the three pillar system there is a fourth pillar; continue working and therefore keep your expenses low.
The first pillar: government benefit of the social minimum
This consists of the following benefits: AOW benefit, ANW (general Widows and Orphans Act) benefit and (half) orphan benefit.
General Old Age Pension Act (AOW)
Anyone who lives or works in The Netherlands, builds on their AOW-benefit. You pay the premium for this out of your income in box 1 which then is processed in the rate for tax bands. You are entitled to the full AOW if you have been insured 50 years prior to the AOW benefit age. For every year that you were not insured (because, for example you had lived abroad) your benefit is reduced by 2%.
The level of your AOW-benefit is linked to the minimum wage and whether or not you are living together with a partner. It is also taken in consideration if your partner is insured by the AOW, whether or not you are living together with your child and the total household income.
The base income is 50% of the net minimum wage. Someone who lives alone or is taking care of a child is entitled to a higher benefit (respectively 70% and 90% of the net minimum wage).
If you are living with someone who is also insured by the AOW then you receive twice the base income. If your partner is not insured by the AOW then you receive the base income once.
The raising of the AOW-age ceiling
The government wants to link the pension age to the life expectancy. The AOW age is completely dependent of the life expectancy from 2024 and the AOW age is unknown in this. Until 2023 the AOW age is raised to 67 years step by step.
2.General Widows and Orphans Act (ANW)
The ANW provides your partner and/or children with a (temporary) benefit if they cannot provide for themselves. The benefits vary from 20% to 70% of the minimum wage. However, not all next of kin are entitled to the ANW-benefit.
Your partner, for example, is only entitled to an ANW-benefit if he/she is providing for an unmarried child, younger than 18 years, or he/she is unable to work for at least 45%, or was born before 1950.
When determining the amount of your ANW-benefit your partners income is taken into account as well. If your partner has an income from employment or entrepreneurship a reduction on your benefit may take place, this reduction can amount to 100%.
3. (Half) orphan’s benefit
If your children are younger than 18 years, your partner will receive, at the least, a half orphan’s benefit. This benefit is independent of the income of your partner and the number of children. In the case of the of your partner’s death, your children will each receive an orphan’s benefit until, at the latest, they become 21 years old. The amount of the benefit depends on the age of your child.
The second pillar: pensions through your employer/company
When the media speaks of pension, they are usually talking about pension in the second pillar. The pensions that are defined during employment in the work relation between employer and employee fall under the second pillar; the employee pension. This forms an addition to the pensions that are granted through the government (first pillar). In virtually all pension arrangements the government pension is taken into consideration. This happens by means of an AOW-franchise.
In The Netherlands there is no pension obligation. When no agreements are made in the collective agreement or no obligated participation in a sectorial pension fund applies, it is up to the employer whether or not to come to an agreement with his/her employees regarding a pension arrangement. If they come to an arrangement, the fiscal regulation of the Law on payroll taxes applies. The Pension Act also applies in this case. The purpose of the Pension is to guarantee and secure the pension entitlements of employees.
Among others, this law guarantees that the pension provisions are to be secured in an entrepreneurial pension fund (e.g. Shell and Phillips), a sectorial pension fund (e.g. ABP and PGGM) or a life insurance. Therefore, pension funds need to be set outside of the relevant entrepreneurial risks. Pension funds can also be included in a professional pension fund (like notaries, doctors are pharmacists).
The different kind of pensions for employees
One of the priorities of the Pension Act is to make clear and transparent what pension is agreed upon. Every pension agreement will have to be named as one of the following pension forms: The benefit agreement, the capital agreement or the premium agreement. A combination of these pension forms is also possible.
1. The benefit agreement
The benefit agreement guarantees a periodical pension benefit in euro’s. The payment amount of the benefit is guaranteed upon agreement and can be indexed. The investment risk, like market interest and the risk that people live longer than expected lies entirely with the pension fund. Known forms of the benefit agreement are the final pay scheme and the career-average scheme.
Final pay scheme
A final pay scheme is a pension agreement where the pension benefit is based on a yearly build-up percentage and on the last earned wage. This way you build up a pension over 40 years of employments that consist of 70% of your final wage plus your AOW pension. The surviving dependant’s pension is a maximum of 70% of the maximum achieved retirement pension. Every pay rise leads to an increase of the past pension agreements. This can lead to large pension costs for employers. For that reason, pay rises that are included in the pension agreement are often limited.
Career- average scheme
An average pay scheme is a pension agreement of which the level of the agreed upon pension is based on a build-up percentage of the salary in that year. A later salary increase, therefore, has no effect on the level of the already defined pensions. The total pension is 70% of the average of your salary after 40 years of employment plus your old age pension. Sometimes the choice is made to index the existing pension agreements with, for example, a price- or salary index. This is because with a pension based on the average pay scheme, salary increases are not accounted for.
2. Capital agreement
With the capital agreement it is agreed upon that a previously determined capital- due on the pension date- should be utilised for the pension. The key point of the capital agreement is that you securely build up a capital. In the case of your death, your next of kin receive a previously agreed upon percentage of the insured capital for the purchase of the surviving dependant’s pension. The level of the purchasable surviving dependant’s pension with that capital is dependant of the rates at the moment of purchase. The risks concerning the interest rate and changed life expectancy are not for the employer or the pension fund.
3. Premium agreement
With premium agreements, only the premium is guaranteed. The employer, in this case, does not agree upon the level of the pension or the pension capital, but the level of the annual contribution to the pension arrangement. This premium can, in accordance with what is agreed upon, be used for the direct purchase of a benefit (interest insurance), a capital (capital insurance) or used as an investment (investment insurance). The final level of the capital with which the pension has been purchased is uncertain and dependent on the invested premiums and the achieved interest on the deduction of expenses. As an employee, depending on what is agreed upon with the pension provider, you run certain risks during the build-up of your pension. These are: decrease of interest, longevity and decrease of investment results.
The (in)security of pension
The difference between these three arrangements is that as a participant in one of the arrangements, you run more risk during the build-up phase than with the other arrangement. In the pay-out phase the risks in all three arrangements are for the provider of the pension.
However, the risks that the pension providers have taken, like not indexing of pensions or even shortening of pensions, show more than ever that even the pension providers are also dependent on premium income, life expectancy, capital market interest and investment results when it comes to granting pension benefits. Because a pension fund also invests the entrusted pension capital. In 2010 750 Billion euro was invested by pension funds alone; of that 50% was invested in fixed income portfolios and 33% in shares.
The relation between obligations and investments is measured in the coverage. In other words: the position of income and the pension fund. If the coverage is 100% the pension fund will have just enough capital to meet its obligations.
The government states that a pension fund needs to at least cover 105%. The Dutch Central Bank supervises this. If a pension fund does not meet this requirement, a recovery plan must be submitted, in which is indicated how to get the coverage back to the desired level.
One of the causes of the low average coverage of pension funds is the financial crisis, along with decreasing capital market interest. The fact that the government and employers have not paid sufficient pension premiums at the time when the pension funds had sufficient capital, is certainly also a cause for the current problem. Some employers have even received money back from a pension fund. Furthermore, VUT (early retirement) benefits have been financed by the government, employers and pension funds with pension money that was really meant for retirement pensions.
If the coverage of the pension funds does not improve in time, then the funds will have to take action. One of these actions could be to raise the pension premiums. They can also implement cut backs in regards to the pension arrangement, by, for example, going from a final pay scheme to an average pay scheme, like the ABP and PGGM did in 2004. In addition, current pensions can be shortened or no longer indexed.
You, of course, have no influence in these matters, nor can you influence the investment strategy of your pension fund. Nor, to an important extent, do you have influence on the risks that you run during the build-up phase of your pension. Yet it is, however, important to takes these matters in consideration when planning your pension arrangement.
executive-majority shareholder (DGA) and pension
The Pension Act determines that pension arrangements need to be arranged with a professional pension insurer or pension fund. However, the executive-majority shareholder (DGA) is not included in the employee concept of the Pension Act.
Therefore the Pension Act is not applicable to the DGA. That does offer the DGA the possibilities of carrying out his or her own pension autonomously. In other words; carrying out the pension arrangement is not executed by a pension fund or –insurer. The possibility of executing your own pension does not mean that the pension cannot be arranged by a pension fund or – insurer.
However, the choice to execute autonomously (at least in part) of one’s own pension is often made. This is because the reserved amount of money can be used for his or her own enterprise. Another reason is that the pension money in the case of death is not for the insurance company, but for the pensioen-BV (pension-LLC) or Foundation.
Just as with regular employees, various pension arrangements can be assigned. A final pay scheme-, regular pay scheme- or availability premium arrangement can be assigned. Combinations are also possible. The dependant’s- and orphan’s pension are usually insured with an insurance company by the pensioen-BV.
A disadvantage of pension in one’s own control can be that the financial means of the pensioen-BV are insufficient to fulfil the pension obligations. For example, because the pension obligations are not fulfilled due to continuous losses of the BV. Investment results on the portfolio and the longevity risk also have influence on the ultimately received pension. Besides, because of stricter tax regulations, you can build up more pension through a pension insurer than when the pension is in your own control.
Self-employed professionals: reserving and ceasing the enterprise
1. The old-age reserve
Because with self-employed professionals an employer/employee relationship is missing, a self-employed professional may not be assigned a pension. The self-employed professional, therefore, must facilitate with his or her own means for his or her retirement and next of kin. Some entrepreneurs are obligated to join an existing professional retirement arrangement, like doctors, notaries and pharmacists. Because the self-employed professional cannot facilitate a pension arrangement, for them another possibility has been offered in the Wet inkomstenbelasting 2001 (Law on income tax 2001). The entrepreneur can, under certain conditions, start an old-age reserve. See the third pillar for other possibilities.
The old-age reserve is a fiscal reserve to which you can add an amount annually. It is only an act for accounting purposes. This act ensures that you do not have to pay taxes over 12% (with a maximum) of your profit income. The old-age reserve is considered a fiscal reserve on the balance sheet and cannot exceed the business assets. Usually, no payments are done to an insurance company. The money is invested in the enterprise.
The old-age reserve is not really a retirement fund. It is an extended tax payment. Ultimately at the termination of the enterprise a retirement provision in the form of a life annuity will need to be purchased. If not, then, taxes will need to be paid (progressively) over the amount of the old-age reserve. Therein also lies the risks of the old-age reserve; If the enterprise is doing poorly, there probably will not be sufficient income to purchase the retirement or to pay the tax authorities.
2. Profit from ceasing an enterprise
When you stop working as an entrepreneur, your company will be terminated, or perhaps sold, With this termination or sale, profit is usually made. The tax authorities will need to be paid according to the progressive rate.
The profit from ceasing an enterprise can be created because reserves, such as the old-age reserve are released. But also whenthe company assets are sold for a higher price than the carrying amount. The goodwill usually plays a part as well in the profit gained from ceasing an enterprise
Instead of paying the entire amount at once to the tax authorities against a high tax rate, a ceasing an enterprise life annuity can be obtained from an insurer or bank. There is a maximum amount that can be used from the profit from ceasing an enterprise when purchasing a life annuity. The life annuity benefits that will be received in due course will be taxed with income tax. Therefore, we can speak of postponement of taxes. It can be advantageous for the ceasing an enterprise life annuity to pay out the life annuity in parts, if the future payments fall under a lower tax rate.
It can be very tricky to take in account the profit from ceasing an enterprise when planning your pension. What will the profit from ceasing an enterprise be? Especially future receivables and goodwill are difficult to determine.
The third pillar: your own facilities
All facilities that you yourself make concerning the AOW-pension and the pension through an employer fall under the third pillar. This concerns immovable assets, savings in a savings account, investment and money from an inheritance. Sometimes the government stimulates saving with tax measures to relieve a pension gap or –shortage. For example, through a life-span scheme and salary saving scheme or with the purchase of a life annuity.
Someone is considered to have a shortage in their pension when, looking at their annual income, they did not build-up enough pension. This should not be confused with a pension gap that exist when, after retirement, someone has a pension that is less than 70% of his last earned salary.
A life annuity is an excellent way to eliminate a pension shortage for employees. But a life annuity is also a great facility for their retirement or their next of kin; for self-employed professionals and freelancers, that have less opportunities to build up their pension.
What is an Life annuity?
A life annuity entitles you to a steady and equal periodical payment of benefits with an insurer of life insurance. From the point of view of the insurance, there is not much difference between life annuity and pension. You can take out a life annuity as an addition to your pension, but also to secure the income of your next of kin. Naturally, a combination between retirement –and surviving dependant’s life annuity is also possible.
Differences between Life annuity and pension
Differences also exist between pensions and life annuities. The most important difference is that in the case of a pension we can always speak of an employer/employee relationship. Pension also falls under the Law on pay roll taxes and not under the Law income taxes which is the case for life annuity. Another important difference is that a pension always provides for life, while in the case of life annuity a temporary benefit can also be chosen.
The tax authorities support the elimination of a pension shortage through the taxation. You can deduct the amount you have paid for a life annuity from your box 1 income. At the moment this results in a tax saving. Pay roll tax is withheld from the subsequent life annuity benefit. The value of the life annuity is exempted in box 3 during its term. In this case we can speak of an extended tax payment. Saving through a life annuity is, therefore, mostly interesting if the future payments will be taxed with a lower tax rate than the rate with which income tax and the premiums for social securities are now imposed.
Limits concerning the Life annuity deduction have been set by the tax authorities. The amount you can save has a ceiling. How much you are allowed to save and fiscally deduct depends, among other things, on your income or profit from enterprise, the level of your pension premium payments with an employer and whether or not you utilise the old-age reserve. Your income and build-up pension in the previous 7 years may be taken into consideration.
A life annuity is no more than the exclusive product of an insurer. Through the so-called bank saving you can also build up a life annuity capital with the bank. The expectation is that if banks are competing with insurance companies on the market of life annuity products, the prices will fall. Eventually this results in a higher life annuity capital with a similar investment. There are some differences between saving for a life annuity through a bank and through an insurer. But, the most important difference is probably that a blocked savings account with the bank falls under the deposit guarantee-scheme of The Dutch Central Bank.
Saving and investing
This is, of course, also possible, but is not fiscally facilitated and falls under the box 3 tax.
Self-employed professional and pension
Self-employed professionals also have the possibility now, just like everyone, to acquire a life annuity insurance or bank savings product. Both possibilities are not ideal; it is either too expensive or does not supply an adequate interest rate. Currently, however, a solution is being sought; a pension that is cheap in execution costs, but can still offer the opportunity to higher interest.
Interest and expenses
What the amount of the final capital will be, beside your own contribution, depends on several things. For example, it is determinative if you will save at a variable or steady interest rate and/or if you will let the money be invested (and in what). In other words; the interest of your savings.
The costs that the insurer or bank charges also influence the amount of the ultimate capital. In this manner the insurer often charges administrative- and policy costs. These costs are relatively higher if you make a single deposit. If you choose to invest your money, a variety of costs will also be charged by both banks and insurers. Those costs have an adverse effect on your interest and subsequently the ultimately achievable capital.
Beside this it is also important if insure yourself against the risk of death and/or the incapacity to work. These insurances are an added expense and will diminish your savings.
Do you have a pension shortage and are you considering the purchase of an life annuity? Then you should know that the differences in costs between the providers can be great. You should seriously consider the option of saving with a bank. A careful consideration is needed, because saving, insuring or investing have their advantages and disadvantages. Always determine how much and how long you want to save and whether or not you want to insure against the financial implacations of your death or incapacity to work.
Fourth pillar: continue working and keeping your expenses low
The government measures are directed entirely on cutting down the ‘’fiscal’’ deduction possibilities of building up a pension. More and more seniors continue working (part time) after they retire. The wages they earn with that are an addition to an AOW-pension. Beside that you can keep your expenses low by, for example, growing your own crops or paying off your mortgage.
Your retirement income will consist out of several of the pillars. It is important to have a realistic image of your income. Get advice, it can give you peace of mind and direction.
Sources: Aldo, rijksoverheid.nl, Sociale verzekeringsbank (SVB.nl).