Strengthening the growth potential of the third pension pillar based on individual savings, supported by the state and employers, is a crucial step towards ensuring dignified pensions in the future as well as enhancing the tax competitiveness of our economy, writes Croatian Employers’ Association in its weekly analysis of economic trends.
The average net pension from the first pillar (intergenerational solidarity) amounts to only 642.10 euros, which is 45.3 percent of the average salary. This share is in line with the EU average of around 45 percent. However, projections from the European Commission indicate that due to negative demographic trends in Croatia, the share of the average net pension paid from the first pillar in the average net salary in 2070 will amount to only 23.7 percent. Additionally, the average theoretical replacement rate, or the ratio between salary and pension after 40 years of work, is expected to fall from 55 percent to 50 percent by 2059, which is a warning and a call to action.
Given the unfavorable demographic trends and the increasing share of retirees relative to the number of employed, the first pillar can no longer and will not be able to provide sustainable pension benefits. The solution lies in strengthening the mandatory second and especially the third pillar, which is voluntary and in which employees invest only if they wish and at a pace that suits them. Less than a quarter of employees today have voluntary pension savings, meaning they are members of the third pillar, although there is an option to choose investments in eight open voluntary pension funds, and there are also 21 closed voluntary pension funds active, sponsored by companies or unions.
The total net assets of the third pillar amount to around 1.5 billion euros, which is only six percent of the net assets of mandatory pension funds. Although the market is stable, its growth has slowed. Members of funds sponsored by employers make up only 11 percent of the total number of savers in voluntary pension savings, but they manage 17 percent of the total assets, confirming that employer contributions are the main driver of the success of this model. Companies that contribute to the voluntary pension savings of their employees are entitled to tax benefits, and from the examples provided by HUP, it is clear that they directly reward employees.
Namely, a person entering the labor market now, earning an average salary throughout their working life, with their employer contributing 67 euros monthly to the third pillar and being a member of category A of the mandatory pension fund, with an assumed real return of the mandatory and voluntary pension fund of only 2.2 percent annually. The result of the investment: companies contributing the amount of 67 euros monthly, which is fully a tax benefit (3.5 percent of the average gross salary), can ensure their employee a pension that is even 19.4 percent higher in the future.
Necessary Strengthening of Voluntary Pension Savings
In the context of strengthening the third pension pillar, HUP highlights two key aspects where improvements can be made.
1. Increase in Tax Benefits to the EU Average
In the first aspect, state incentives of 15 percent on all contributions in the calendar year, up to a maximum of 99.54 euros, are paid into each member’s personal account in December of the following calendar year, while employers are entitled to a tax benefit for contributions up to 804 euros annually per employee. Failing to keep pace with salary growth over the last years of inflation, the value of the tax benefit for employers for contributions to the third pillar has fallen from 6.5 percent of gross salary in 2010 to 3.9 percent of gross salary in the past long-term period, which is why this tax benefit does not attract new users and does not positively contribute to the capitalization of voluntary pension savings. Therefore, HUP proposes an increase in the tax benefit to the EU average of around 29 percent (weighted) of the average gross salary. Increasing benefits is advantageous for both employers and employees, as it increases net financial benefits without raising the gross cost for the employer, while employers can use this instrument to attract and retain (key) employees.
2. Indexing Incentives for Inflation
In addition to the evident space for correcting the gap in incentives compared to EU members, best practices dictate indexing incentives for inflation and, moreover, stimulating voluntary investments through a system of automatic enrollment of employees in voluntary pension schemes. Regarding the model of automatic enrollment, experiences from the United Kingdom show that the number of savers increases multiple times when the first step is automated. Workers who enter the system once remain in it; especially when contributions come from the employer – which is the solution to the biggest challenge in increasing the number of members, which is motivation for enrollment. The automatic enrollment system, most significantly, changes the initial assumption: saving becomes the standard option, and opting out is a personal decision. This does not limit freedom but promotes financial literacy, in which we must actively and independently participate in building, enabling a more rational choice. And given that only 11 percent of members are in closed voluntary funds out of the total number of members in pension funds, there is a significant space for the expansion of this model of age savings.
