The EU’s pension reform proposals published last November included recommendations for auto-enrolment in a supplementary pension product for all workers, with an opt-out for individuals.
But a cautionary tale has emerged from Estonia, recently encapsulated in research carried out by Heidi Reinson, financial behaviour researcher at the University of Tartu, Maastricht University, and Baltic Finance Center, and which highlights potential flaws in the design of any auto-enrolment system.
Estonia’s three-pillar pensions system, introduced in stages from 1998, is made up of a state pension; a mandatory second pillar funded by a 2% employee contribution plus a 4% social tax on gross salary paid by the employer; and a voluntary third pillar.
In 2021, controversial changes took effect, intended to give participants more control over their savings while creating a more competitive market to improve returns and cut fees.
The system became voluntary and members could withdraw their accumulated savings before retirement age, in one of a series of windows. They could also continue within the system, using a personal investment account to choose their own investments.
Those withdrawing savings had to take out all their contributions at once, paying income tax, and are not allowed to re-enter the system for 10 years. The employers’ 4% contribution is redirected into the PAYG first pillar system to help pay current pensioners.
Around 20% of participants withdrew their savings in the first window in 2021, withdrawing €1.3bn in total, around 4.5% of the country’s GDP.
The result was a boom in spending, making retailers happy, taxi drivers less so (“They complained the TV sets were so large they couldn’t fit in their vehicles,” recalls Reinson) and creating a 1 to 2% jump in inflation.
“But five years on, there is a risk that people will withdraw their savings and experience economic difficulties later,” Reinson told those attending the webinar “A Cautionary Tale of Opt-Out Pension Reform” hosted by the International Centre for Pension Management in April.
“Meanwhile, many have already lost in financial terms: a year after the reform, half the money was still in bank accounts, and not even savings accounts with a high interest rate.”
The decision to allow large-scale withdrawals formed part of the general election campaign by the Conservative Party, which used posters with pictures of flames and the slogan “Your money is burning in second pillar pension funds”. The party then joined the resulting coalition government.
After bitter parliamentary opposition, Estonia’s then president refused to sign the changes into law on the grounds they were unconstitutional, but was overruled by the Supreme Court.
In subsequent years, withdrawals decreased, but even so, over one-third – 37% – of participants have now withdrawn their savings.
Coincidentally, this is the same figure for withdrawals also experienced by Lithuania in the first three months of 2026, after it allowed participants to leave the second pillar. The much faster rate of attrition is partly because there is a 24-month window for withdrawals.
In Estonia, many participants who withdrew money did so because they needed the cash. These included people with high consumer credit debt, lower savings, a lower level of education and less trust in institutions.
“The original Estonian system was introduced as automatic but then people discovered their savings hadn’t earned enough and had been eaten by fees,” says Reinson. “This disappointment is related both to trust, and rebellion against ‘greedy’ banks, and I believe it played a part in the high withdrawals.”
According to the Estonian Central Bank, during the first year of payouts, while half the money withdrawn became bank deposits, one-third went into loan repayments, and for younger participants, 9% was spent on gambling.
There were, however, some positives.
“Because the system is now more transparent, pension funds may try harder, publishing returns and lowering fees, so the flexibility for those who stay makes it more of a risk-free savings option,” Reinson says.
The initial withdrawals also created a fiscal windfall for the state, together with the cumulative boost of saving the social tax on employer contributions.
But Reinson cautions: “There was this naïve belief that people would invest their money elsewhere, but we haven’t really seen any proof of that. The reality was that it was a liquidity event and nothing to do with investment.”
She adds, “The saddest part is that this will probably lead to a two-track system where those with all three pillars will have a comfortable retirement, and those relying only on the first pillar might regret that decision later on.”
But could the original system have been designed better?
Reinson thinks so.
Equity investing was prohibited from the start, leading to low returns. Furthermore, payouts to retirees were made as regular pensions, and not lump sums. Both these restrictions have now been removed.
Meanwhile, participants can now choose to increase their contribution rate to 4% or 6% of gross salary.
The 10-year lock-out period was supposed to discourage withdrawals, but Reinson observes: “For those households with liquidity constraints, ten years is very abstract and didn’t stop people from pulling out, so ended up being more of a punishment.”
The government is now considering whether to reduce the lock-out period to five years instead of 10.
So what would Reinson do differently?
She says, “I would recommend a low contribution mandatory second pillar for retirement, plus a flexible third pillar reframed as long-term saving – with an income tax boost – rather than as pensions.”
And she adds: “I now think this is a psychological and not just an economic decision – it is both, but we cannot forget the psychology behind these economic decisions.”
She is surprised at her own reaction to the research.
“I used to think there is one right decision, and no one should withdraw,” she notes. “Now I’m more flexible, and think people should have freedom to do what they want with their money. We cannot be too paternalistic, we need to find the middle ground.”
