The Danish government and a key political party have finally agreed on tax reforms that include incentives for retirement savings.

The parties agreed changes to the way pensions are taxed, solving a long-running problem of no financial incentive to save for a pension in the years leading up to retirement.

The pensions industry welcomed the deal, saying it eased the so-called “interplay problem” that had existed for many years. Private pensions income is currently offset against social security eligibility, effectively removing the benefit of making pension contributions in an individual’s last years before retirement.

In the pact sealed by the government and the Danish People’s Party, DKK5bn (€672m) was earmarked to lower tax rates, especially on work and pension contributions.

A key element of the reform is that up to DKK70,000 a year in pension contributions will be tax deductible – with the deduction being targeted in particular at the point in working lives where the interplay problem is worst, the government announced.

People with more than 15 years to state pension age will be given a deduction at a rate of 12%, whereas those with 15 or fewer years to go will have a 32% deduction rate, it said.

Brian Mikkelsen, minister for industry, business and financial affairs, said: “I am glad that we have delivered, with this agreement, a significant contribution to solving the interplay problems which mean that for various people it has not been worth it to save up for their own pension.”

Insurance & Pension Denmark (IPD), the industry association, said another measure contained in the package also helped incentivise pension saving. A new tax deduction for employees and the existing employment tax allowance now take pension contributions into account, which is not the case today.

Per Bremer Rasmussen, chief executive of IPD, said: “I am glad the government has now on the whole reduced the interplay problem quite considerably with this new initiative in conjunction with the solutions put in place last year.”

The government’s new political programme for pensions and retirement announced last summer was also aimed at removing disincentives to save for pensions, but it received a lukewarm response from the industry.

Bremer Rasmussen said IPD wanted the taxation of pension saving reduced even further. “But that would have cost more money, especially in the short-term, which was not politically possible to find,” he said.

Laila Mortensen, chief executive of the labour market pension fund Industriens Pension, said the new tax and pensions agreement had made it more attractive to save for a pension in Denmark.

“The introduction of the new tax deduction doesn’t mean that pension savings will rise, but members who pay in to us will typically get a tax break on their pension contributions of between DKK1,000 and DKK3,000 a year, depending on how much they pay in and how near to state pension age they are,” she said.

Peter Damgaard Jensen, chief executive of labour market pensions provider PKA, also welcomed the political deal.

The new rules would mean a PKA member with less than 15 years to state pension age, contributing DKK50,000, would have around DKK3,800 more in disposable income, the firm said.