Second-pillar members can expect third more income, Lithuanian study shows

LITHUANIA – A recent Bank of Lithuania (BoL) survey has concluded that the country’s revamped second-pillar pension system could result in retirement incomes of up to a third higher while ultimately reducing public state financing for pensions.

The voluntary second pillar, launched in 2004 and financed by diverting a set share of the 34% of wages funding social insurance, underwent significant revisions last year.

The second-pillar base contribution rate was raised from 1.5% in 2012 to 2.5% in 2013, falling to 2% in 2014-15 when an additional rate kicks in.

Workers can add an extra 1% from their gross wages, match-funded by an extra 1% from the state, the so-called ‘2+1+1’ formula.

In 2016-19, the additional rate from both workers and the state rises to 2%, while from 2020 onwards the base second-pillar rate rises to 3.5%.

BoL, the country’s pan-financial regulator, devised a mathematical model analysing some 50,000 variables such as wages, pension returns – highly conservative ones according to the Bank – and other scenarios.

According to the model’s results, workers in the second pillar who make additional contributions can expect a pension income 15-34% greater than those who do remain exclusively in the first.

However, workers aged 55 years or more on low or average earnings face investment risks by remaining in the second-pillar system.

The model also looked at the impact of the second pillar on public finances.

A deterioration in the country’s budget deficit following the global financial crisis and a severe recession caused the government to slash the second-pillar contribution from 5.5% in 2007-08 down to 1.5% by 2012.

According to the model, if all participants take up the additional top-up option, the state’s additional contribution would total LTL200m (€58m) next year, and average 0.29% of GDP in 2014-20 and 0.48% in 2020-60.

The BoL warns that state funding for the second pillar may lead to higher taxes, lower public spending or greater debt in the future.

Overall, however, it concludes that, in 2036, the two-pillar system will become the cheaper option for the state because of reduced outlays from SoDra, the state social insurance fund, coupled with the higher wage-replacement rate generated by the second pillar.

In covering both retirement and public finance outcomes, the model is more comprehensive than previous analyses carried out by Lithuania’s social security and labour ministry, notes Šarūnas Ruzgys, general manager of DNB Asset Management Company and president of the Lithuanian Investment and Pension Funds Association.

He added that its results should counter objections from some politicians that the second-pillar system would produce no benefits for participants while increasing the public debt.

New entrants to the second pillar as of the start of 2013 have to make the additional contribution, while existing fund members have between 1 April  and 1 September this year to inform their fund managers that they want to make the additional payments or terminate second-pillar contributions altogether, leaving the monies accumulated thus far in the pension funds until retirement.

If they choose the second option, they have a calendar year’s grace to revert their decision.

Those that do not inform their managers will by default continue paying the base rate into the second pillar.

“Ours and other surveys suggest 20-30% will choose to make the additional payment, while 5-10% will stop paying contributions,” Ruzgys said.

Given the many changes that have taken place since the financial crisis, the majority unsurprisingly remain undecided.

The primary decision tool is the Social Security and Labour Ministry’s online spreadsheet calculator that factors in present and anticipated salary, age, sex and years of employment to project both first-pillar pensions from SoDra and second-pillar annuities.

While the second pillar has achieved a high take-up rate of more than 80%, it has until now not involved any extra expenditure on the part of employees, so it remains to be seen how many Lithuanians, amongst the lowest earners in the EU, dig into their pockets.

As of 15 April, according to SoDra, 15,307 had joined the second pillar this year, bringing the total membership to just over 1m, while 27,343 requested the additional top-up, and 1,059 asked for their contributions to be suspended.