Spain: A pessimistic outlook for pensions
Spanish workers can expect to receive detailed information from their employers about their retirement outlook, according to Carlo Svaluto Moreolo. Few think this will boost supplementary retirement savings at a time when the government is reducing tax incentives
Positive economic forecasts show that Spain is already benefiting from its momentous reform efforts, which have consisted of a controversial labour market overhaul and a hefty reduction of pension benefits.
But as the country embraces a new pension regime, there are two unanswered questions in the industry. First, to what extent will the living standards of Spanish pensioners decline as a result of the reduction in benefits?
Second, will savings in the second and third-pillar systems grow?
The answer to the first question hinges on various factors, but the long-term path of the Spanish economy is key. The new rules mean that state pensions will no longer be directly linked to inflation. Instead, benefits will be uprated according to a complex formula, with a minimum guaranteed annual increase of 0.25%. Inflation will be factored in only if the social security fund is in surplus and, even then, pensions will not be uprated by more than 0.50% above CPI. From 2019, the level of state pensions will also be linked to life expectancy. Therefore, whether pensioners will be able to afford acceptable living standards, will ultimately depend on their future purchasing power.
At a glance
• An upcoming tax reform is hoped to boost pension savings but appears biased towards the third pillar.
• Maximum annual deductible contributions to pension plans will be reduced significantly.
• Employees will be allowed to access their second pillar savings after 10 years.
• No tax incentives for employers setting up pension schemes are foreseen.
To raise awareness, lawmakers have established that workers will receive detailed information by the state and by their employers about their financial prospects in retirement. Jaume Jardon, pension manager at Deloitte in Barcelona, warns that this measure could have a paradoxical effect, with people deciding that it is worth holding on to cash rather than investing it. “People receiving information on their future pension could be discouraged to save for retirement if they decide that their private pension is too low compared to their current contribution”, he says.
A potential answer to the second question – whether lower state retirement benefits will result in growth of complementary pensions – lies in the fiscal overhaul that is currently under discussion.
The upcoming tax reform represents the third step of Spain’s ambitious reform package and contains measures that may affect the way Spanish citizens choose to save for retirement. However, few think such measures will generate growth in second and third-pillar assets.
“My worry is that the government has no special policy aimed at strengthening complementary pension plans, and its needs for tax income drive a ‘no-policy’ approach,” says Diego Valero, chairman and CEO of Spanish consulting firm Novaster.
An analysis of the proposed new tax rules affecting pension savings suggests the effect of the reform might be marginal.
The government hopes to make pension saving more attractive as restrictions on the use of fund assets are lifted. To this end, one of the measures is to allow pension plan members to access their savings after 10 years.
“Employees see illiquidity as one of the biggest hurdles preventing them from investing for a pension,” explains Angel Martinez-Aldama, director of INVERCO, Spain’s pension fund association. “They want the freedom to access their savings. The idea is to make pension products attractive by removing this obstacle. We have seen the experience of the Basque region, where there are similar products and only a small percentage of people take the money out.”
Tax benefits will be offered through new third-pillar financial instruments called ‘Ahorro 5’, which allow individuals to save up to €5,000 and access the savings after five years, during which the savings are invested by the issuing entity (banks or insurance companies). The issuer guarantees 85% of the funds and the returns will not be taxed if the investment is kept for five years. Such products, according to some estimates, will return 2-3%, considerably more than normal bank deposits. Another tax incentive will be offered to people aged over 65 years who sell real estate assets. The gains from the sale of real estate assets up to €240,000 a year will not be taxed, provided that the seller buys an annuity.
Mariano Jiménez Lasheras, senior consultant with the actuarial consultancy CPPS, believes these new measures are not effective enough to steer the Spanish pension system in the right direction. “Excessive variety and complexity of financial products does not lead to the overall development of the system,” he says. “These products are created with the purpose of fostering long-term savings but they fail to create pension security in the long term. Fiscal stimulus should be directed towards the second-pillar system – for instance, by offering tax breaks to companies that subscribe to sector or collective pension funds.”
Missing from the draft bill is any incentive for companies to set up pension plans. This lack of incentives, coupled with the uncertainty of regulation, is what makes it difficult for companies to set up pension plans, says Rosa di Capua, partner at Mercer in Spain. “Companies have had to deal with sudden changes in pension regulation, therefore it is difficult for them to measure the impact of setting up pension plans. It is not reasonable to think that, without the benefit of tax advantages and stable regulation, more large and small employers will provide pension benefits.”
Instead, the government is putting forward one potentially damaging proposal. This is to lower the maximum upper limit for tax deductible employer and employee contributions to a pension plan. Maximum deductible contributions will be set at €8,000 per annum for both employees and employers. At the moment, employees and employers can contribute up to €10,000 (€12,500 for employees older than 50) to pension plans.
As well as looking for avenues for growth, the Spanish private pension industry is facing regulatory pressure on many fronts. Jardon believes that the IORP II directive will bring about significant changes for Spanish pension funds. IORPs in Spain have no legal personality and are managed by pension fund-managing entities, mainly banks and insurance companies, and the new directive opens up questions regarding the sharing of responsibilities among the management entities and control committees, which are made up by scheme sponsors and participants.
“IORP II will be a challenge for Spanish pension funds over the next years,” says Jardon. “The directive will force them to address issues such as remuneration of control committee members and to develop internal functions such as audit and risk assessment.”
As part of the pension reform that came into force this year, lawmakers introduced a cap on management fees. The ceiling for fees to asset or fiduciary management entities is reduced from 2.5% to 1.75%. However, this is only expected to have a significant impact on third-pillar investment.
“Average management fees for occupational pension schemes are around 0.24%, so they will not be affected by the new ceiling,” Valero says. “The cap is relevant in the case of third-pillar funds, where managers will either need to accumulate larger volumes of assets via new sales or create better returns to maintain current levels of profitability.”
From the members’ perspective, most plans still offer limited choice in terms of investment, and the new pension regulation has failed to address this. álvaro Molina, senior investment consultant at Towers Watson in Spain, believes that the government should give members of second-pillar funds more flexibility in investment options. “Pension plans have to offer the same investment strategy to each member. They cannot implement lifecycle strategies. The regulation is very strict and prevents plans from providing employees with an investment strategy that is adequate for their profile. It would be beneficial if the regulator allowed a higher degree of choice and flexibility.”