Spain: Low incentives to save threaten pensions sustainability

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Spanish tax reforms lack measures to encourage pension savings by workers and contributions by employers, raising questions about the adequacy of future benefits 

Regulation in summary

• After reforming the labour and pension systems, Spain enacted a major tax reform.
• The new tax regime contains no incentives for firms to set up pension arrangements.
• The reduction in the limit for tax-free contributions has penalised pension savers.
• Second-pillar pensions are not on the political agenda, although it is clear that public pensions will not be affordable in the future.

At the end of 2104, the Spanish parliament approved a comprehensive tax reform, representing the third milestone of a broad modernisation programme, which also entailed an overhaul of the labour and pension systems.  

Laws 26/2014 and 27/2014, which took effect at the beginning of this year, introduced changes to several aspects of fiscal law, including a reduction in the corporate income tax rate from 30% to 25% from 2016.

The reform, however, failed to live up to the hopes of many in the pension world by not introducing fiscal measures aimed at strengthening the country’s sluggish second-pillar system. 

On the contrary, to balance other tax reduction measures, the law reduced the €12,500 ceiling for tax-free pension contributions. From January this year, employees can only save up to €8,000 per year tax-free into second or third-pillar products, including employer contributions. 

Rosa Di Capua, a partner at Mercer in Barcelona, says that to justify the reduction the government argued that only 1% of savers made full use of the allowance, saving up to or more than the set limit.

However, she adds: “The government does not take into account that, although Spain lags behind other European countries in terms of pension savings, setting a high threshold for tax-free savings is an important aspect in encouraging the development of the system.”

Spain retirement assets

The pension fund sector was also hoping that lawmakers would introduce tax incentives to encourage firms to set up pension fund arrangements for their employees, according Di Capua. Instead, parallel tax measures affecting firms is a disincentive for the growth of private pension savings. In 2014, rules were introduced that increased the cost of social security contributions for companies that choose to contribute to a private pension scheme on behalf of their employees. 

Prior to the reform, employer contributions to private pensions were not included in the calculation of overall contributions to social security. Now, employer-sponsored payments to private pensions are added to the base for calculating the percentage of social security contributions for each salary, which increases firms’ overall cost of contributing to social security. 

This, says Di Capua, is a disincentive to companies that do not offer payments to private pension schemes as part of pay packages to offer them. “It is a perverse mechanism, as it hits smaller salaries,” says Di Capua – since employees’ social security payments also increase, while the upper limit to yearly social contributions of €38,000 per employee is unchanged.

So, while there are no new reform measures to stimulate the growth of private pension savings, in the past few years Spain has approved several reform packages specifically aimed at reducing the burden of public pensions on its budget. The new rules will result in lower benefits, particularly the changes in pension indexation rules.

From 2019, a sustainability factor will be applied when calculating state pensions. This will be revised every year and will link benefits with life expectancy at retirement, as well as contributions to the system. In practice, pensions will be reduced as a result of higher life expectancy and the growing gap between contributions and overall pension expenditure.

Spain Country facts

Such radical changes in state pensions clearly pose questions on the adequacy of future benefits. 

The government has continued to tap into the social security reserve fund, Fondo de Reserva de la Seguridad Social, the fund set up to cover shortfalls in pension payments. The fund, which has slowly increased its exposure to long-dated domestic bonds, has shrunk from €67bn in 2011 to the current €41bn, with more outflows expected this year. 

Despite the existence of this arrangement, there is a worry that, unless the economy accelerates, the pension system will become increasingly unsustainable. 

It was also hoped that the Spanish government would keep its promise to offer more transparency on the level of pension benefits. As part of the 2011 reform, it was agreed that last year the state would start informing employees over 50 years of age individually on their likely level of pension benefits once in retirement.

This has not happened, however, and there is speculation that such a lack of transparency was the result of the government’s reluctance to send a negative message – that pension benefits are going to be significantly lower than in the past. 

Since the economic crisis, the political dialogue between trade unions and employers has focused on short-term matters, with pensions falling off the agenda, according to Di Capua. Workers have felt little external pressure to start building pension savings using the available options.

A general election is expected to take place before the end of this year. The government’s centre-right People’s Party is currently leading the polls. However, left-wing opposition parties, including populist movements, which propose to roll back some of the harsher pension reforms, are closing in.

Meanwhile, the Spanish Association of Investment and Pension Funds (INVERCO) reported that Spanish pension funds returned almost 11% on average in the 12 months to the end of March 2015, improving on last year’s 7.14% return. Total assets grew by 7.3% to €35.6bn, with membership stable at just over 2m.

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