Last July the Supplementary Voluntary Retirement Provision Act passed the Bulgarian parliament. This act is a result of a five-year public debate over the issue, the beginning of which can be traced back to when the first tax incentives on supplementary voluntary pensionable contributions were introduced in 1994.
The maximum income-tax deductible contribution limit continued to rise after 1994, until the actual amount of contribution which a person voluntarily pays into a privately managed pension fund was recognised as deductible from personal income, without any maximum limits, as from January 1, 1999. Contributions and investment income accrue in individual retirement accounts. Upon retirement, the individual account accumulation is available to the retiree who is entitled to receive a pension for a certain period of time, a pension for life, or planned withdrawals until the account is exhausted. All voluntary pension fund payments to the individual are made regardless of the government social security pensions.
Over five years, Bulgarian tax legislation has made a tremendous breakthrough in the deeply-rooted perception that social security is exclusively an employer’s obligation, or the obligation of the state in a state-run economy. By way of privately managed individual retirement accounts, based on tax-deductible defined contribution principle, third-pillar pension funds in Bulgaria have helped the public redefine the traditional 20th century understanding of the relations and responsibilities of an individual and society.
The reform of the first PAYG pension pillar and the establishment of second and third pillars with increasing individual involvement in retirement provision, are undoubtedly implications of the revolutionary notion that 21st century individuals are less likely to be people who – having fulfilled their obligations to society in terms of required social insurance contributions – know that society will take care of them upon retirement.
Young Bulgarians are much more likely to be people who – provided society has fulfilled its obligation to them in terms of legal and economic possibilities, guarantees and even incentives for the provision of supplementary retirement savings – know that they will predominantly take care of themselves in retirement.
Income redistribution under a government PAYG retirement programme is strongly rejected by young generations today – not because of the redistribution itself, but rather because of the anonymous character of redistribution. You pay compulsory contributions to the government PAYG retirement programme to secure benefits for the old society members. However, the latter seem pretty abstract, given the parallel financial support you voluntarily provide – out of love, sympathy or even hypocrisy – to support the elder members of your family, regardless of the compulsory social security contributions paid. Are your elder family members not part of the same abstract old-society-member entity?
More and more young Bulgarians are feeling that the traditional pay-as-you-go social security system has been evolving into a system where benefits are not sufficient to sustain your elder family members and you have to pay their bills as you go to visit them.
Young people are notorious for their retirement myopia. Some think the idea of starting to save for their retirement at 20 is ‘offensive’, but at the same time they might be spending money on their elder family members and being taxed on it. Here is how the idea of individualised redistribution comes forward. Bulgarian legislation provides physical persons the opportunity to deduct for tax purposes the total amount of contributions they pay into a supplementary voluntary privately managed pension fund, regardless of whether they pay the contribution into their own accounts or into the account of, and for the benefit of, another person. Young people in their 20s and 30s can pay contributions into their elder family members’ individual accounts with a privately managed pension fund and deduct the contributions for tax purposes.
The elder family members could receive pensions for a certain period of time, pensions for life or planned withdrawals of the accumulated capital. The income received from a private pension fund is taxable as ordinary income. Being retirees, elder family members most often fall into lower tax brackets than their young contributors would otherwise. The more income the elderly receive from private pension funds, the less dependent they are on the government PAYG retirement programme. Less dependency on the government PAYG retirement programme would provide room for manoeuvring: the compulsory social security contributions could slow down their devastating growth under unfavourable demographic trends and economic downturns or even become lower under a better demographic picture and economic stabilisation. Thus labour could become much cheaper to employ, other things being equal. The more people are employed, the more financial resources the government PAYG retirement programme would collect. Even if none of these things occurs during the Bulgarian transition to a market economy, one could argue that, at least, a profound national pension reform should be much easier to implement with less dependency on the government PAYG retirement programme.
Thanks to the privately managed individualised scenario under the Bulgarian Supplementary Voluntary Retirement Provision Act, the young are not ‘insulted’ and enjoy excellent tax treatment while supporting the elderly.
For those who do not have young family members and are unemployed, there is a possibility for any physical or legal entity to pay the contributions and deduct them for tax purposes. Employment relations between the contributing legal entity and the beneficiary are not required, nor are kinship relations.
The questions pertaining to public-private partnerships in social security and pensions, are so interwoven that the moment you start disentangling a single thread of problems, you feel that another thread of questions starts tightening up the total mix of problems.
Bulgaria has also faced the modern society’s Gordian Knot: if government PAYG retirement programmes are needed because of shortsighted workers, how can these same workers be counted on to make wise investment decisions in privately managed voluntary pension plans?
If governments have mismanaged their centrally administered pension plans, how can they be counted on to regulate private funds effectively?
If governments regulate and guarantee the privately managed pension plans, won’t they eventually end up controlling these funds?
Bulgarian legislators did not fuss much about untying the knot. While keeping the government PAYG first pension pillar intact, they cut through the knot with the sword of modern economics: tax incentives for individual retirement savings and privately managed individualised redistribution. That is expected to lower the dependency on the government PAYG retirement programme and to facilitate the profound pension reform in the country which is already under way.
Nicolai Slavchev Stolkov is chief retirement schemes analyst with the Allianz Voluntary Pension Scheme in Sofia