Pension reform bill passes Riigikogu vote

Opposition Reform Party MPs protesting the second pillar bill earlier on Wednesday.
Opposition Reform Party MPs protesting the second pillar bill earlier on Wednesday. Source: Siim Lõvi /ERR

The Riigikogu has passed the controversial pension reform bill, by 56 votes in favor to 45 against, making membership of the so-called second pillar of the Estonian pension scheme voluntary, also passing the vote of confidence it attached to the bill.

The Compulsory Funded Pension Reform Act, to give it its full title, once it comes into effect, will make membership of the so-called second pillar of the Estonian pension scheme, which deals with employee contributions, voluntary, where it had previously been mandatory.

The coalition had linked the vote on the bill, which was at its second and final reading, to a vote of confidence, to block further delaying tactics from the opposition parties, ERR reports. The bill passed about half an hour before midnight on Wednesday, after over nine hours of debating.

Opposition MPs had earlier expressed their protest against the bill by carrying placards into the chamber which had been on display at a demonstration outside Toompea Castle, seat of the Riigikogu.

The bill's explanatory memorandum says the aim is to increase freedom of choice in second pillar membership, and: "Represents the freedom to decide whether or not to raise money in the second pillar. [The bill] also gives people additional options for investing and using their retirement money both before and after retirement."

Finance minister's comment

Finance minister Martin Helme (EKRE) said rejected concerns that aspects of the bill ran against the Estonian constitution. Chancellor of Justice Ülle Madise, whose role includes acting as an independent supervisor who ensures the basic principles of the constitution are adhered to, had noted unequal treatment between holders of second and first (state pension) pillar fund holders, once the second pillar membership was optional.

"While there have been concerns about this reform, that not all its components may be constitutional, I do not agree," Helme said Wednesday night.

"We have proposed a balanced solution during the past six months, that will make today's rigid system much more flexible for people, while maintaining the necessary restrictions for social purposes. These restrictions, in my opinion, are proportionate and necessary, also sound within the consitutional context," Helme added.

Aivar Kokk (Isamaa), chair of the Riigikgou's finance committee, took a similar line. "The allegations of unequal treatment are unfounded," he said, adding that it was important that pension funds continue to invest in the Estonian economy and earn an annual income through their investments.

The second pillar always made use of managed funds; critics had said that these were inflexible, and often performed below the market average.

Opposition parties

Reform Party chair Kaja Kallas, a staunch opponent of the bill, said that it was one of the worst laws ever to pass through the Riigikogu, and would disrupt the national pension system.

"Today's decision will be paid for by our children and future generations," she said.

Critics of the reforms even came from the international stage; the International Monetary Fund (IMF) had cited concerns about short term shocks to the economy if a large number of people withdraw their second pillar funds - which must be done in one go and not in instalments – followed by a shrinking pension pot to be shared out among an ageing populace.

Indrek Saar, Social Democratic Party (SDE) chair, said it was a sweetener for the short-sighted - those believe that it is they who are best placed to invest their money and make wise decisions.

Saar cited experts who had warned against breaking the pension system, and also suggested thinking about people who end up taking money out and losing their savings due to thoughtless investment decisions in the light of big promises.

Another critic is Bank of Estonia chief Madis Müller, whose line has been similar to that of the IMF, and has said that the reforms had not seen sufficient impact analysis ahead of becoming a reality.

The opposition was accused by Isamaa leader Helir-Valdor Seeder, who championed, and got, pension reform of the second pillar finding its way on to the coalition agreement his party signed with the Center Party and the Conservative People's Party of Estonia (EKRE) in April, of filibustering tactics in bringing large numbers of questions and proposed amends to the bill, including dozens on the date by which it would come into effect.

Lawyer Paloma Krõõt Tupay told ETV current affairs show "Aktuaalne kaamera" that the issue was complex.

"It has a wide-ranging impact on everyone, and will undoubtedly require constitutional analysis," she said.

Tupay added that the reforms could have been discussed more at the Riigikogu.

The only block to its being passed is if the justice chancellor takes the case to the Supreme Court – as happened in summer with the bill making alcohol excise duty cuts. That time, the Supreme Court ruled in favor of the government, and the bill passed.

Aside from that, the Estonian president has to sign the law into being, Tupay pointed out.

While the law is scheduled to enter into force this year, the reforming aspects of it will be implemented for the most part by or in early 2021. 

How the second pillar will now work

Once the pension reform enters into force, joining or leaving the second pension pillar will become voluntary for everyone. By default, everything will remain as it is — if an individual wants to continue collecting their pension the same way, they will not have to do anything. Should they want to exit the pillar, join the pillar or simply stop contributing to it, they must submit an application either to their bank or to the Pension Center, spokespeople for the government said earlier this week.

Current payment rates to the pillar will remain unchanged — 2 percent of an individual's gross salary and 4 percent of their social tax. With the new option, people will be able to reinvest the funds they have accrued in the second pillar themselves. In order to do so, they must submit a conversion application to cash out their second pillar funds and transfer them to the individual's pension investment account set up at a bank.

The pension investment account can be used to transfer both already accrued pension money as well as new second pillar contributions there — no other money can be transferred there. Withdrawal from the pension investment account will be carried out under the same conditions as for the pension fund. This means that people will generally have to wait until retirement, but, if necessary, they can exit the second pillar with the money sooner.

As with switching funds, an individual can move their money between a pension investment account and second pillar funds. For example, they can invest themselves for some time, reach the conclusion that this may not be the best solution for them, and then return to a fund.

The assets of a pension investment account can be invested in the same way as with a regular investment account ⁠— for example, in securities and other financial instruments.

Upon reaching retirement age, it is up to each individual to decide whether withdraw all of their money at once or as a fixed-term or lifetime pension. Should money from the second pillar be used as a lifetime pension or as a long-term pension, with the money distributed across at least the average years left for the person to live, then no income tax is payable on such payments.

With a shorter-term pension or when withdrawing all of one's money as a lump sum in retirement age, the individual will have to pay less income tax than when withdrawing the money earlier — 10 percent instead of the usual 20 percent. These payments will not affect the calculation of a person's tax-exempt income.

Chance to leave, chance to return to pillar

Compared with the current procedure, once the pension reform bill enters into force, those who wish to may stop contributing to the second pillar. There are two ways to do so — suspend payments to the second pillar but leave already accrued money in the account to continue to grow, or withdraw the money, which will also stop payments to the second pillar.

Once someone has exited the second pillar, regardless of whether they only stopped contributing to it or withdrew already accrued money from it, they may rejoin the pillar after a period of ten years. After that, they will have the opportunity to exit the pillar again in another ten years' time — either by simply stopping payments to the second pillar or by withdrawing the money they have accrued there.

If an individual leaves the second pillar a second time, they cannot rejoin it and will no longer be able to contribute to it. Thus, people will no longer accrue money in the second pillar, will be left with only the first pillar in retirement.

When withdrawing the money when exiting the second pillar, it must be taken into account that the payment will be made in a lump sum and that all the money that the person has accrued in their second pillar will be paid out. The money will be subject to 20 percent tax, however the calculation of their tax-exempt income will not be affected by the second pillar payout.

People who voluntarily join the second pillar for the first time can withdraw money from the pillar for the first time or simply stop making payments at least ten years after they joined the pillar.

Current second pillar pensioners can also exit the second pillar if they wish. To do so, they must submit an application to their bank or the Pension Center for the termination of the fund pension and for a one-off payment or cancellation of the pension contract with the insurer. The payment to be made to retired second pillar pensioners will be subject to 10 percent income tax.

Payouts three times a year

Money will be paid out of the second pillar and payments can begin or end three times a year — in January, May and September. The submission of applications for joining the pillar voluntarily as well as exiting the pillar, including the withdrawal of accrued funds, will begin in January 2021. All applications filed by March 31, 2021 at the latest will be realized in September 2021.

Pension funds will have at least five months' notice about leaving the second pillar. The longer notice of pension withdrawals will help people better manage their pension fund investments. In order to mitigate the risks involved for the pension fund in paying out money, the bill also raises the threshold for borrowing from the pension fund from the current 10 percent to 25 percent.

The submission of applications for transferring the funds collected from the pension fund to the pension investment account will begin on April 1, 2021. As with the conversion of units in a pension fund, the money will be credited to the pension investment account on September 1 if the application for conversion is submitted by July 31, 2021 at the latest. If the application is submitted during the next cycle, the conversion transaction will take place on January 3, 2022.

Second pillar payments can also be redirected to a pension investment account beginning in September 2021. To do so, people must submit a new choice application to their bank or the Pension Center. Payments will be redirected within a maximum of three business days.

The first pillar refers to state pensions, the third pillar, private pension schemes, which opting out of the second pillar effectively moves towards in any case.

Editor: Andrew Whyte

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