IMF criticizes second pillar pension reform

Abolition of the second pillar of pension (illustrative)
Abolition of the second pillar of pension (illustrative) Source: Caro/Preuss/Scanpix

The International Monetary Fund (IMF) has expressed concerns about coalition government plans to remove the so-called second pillar pension provision.

The second pillar comprises mandatory contributions to pension pots from employees, as against employers (first pillar) or private pension schemes (third pillar).

Mandatory from 2010, those born in or after 1983 must pay into the second pillar; those born between 1942 and 1982 had the choice to opt out when the scheme was first introduced.

Abolition has was a central plank of Isamaa's pre-election manifesto. A common argument in favor of removing the second pillar is that funds underperform in comparison with the economy. Opponents to abolition say it would hit lower-income earners the hardest.

The IMF says that removing, or even reforming, the second pillar would, given Estonia's ageing population, increase the burden on future generations further, as people potentially raid their pensions savings early.

IMF view

A statement published this month noted concerns the IMF has about both short- and long-term budgetary risks arising from potential abolition of the second pillar, following a visit by representatives of the organization in late May.

The statement adds that while reform is partly motivated by the low rate of return the second pillar exhibits, removal would nonetheless strip that minimum rate of return from individuals who belong to a defined contribution scheme. 

Although the second pillar pension system is effectively a private scheme, there are clear implications for the (state) budget, the IMF said.

Furthermore, those who opt out of the second pillar could require future assistance due to insufficient funds in the first pillar (see above), according to the statement.

The IMF also found that cashing-out saved balances could boost current consumption, fiscal revenue, and economic growth in the short term, but reduce future pension entitlements in the longer term.

Furthermore, a knock-on effect could see the role of pension scheme managers diminish, due to the significant reduction in participation rates.

"The IMF recommends that the government coalition conduct an in-depth assessment of the current pension system and only embark on a new structural pension reform if all other options are exhausted and a broad-based agreement is achieved regarding the policies and technical details of a new pension system," said Kristjan Tamla, head of NGO FinanceEstonia's work group on funded pensions, paraphrasing the IMF statement.

FinanceEstonia thus supports the IMF position that reforms concerning the entire population should not be rushed into without in-depth impact analyses, BNS reports. 

FinanceEstonia has come up with its own pension system improvement recommendations, without the need to remove it, Tamla added. 

Editor: Andrew Whyte

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