Summary agreement in principle on Dutch pension system
12 June 2019
On 5 June 2019, the parliament, employers and trade unions presented an agreement in principle on the reform of the Dutch pension system. Some details of this agreement in principle are known, whereas other details will be worked out in the coming period. In this article we discuss the most important items regarding the state retirement age, the employee pensions and other measures.Download PDF version
- State retirement (AOW)
The state retirement age remains at 66 years and 4 months in 2020 and 2021 and then increases in two steps to age 67 in 2024. After that, the state retirement age rises by two months for every three-months increase in life expectancy. We already wrote a separate article on the changes in the state retirement age.
- Employee pensions
- Abolishment of the uniform contribution rate
In the Dutch pension system time-proportional pension accrual applies in each pension scheme. For the elderly, more contributions are needed than for young people for the same level of pension accrual. At industrywide pension funds, where an uniform contribution rate is mandatory, too much is paid for a younger employee and too little for an older employee. This system will be abolished. In the new pension system there will be age-independent contributions and the annual pension accrual will vary per age. This will have a massive impact. In our earlier article on the abolition of the uniform contribution rate we already wrote extensively about this.
- Maximum tax allowed pension contribution
A uniform age-independent maximum contribution rate will apply, which will depend on market interest rates and life expectancy. However, frequent adjustment of this maximum contribution rate is not desirable. For all contracts, the maximum contribution rate will be based on a pension ambition of 75% of the average salary in 40 years (accrual old age pension 1.875% per year).
- Compensation for missed pension accrual
Transition to age-independent contributions means that existing participants must be compensated. The agreement basically mentions three possible sources of funding, which we believe are not realistic. Please see our comments later in this article.
- Lump sum withdrawal
It will become possible to withdraw 10% of the individual pension capital on retirement date. The spending purposes for this amount do not appear to be limited by legislation.
- Change in short-term cutback rules for pension funds
It has been agreed that the current rules on lowering pensions (cutbacks) will be temporarily adjusted in case the funding ratio of a pension fund is too low. According to the agreement in principle, it is not required to apply cutbacks if the funding ratio is above 100% (after having a funding ratio below 104-105% for five consecutive years). If the funding ratio is below 100% after five years, only a funding ratio of 100% is required, instead of 104-105%, which lowers the cutback in this situation.
In the new pension system, cutbacks will be applied faster and indexations can be granted faster as well.
- Two types of contracts at pension funds
The existing Defined Contribution agreements, with the accumulation of individual pension capitals in the accrual phase and collective risk sharing in the benefit phase, will be made more accessible to pension funds.
The agreement in principle furthermore introduces a new type of pension contract. In this contract, pension entitlements are more conditional and there will be a lower aim for nominal certainty. No more buffers need to be formed (thus aiming for a funding ratio of 100%), so pensions will be reduced and increased sooner. The agreement in principle promotes the transition of current accrued pension benefits into the new pension contract.
In addition, future pension accrual at pension funds will be purchased at market interest rates. A cushioned contribution rate (based on expected investment returns or historical interest rates) will therefore no longer be possible.
- Investments according to the lifecycle principle
In all Dutch pension contracts, investments must be done according to the lifecycle principle. This means that investment risks should decrease when retirement draws closer. More specific, this also means that annual investment returns will vary per age. This can be achieved in different ways. For example, pension funds can still invest uniformly and allocate the returns age-dependently.
- Improvements in survivor’s pensions
Later this year the Labour Foundation (STAR) will advise on improvements of the survivor’s pension benefits. This will concern both the partner definition as well as the desired coverage (both in terms of height and financing).
- Other measures
Freelancers will be obliged to have an insurance to cover the disability risk. No pension obligation will be introduced for this group of workers. However, it is considered whether freelancers can more easily participate in a pension fund where they have already accrued pension benefits in the past.
- Early retirement (arduous professions)
To enable certain groups of employees to retire earlier, the rules regarding the fine in case of early retirement (the so-called RVU Levy) will be relaxed in the period 2021-2025. If early retirement takes place for a maximum of three years before the state retirement age, employers don’t have to pay an additional tax to an amount of approximately €19,000 gross per year (the annual state pension benefit for unmarried persons).
It will also be made possible within tax legislation to save for up to 100 weeks leave (now: 50 weeks), to make early retirement possible by means of taking paid leave.
Finally, it is examined whether pension accrual on salary allowances (irregularity, overtime) can also be specifically used to retire earlier.
- Retirement via annuity payments
The fiscal framework for the 2e and 3th pillar is drawn equally. This implies, amongst others, that the maximum contribution rate will also apply to annuities.
- Next steps
On short term, the members of the trade unions will vote on the agreement in principle. If they agree, legislation will soon be drawn up to ensure freezing of the state retirement age and to prevent/lower cutbacks in 2020. For the detailed elaboration of the agreement in principle, time will be taken, with legislation to be completed in 2022. A steering committee will be set up by the parliament to work out the new pension system and the transition framework.
The agreement in principle offers little news compared to the letter of Minister Koolmees on 1 February 2019. The demands of the trade unions have largely been met (freezing and amendment of the state retirement age, prevention of (large) cutbacks and early retirement measures for arduous professions), while substantive elaboration of the second pillar pensions is pushed forward. We wonder what will happen to the state retirement age and the cutback measures if, in 2020 or 2021, the steering committee, consisting of representatives of social partners and parliament, will again not agree on the required details.
In our opinion, the agreement in principle initially leads to a subsidy from the younger generation to the older generation. After all, because lower or no cutbacks are required, more money will be paid over the next few years than would be the case using the current rules. This automatically implies that less money is available for later generations. Due to the lapse of the solvency buffer requirements, young generations will no longer be able to benefit from these buffers. It was precisely the intention of the pension agreement to prevent generational conflicts. In the long term, the plans will in fact have this effect, but only after the existing generations have disappeared. In particular, the costs seem to come for the account of the current 40- to 60-year-olds. This conclusion is endorsed by the Dutch Central Planning Agency (CPB), that published a report on this on 5 June as well. Compensation for lower pension benefits and higher investment risks seems to be in place.
In regard to this compensation, the application of the solvency buffers of pension funds is mentioned. However, it does not mention the fact that these buffers are for both active and inactive participants, and therefore they cannot be used like that to solve a problem of only current and future actives. As a second possible funding source, the lower contributions due to the increase of the pension retirement age from 67 to 68 years (from 1 January 2018) is mentioned. We believe that this alleged release has been deployed before, for example by increasing the low premium coverage ratio at pension funds or by reducing the employee contributions. The third funding source concerns the premium release due to the longer investment horizon. The pension result is mainly determined by the amount of the contributions invested and the investment returns that are realised. As the pension contributions are made available earlier, the investment component in the total pension result will become more important compared to the contribution component. Therefore, the idea is that a comparable pension can be achieved with less contributions and more investment risk. Normally, taking more risk is accompanied by a higher expected return (and therefore higher expected pension benefits), but that does not seem to be valid here. The "compensation" must therefore be partially paid by the participants, in the form of more risks. Hence, the employees have to pay for this compensation out of their own pocket.
We also regret that the agreement in principle is written from a pension fund’s perspective. For current Defined Contribution schemes, with a contribution increasing with age, the impact of the transition to an age-independent contribution rate is massive. The same applies to insured schemes. This impact may be even greater than for pension funds, as fewer sources of funding for compensation are available. We therefore anticipate a substantial pension cost increase for employers and we are curious whether the government is prepared to take additional measures to meet companies in this respect.
Finally, the agreement in principle mentions that parties are in consultation with the European Commission to give clarity to the European legal sustainability of compulsory industrywide pension funds. After the abolition of both the uniform contribution rate and the solvency buffers, we believe there are few grounds on which the Dutch exemption position can be substantiated.