Only three percent of citizens “regularly” save for private pensions in Serbia, according to the recently published analysis of the Fiscal Council of Serbia, which covers the previous 15 years of existence of private pension funds in our country.
Yield rates on this “old-age savings” are not satisfactory as a result of high fees charged and legal restrictions on investing the funds raised. The Fiscal Council warns that the substantial inclusion of such savings in the Serbian pension system will require radical reform and a change in the current approach, which includes a tender selection of a private investment fund that would passively invest the pension savings of all savers on international stock exchanges.
“After 15 years of private pension funds, we can say that this system has largely failed to meet the goals for which it was established – despite generous and exclusive tax breaks, only three percent of workers regularly save in private funds,” said the Fiscal Council in a recent analysis.
In addition, as it is pointed out, the funds are not able to provide satisfactory rates of return on savings. The Fiscal Council is proposing a systemic reform that will enable greater investment of funds abroad and increase the yield on savings. But it also points to the need for radical reform.
“The existing system of generous and regressive tax reliefs for DPF needs to be reformed and replaced with a more modest and progressive system of direct budget subsidies for pension savings. Substantial inclusion of capitalized savings in the pension system of Serbia will require radical reform and a change in the current approach,” warns the Fiscal Council.
State pensions will be more modest in the future
In its analysis, the Council points out that state pension systems will continue to be the dominant source of income for the elderly in the coming decades.
“However, due to demographic aging, state pensions will be relatively more modest in the future, so current generations of workers across Europe need to consider additional private pension savings,” the Council said.
To that end, it is recalled that in 2005 Serbia established a system of voluntary private pension funds (DPF). After 15 years of operation of private pension funds, the Fiscal Council finds that this system has largely failed to meet the objectives for which it was established.
“Partial measures can eliminate the biggest shortcomings of the current system. By lifting restrictions on investments abroad, DPFs will no longer be limited to domestic capital markets, which will enable them to properly diversify investment portfolios and increase rates of return,” the Fiscal Council states.
The Council, as an additional approach, states that it is possible to specialize these funds which, with many times less fees, would exclusively invest in government bonds of the Republic of Serbia and thus provide savers with guarantees of positive nominal returns.
Necessary state intervention
Although partial measures can undoubtedly address some of the obvious shortcomings of the current voluntary pension fund system, international experience, according to the analysis, shows that broad state coverage of pension savings requires active state intervention to correct immanent shortcomings in the private pension fund market.
“Specifically, in the case of Serbia, that would mean the establishment of a public-private partnership where a private investment fund would be selected in a tender that would passively invest the pension savings of all savers on international stock exchanges,” the Fiscal Council points out.
Financial theory suggests that this is said to be an appropriate approach to provide savers with optimal rates of return, with minimal costs (up to 0.1 percent of assets for investment in developed country stock markets compared to existing fees of 1.25 percent assets per year.
“The role of the state would be reduced to stimulating citizens through potential guarantees for the return of invested funds or through a system for automatic registration for pension savings. In this way, an efficient and credible pension savings system would be established, which would naturally integrate with the state pension system and provide future users with safer and more generous income in old age,” the analysis states.
In the end, as it is stated, it is necessary to ensure the integrity of the reform process, which will be guided exclusively by the interests of the insured – present and future.
The goal of every pension system is to provide an adequate level of income in old age. In the case of state systems, the issue of adequacy of pension income is primarily of socio-political nature, ie intergenerational agreement on how the burden of demographic aging will be distributed – between current and future generations of workers and retirees.
However, due to the need for additional private savings, the financial industry is becoming an active participant in the pension reform process.
Avoid the painful experiences of others
“Indeed, the financial industry has an important role to play in providing pension income in countries like the Netherlands or Switzerland, where state pensions have the character of social assistance. However, it is crucial to ensure that financial intermediaries successfully integrate with the state pension system and in the best interest of the insured” the Council states.
The paper points out that this was unfortunately not the case in most Eastern European countries, where mandatory private pension funds were introduced to the detriment of the state system and in a way that no developed country in Western Europe has implemented.
“Therefore, it is important that Serbia avoids the painful experiences of Eastern Europe and implements future reforms of private pension savings in accordance with local needs and constraints, taking into account the good practice of Western European countries like Germany, which the Serbian pension system has followed for decades.”
What is the “earnings” on private pensions
Unlike savings in banks where the interest rate is known in advance, the rate of return of pension funds depends on the success of their investment policies – so it is not known in advance and the insured, explains the Fiscal Council, have no explicit guarantees in terms of yield.
This concept relies on the expectation that by investing in (international) capital markets, pension funds should, on average, provide policyholders with higher rates of return than interest in the bank, but due to the volatile nature of the capital market, it is not possible guarantee in advance the rate of return that will be achieved,” states the Council.
The average real rate of return was three percent in the period from 2007 to 2019.
In order for a citizen who saves for a private pension at a time when he can legally count on its payment (which is from the age of 58) to have a satisfactory amount of pension savings, it is necessary, above all, to save regularly, and for funds to provide appropriate rates of return.
The analysis of the Fiscal Council shows that the average real rate of return in the period 2007-2019 amounted to 3.05 percent.
“This can be considered an adequate result, especially having in mind the global financial crisis in 2008. However, these results are not sustainable in the long run, because the yields were achieved by virtually exclusive investment in government bonds of the Republic of Serbia, which, due to the fiscal crisis, provided extremely high interest rates in the period 2012-2016,” warns the Fiscal Council.
Tax reliefs
Payments of up to 50 euros per month to the pension fund are exempt from payroll taxes and social security contributions.
When an employee pays private pension contributions up to this amount, they are exempt from payroll taxes.
And when the employer pays private contributions to these funds on behalf of the workers (amount up to 50 euros per month) or does so within the so-called pension plans, the payments are, in addition to the payroll tax, exempt from paying contributions for compulsory social insurance.
“The amount of the monthly limit that is tax-stimulated is indexed every year for the inflation rate, so that it increased from the initial 25 euros per month in 2007 to 50 euros in 2021,” the Fiscal Council points out.
The Fiscal Council points out that tax breaks for private pension funds reduce state budget revenues by more than 10 million euros a year. The calculation of the Council says that the tax relief for pension savings amounts to over 10,000 euros for each employee in the pension fund industry, which is a larger amount than the most generous existing programs for subsidizing (foreign) investors and employment.
“At the same time, the mentioned subsidies for employment are paid once, while tax reliefs of over 10,000 euros per employee in the pension fund industry are paid every year. This fact further points to the question of efficiency and justification of the existing system of tax relief,” it is stated, among other things, in the analysis of the Fiscal Council.
In Serbia, by the way, today there are four companies for managing voluntary pension funds. They manage the assets of seven private pension funds, through which they save 206,830 citizens (data from the National Bank of Serbia for 2021).
Out of the total number of members of voluntary pension funds, only 70,759 are active – those who have made at least one payment to a private pension fund in the last 12 months, BiF reports.
