Estonia: First steps towards a more flexible pension system
The Estonian government has proposed several changes to its pension system, including tying the retirement age to life expectancy and making the state pension less dependent on income. All interest groups will be kept informed and consulted during the preparation of the draft legislation, when the social partners will have formal opportunities for consultation.
Currently, the Estonian old-age pension system consists of three pillars:
- state pension;
- mandatory funded pension;
- supplementary funded pension.
The state pension is entirely financed from the social tax contributions of current taxpayers. The amount of pension insurance in the social tax is 20% or 16% of a person’s gross wage, depending on whether that person has joined the second pillar (a pay-as-you-go system).
Until 1999, the system took into account only a person’s pensionable service (that is, the years worked before retirement) which was added to a flat rate base amount. From 1999, an insurance component, calculated on the basis of the social tax paid for the employee before retirement, was added to the calculation, thus making the first pillar more dependent on people’s incomes.
The second pillar was created in 2002 and is mandatory for everyone born in and after 1983; older people were allowed to join the second pillar up until 2010. Under this pillar, a person contributes 2% of their gross wage, while the state adds an additional 4% from the social tax paid by the employer (as part of the total 20% of pension insurance contribution from social tax).
The third pillar allows everyone to make supplementary contributions to their retirement years. However, this is not widely used.
According to current policy rules, the retirement age is increasing by three months with every cohort from the age of 63 to 65 until 2026.
In Estonia, as in many European countries, the first pillar is not financially sustainable due to an ageing and decreasing population. Also, pensions are quite low in Estonia, often close to the relative poverty threshold. According to data from Statistics Estonia (WS011 on average monthly gross and net wages by economic activity and SW153 on monthly average pension and old-age pension), the average ratio of the state pension to net earnings (replacement rate) is 42%. Fiigures from Eurostat from 2015 show that 37% of Estonians aged 65 and above are at risk of poverty – the third highest rate in the EU (the rate for the EU28 is 17.4%).
The inequality of pensions is also likely to increase in the future. A 2015 study by researchers at the PRAXIS Centre for Policy Studies found that, by 2048, the state pension would be calculated on the basis of 70% of a person’s individual earnings over an entire working life (44 years) with the current pension system.
Also, the current pension index, which increases the state pension each year, takes into account changes in the number of contributors to the system but not the number of pensioners (currently 20% of it is based on the annual increase in the consumer price index and 80% on the annual increase of the social tax revenues).
To tackle the above challenges, the government has moved to reform the system.
Outline of pension reform
Preparations for change
Discussions and preparations for the reform began in 2015, involving interest groups and specialists. More in-depth discussions within the government started in September 2016 when a report, State old-age pension sustainability analysis (PDF), was published. Based on this the government had several options, including increasing the retirement age to 70 or tying it to life expectancy.
There were also discussions on how to change the first pillar (that is, whether to introduce a flat rate old-age pension or to tie the pension entirely to the number of years worked) and on whether the second pillar was sustainable. Changes to the pension indexation rules were also suggested.
In November 2016, the government lost a vote of confidence and resigned, but the new government has continued with the reform plans.
In January 2017, the new government agreed on changes to make the pension system more flexible and stable. These include:
- greater flexibility on when to retire, with the option to delay taking a pension, leading to higher benefits in subsequent years, and the option to retire earlier but with a reduced old-age pension (both alternatives would leave the total pension wealth unchanged);
- the opportunity to receive a partial pension, in addition to being able to choose the year of retirement,;
- tying the retirement age to life expectancy in 2027 (following the increase of the retirement age to 65 in 2026);
- linking the first pillar new entitlements to the number of years worked as of 2037, with a transition period from 2020 to 2036 – 50% from the insurance component (calculated on the basis of income) and 50% from the service component (on the basis of years worked) will be taken into account during the transition;
- making the indexation of pensions fully dependent on social tax revenue and on the number of pensioners as of 2023;
- the opportunity for cohorts born in 1970 to 1982 to join the second pillar (about a quarter of eligible people have not joined).
The government is also continuing with the reform of the special pensions paid to some groups of civil servants (such as judges, police officers, defence forces and prosecutors). The current system is not financially sustainable and is considered unfair compared with other pensioners. The final special pensions (apart from the presidential pension) will be abolished as of 2020. Moreover, it is also planned to abolish the special retirement regimes for workers in arduous or hazardous jobs, which currently allow such workers to retire earlier. Some 10% of pensioners receive this pension; the consultations are continuing.
Feedback regarding reform
Opinions of experts and the social partners
The Estonian pension system generally, and pension pillars in particular, have been a topic of discussion in the media, by policymakers, the social partners and experts.
This discussion gained momentum with the proposal by the Minister of Social Protection to increase the retirement age to 70 in 2040 (as well as making it more flexible). Coalition partners, opposition politicians, experts and trade unions criticised this idea, with some recommending a link between retirement age and life expectancy, with a trade-off of no correlation between life expectancy and healthy life years. The official retirement age may increase but it will not make the system sustainable if the effective retirement age does not increase.
Views of the social partners
The social partners have participated in several seminars on pension reform and support the overall reform plan. However, the Estonian Trade Union Confederation (EAKL) has also criticised the government for not starting a formal tripartite dialogue and consultation with the social partners on the proposals and the draft legislation.
EAKL has also suggested that the minimum pension should be at least 1.25 times higher than the absolute poverty threshold and that the average pension should be 55% of the average earnings, calculated from the three pillars. The Estonian Employers Confederation (ETTK) has made no public statements on the reform. The Estonian Taxpayers Association (EML) said that, if the future state pension no longer depended on the amount of social tax contributions, then it would be appropriate to establish a social tax ceiling for current taxpayers.
Other groups have also criticised the plan to decrease the income component in the pension calculations as it would penalise higher earners. However, the government argues that continuing with the current system would make the pension gap between high and low income earners unacceptably high. It believes the state pension should provide an acceptable income replacement for all workers, while the second and third pillar contributions reflect income differences and increase the pension for those with higher earnings.
EAKL, along with other experts, has emphasised the need to explore training and lifelong learning opportunities, and to consider the health and skills of workers so that they can be active for longer in the labour market.
Although the government has agreed on the proposals, the next step is to prepare the draft legislation, which should be finalised in the first quarter of 2018. According to the government’s good practice guidelines on engagement, all interest groups should be informed and consulted during the preparation of the draft legislation, thus giving the social partners formal opportunities for consultation. However, the trade unions keep reminding the government that they are interested in more comprehensive, ideally tripartite, consultations. Although the government has not responded to their proposals yet and there are no signs that they will do soon, the unions are not planning any industrial action.