Denmark
compiled by Allianz Global Investors
Pension System Design
The Danish pension system is composed of a tax-financed and means-tested public pension pillar, two statutory occupational schemes, voluntary occupational and voluntary private pension savings. Voluntary occupational pension plans are in fact mandatory, given collective agreements between social partners. In 2006 approximately 73% of the workforce participated in any kind of supplementary occupational pension plan.
With both compulsory and voluntary occupational pension schemes in operation, Denmark already has a very strong second pillar market. The market is highly insurance-dominated and further growth, estimated at an average rate of 5.4% annually, will result mainly from performance and regular contributions rather than from new reforms. Pension assets are expected to grow to EUR 437 by 2020.
Throughout the 1980s and 1990s Denmark overhauled its pension system in an attempt to cope with its forthcoming demographic challenge – despite the comparatively small problem it faces. The reforms focused on introducing and strengthening the funded elements of the pension system. The overall goal was to increase the level of pension income generated by the second pillar system, and to ease pressure on the governmental budget. In November 2000, the early retirement system was overhauled and early retirement was made less attractive.
As Denmark has mostly succeeded in making its pension system financially sustainable in the long term, there is no need for major pension reform.
Public Pensions
The so-called “folkepension” is a universal means-tested basic pension financed by general tax revenues and it consists of three elements:
- Annual basic amount – is reduced only if labour income is received
- Pensioners supplement - labour income, capital income and spouse income reduce the supplement
- Supplementary pension benefit – means-tested
The legal claim to receive public pension benefits is subject to certain conditions. The payment is linked to Danish citizenship and permanent residency in Denmark for at least three years between the ages of 15 to 65. Exemptions apply for foreign nationals that have lived in Denmark for at least ten years, five of which must be immediately before the pensionable age. In July 2004, the statutory retirement age was lowered from 67 to 65. However, in 2006, the government proposed to raise the statutory retirement age to 67 again starting in 2017 over an eight year period. Accordingly, the age limit one can qualify for early retirement will be increased to by two years to 63. From 2025 onwards, the statutory retirement age will be indexed to life expectancy taking into account increasing longevity.
Occupational Pensions
Compulsory occupational pension schemes
In addition to the national pension scheme there are two statutory pension schemes: 1. the supplementary earnings-related scheme (ATP) and 2. the Special Pension (SP). Both schemes are funded and externally managed.
1. ATP
Employees aged between 16 and 65 are covered under the scheme. The contribution is determined on an annual basis by the management board of the ATP, which is made up of employer and employee representatives.
All wage-earners in Denmark with more than 9 hours of paid work per week pay ATP contributions to step up the pension from the national scheme. The employer pays two-thirds of the ATP contribution, and the employee one-third. For a salaried employee with 37 hours of work per week, the monthly contribution amounts to DKK 74.55 (EUR 10.13). The amount depends solely on the number of hours worked. The maximum contribution for a full-time employee in the private sector has been unchanged since 1996 at EUR 361 a year, which corresponds to 1% of the earnings of an average full-time employee. Pension benefits depend on how long contributions were paid and accounts for a maximum of 41% of the state basic pension. The pension is paid out either as a lump sum if the balance is small or in the form of an annuity and is subject to taxation.
2. Special Pension
Employees and the self-employed are required to contribute 1% of gross income to the Special Pension scheme (SP). Benefits become payable at the age of 65. Depending on the accumulated amount, the scheme pays one lump sum or for larger sums installment payments over a ten-year period.
Contributions to both schemes are tax-deductible.
‘Voluntary’ occupational pension schemes
Even though, there is no statutory requirement for additional occupational pension provision, plans that have been introduced by collective agreement by the relevant employer associations and unions are compulsory for all companies covered by the agreement with only limited opt-out opportunities. This additional second pillar is well developed with about 80% of the workforce contributing to a ’voluntary’ scheme. On average, the contribution rate amounts to 15% of income with the employer contributing 2/3 of that rate. The overwhelming majority of these schemes (more than 90%) are defined contribution schemes. The importance of collectively bargained agreements is growing rapidly for both blue-collar and white-collar employees.
Both compulsory and voluntary occupational pension plans must be externally funded either by an insured arrangement or a pension fund. Bank schemes are additionally available.
Pension funds
Only about one-third of voluntary occupational schemes in Denmark are funded using a single company pension fund, the vast majority use an industry-wide pension fund, where all employees in the same industry contribute to a single fund. The company pension fund is playing an ever-diminishing role. This reflects the Danish industrial structure with many small and medium-sized companies making the industry-wide pension funds more cost-effective.
Tax treatment of contributions and benefits
The way in which employer contributions to a pension scheme are treated depends on whether it is an annuity scheme or a scheme providing a lump sum payment.
In the case of an annuity scheme, employer contributions as well as employee contributions are tax deductible. However, in the case of a lump sum benefit, the total amount of tax-deductible contributions (employer and employee contributions) is limited and employer contributions are taxable to the employee. Pension contributions are also subject to a labour market contribution tax of 8%.
Benefits earned from annuity schemes are fully taxed as ordinary income. Lump sum payments are taxed at a flat rate of 40% at the time of payment.
Interest earned by pension funds and pension savings plans investing in bonds or equities is taxed at a flat-rate tax of 15%.
Investment of pension funds
Although there is no legal requirement to appoint an investment manager, most companies do so. The appointment is usually made by the board of directors of the pension fund.
Regulations regarding asset allocation stipulate that as much as 50% of the funds can be invested in equity. The supervisory authorities can raise this limit to 70% upon request from the pension fund, after reviewing, for example, the pension funds reserves and risk management procedures.
In practice, over half of assets under management are invested in bonds and only about 20% in equity.
There is a minimum return guarantee of between 2% to 5% imposed on pension fund investments, depending on when the employee entered the pension fund scheme. Employees having entered the scheme after July 1, 1999 have a minimum return guarantee of 2% a year, for those who entered between July 1, 1994 and July 1, 1999 the guarantee is 3% and employees having entered before July, 1 1994 have a minimum return guarantee of 5% a year.
Group insurance schemes
Insurance arrangements are the most popular form of funding for voluntary occupational schemes in Denmark, as well as for the mandatory ATP schemes, with about two-thirds of voluntary occupational schemes being funded by insurance schemes.
Tax treatment of contributions and benefits
The tax treatment of contributions and benefits of group insurance schemes is the same as for pension funds.
Investment of insurance schemes
As with pension funds, there is the same minimum return guarantee imposed on insurance scheme investments of 2%-5% depending on when the employee entered the insurance scheme.
Gains above the guaranteed return are usually used to increase the insured benefits. However, the fund is allowed to return bonuses to the employer.
Although insurance companies are allowed to invest their funds with the view of obtaining the highest possible return, the following investment regulations apply:
- At least 30% of the investments have to be invested in secure assets such as government bonds
- Investment in equities may be up to 50% or even up to 70% if permission is granted by the supervisory authority
- Investment in one single company is restricted to 30%
Bank schemes
Retirement benefits can also be funded through a bank using special savings accounts, which are also applicable for third pillar pension provision.
Outlook
The Danish pension system is mainly based on funded pension provision through the earnings-related portion of the public pillar. With their high coverage, voluntary occupational pensions also play an important role. Defined contributon schemes dominate the occupational market, and the funded public tier is also of the defined contribution type. Clearly, Denmark has followed the two main pension market trends in Western Europe: funding and the shift towards defined contribution schemes. Coupled with relatively favourable demographic development, this demography-resistant pension system set-up has ensured the system’s sustainability.
Clearly, Denmark has followed the two main pension market trends in Western Europe: funding and the shift towards defined contribution schemes. Coupled with relatively favourable demographic development, this demography-resistant pension system set-up has ensured the system’s sustainability.