Finland
compiled by Allianz Global Investors
Pension System Design
The pension system in Finland is predominantly based on two complementary pension schemes. The National Pension is a tax-financed and means-tested public pension providing subsistence level benefits. The backbone of the Finnish pension system is a compulsory occupational pension scheme. Income from this earnings-related scheme, which is partly funded and partly pay-as-you-go financed, reduces the amount from the National Pension.
Voluntary occupational schemes and private pension savings are not well developed due to the dominance of the existing compulsory scheme.
Reform efforts to control the growth of pension expenditure in the longer term will increase the demand for supplementary pension coverage. We expect the second and third pillar pension assets to grow strongly with a compound annual growth rate of 7.3% to EUR 281 billion in 2020.
Public Pensions
The public pension system in Finland is based on the National Pension, which is intended to secure a minimum income for retirees whose earnings-related pension is small. The National Pension provides a flat-rate benefit of up to 20% of average wages in Finland, with minimum guaranteed income that is reduced by the amount of the earnings-related pension. Furthermore, it is residence-based; citizens qualify for it if they have lived in Finland for at least three years after reaching the age of 16. The number of recipients has declined continuously as the earnings-related scheme has developed. In 2005 approximately 50% of all retired persons received National Pension benefits.
In 2008 the maximum National Pension amounted to EUR 558.5 for a single pensioner. This amount is reduced to zero if a retiree has a monthly earnings-related pension exceeding EUR 1,154 (data refer to class I municipality). For married pensioners slightly smaller limits and amounts apply.
In principle, National Pension benefits are taxable income but certain pension income deduction amounts are granted. Hence, National Pension benefits remain tax-free.
Occupational Pensions
Compulsory occupational pension scheme
The statutory earnings-related occupational pension insurance is the backbone of the Finnish pension system, which is partially pay-as-you-go-financed but also consists of a funded part.
The administration the compulsory scheme is decentralised to pension providers such as insurance companies, company pension funds and industry-wide pension funds that are independently acting as private sector financial institutions. The Ministry of Social Affairs and Health as well as the Insurance Supervisory Authority supervise them. In 2009 the supervisory authorities will merge and a new supervisory structure for the financial and insurance sector will be established.
Only some administrative functions for the statutory pension insurance are carried out centrally by the Finnish Centre for Pensions.
Earnings-related pension provision is governed by several acts, each covering a certain group of employees, such as private sector employees, self-employed and public sector employees. In 2007, the pension acts for employees were unified into one act, the Employees Pension Act (TyEL), which covers more than two-thirds of the insured workers in the private sector.
The earnings-related pension is financed by contributions paid by both employers and employees. Under TyEL, the pensions act that covers most private sector employees, the average contribution rate in 2008 is 21.8%. The rate is unequally split between the employer and the employee. Employees aged between 18 and 52 pay 4.1% and those aged 53+ pay 5.2%. The employer bears the remaining lion’s share. The precise contribution rate for the employer depends on its size; the basis is the total wage bill. The employer takes out pension insurance for the employees with the pension company of its choice.
The pension benefits received by the pensioner are calculated on his accruals during employment. The accrual rates are dependent on the age of the employee and are a core element of the 2005 reform that targeted longer working careers and confronting early retirement.
The pension reform, which was implemented gradually from 2005 onwards, mainly focused on the following components:
Statutory retirement age
In 2005 the retirement age in Finland became more flexible. Previously, people were allowed to retire at the age of 65. As of 2005 the choice is left to the individual to retire in an age bracket between 63 and 68. Strong financial incentives to retire later were implemented (see pension calculation). Early retirement is possible as of the age of 62 linked to reductions of the pension income accounting for 0.6% per month.
The main objective of the pension reform was to postpone the average effective retirement age.
Consideration of life expectancy
As of 2010 a new mechanism will be implemented that takes into account changes in life expectancy. The life expectancy coefficient will have influence on the pension amount according to developments in life expectancy to keep the increase in pension expenditures under control by reducing benefits. The coefficient will react in both directions.
Pension accrual
The earnings-related pension accrues a specified accrual rate depending on the age of the employee. It increases with increasing age. Since 2005 earnings-related pensions already start accruing at the age of 18 instead of 23.
The accrual rates are as follows:
- 18 – 52: 1.5% per year
- 53 – 62: 1.9% per year
- 63 – 68: 4.5% per year
- 1.5% annually, working during retirement
A pension accrues from all earnings and is no longer restricted to 60 per cent of pensionable wage.
Until 2004 the following formula for calculating earnings-related pension benefits applied: 1.5% for those aged between 23 and 59 and 2.5% for those aged between 60 and 65. Raising the ratio to 4.5% for those aged 63 and older is a strong incentive for working longer and is therefore increasing pension benefits remarkably.
As the earnings-related pension is calculated as a percentage of annual earnings, wages and salaries need to be adjusted to the actual wage and price level at the time of the pension calculation in order to maintain real purchasing power. For this purpose a wage coefficient applies to earlier wages and salaries. The coefficient is calculated on the annual changes in the wage and price level with a weighting of 80% of wage development and 20% adjustment to movements in prices.
By contrast, the earning-related pension already in the payout phase is adjusted annually according to the wage and price level in a reverted ratio. The weighting is as follows: 20% of wage level and 80% changes in prices.
Contributions and benefits in the earnings-related scheme are directly awarded and paid by the chosen pension provider. Employees with several employers during their working life receive their pension from the pension provider at which they were insured last. Through a cost clearing system handled by the Finnish Centre for Pensions, the current actually-paying-the-benefit provider levies the employees’ previous pension providers.
Tax treatment of contributions and benefits
Statutory pensions are taxable income for the retiree. Income tax is paid to the State, the municipalities and the parishes. The taxation of pension income differs from that of wage earners’ income due to different tax deductions and social insurance contributions.
Voluntary occupational pensions
Due to the strong compulsory occupational scheme, voluntary occupational pension schemes in Finland are less common than in other European countries. Currently voluntary occupational pension plans apply to only about 15% of the workforce, mainly executives.
Voluntary plans often simply involve paying additional contributions into the compulsory system. Voluntary occupational plans are defined benefit schemes with the same accrual rates as the earnings-related part of the state pension system. Employee contributions usually amount to around 3% of salary. However, some plans only require employer contributions.
There are three funding methods for voluntary pension plans, which can also be used to finance benefits under the earnings-related pension system. These are:
- Pension funds
- Pension foundations
- Insured schemes
I. Pension funds and pension foundations
Pension funds and foundations play a minor role in the Finnish pension market. They account for only 15% of voluntary occupational pillar pension assets.
A pension foundation manages the contributions from employees of one single employer, while a pension fund covers the employees of several companies, normally in one particular industry. In both cases at least 300 members are needed to establish such a scheme. In general, full funding of pension liabilities is required for new schemes, an adjustment period applies for established ones.
Tax treatment of contributions and benefits
Employer contributions to a voluntary plan are fully tax-deductible and not regarded as taxable income to the employee. Benefit payments are subject to income tax although pensioners receive a tax allowance.
Investment regulation
In January 2007 a reform took effect, which introduced the Prudent Person Principle to the Finnish pension system. Until 2006 pension providers were allowed to invest up to 25% in equity. As of 2007 this share will be gradually increased in steps of 2% within the next five years, making an investment of 35% in equity in 2012 possible. Further on, the new regulation will also liberalise investments in alternative assets and in non-OECD countries.
II. Group insurance schemes
The overwhelming majority of compulsory and voluntary occupational pension schemes in Finland are financed by group insurance contracts. As in all Scandinavian countries, the pension market in Finland is highly insurance-oriented, with insurance companies holding approximately 85% of all occupational pension assets. These are tightly controlled by a handful of mostly local insurance companies. Employers must choose group insurance contracts if they have fewer than 300 employees covered under a plan.
Outlook
Finland has significantly reformed its statutory pension schemes in recent years. The commanding objective of the changes undertaken was to improve the sustainability of the system.
Further aspects of the reform implemented in 2007 aim at strengthening the competition between pension funds and pension insurance schemes and at changing the management structure of pension companies. The reform is expected to create a completely new pension landscape in Finland.
The Finnish pension system and market have a rather unusual design compared with other European countries. The earnings-related portion of the first pillar is partly funded and managed by private companies, which makes it a unique model in Western Europe. Finland is the only country in which the third pillar is more popular than the second. Despite these differences, the set-up of Finland’s pension system aims to diversify the sources of retirement income, which is in line with general Western Europe trends.