Portugal
compiled by Allianz Global Investors
Pension System Design
The pension system in Portugal consists of a dominating public pension pillar complemented by voluntary occupational pension plans and personal pension saving arrangements. The supplementary pension market is one of the smallest in Europe with an estimated growth potential of 6.9% annually to more than EUR 150 billion by 2020. Future growth will mainly be the result of a lowering of state pension benefits.
Public Pensions
Portugal has a fairly generous first pillar, which provides old-age benefits on an earnings-related basis. However, due to increasing financial constraints, numerous reforms took effect in January 2008. In 2006 the government issued a directive to reform the old-age pension system. The new law on social security came into force on January 17, 2007 and included the following changes:
- Linking pension benefits to life expectancy
To strengthen the financial soundness of the social security system and to cushion the effects from an aging population, changes in average life expectancy now directly affect the level of pension benefits. Beginning in 2008 a sustainability factor included in the benefit formula will adjust pension benefits according to average life expectancy, meaning that an increase in life expectancy will directly lead to a decrease of the benefit level.
- Extension of pension calculation base
The 2002 pension reform changed the benefit formula and extended the calculation base for retirement benefits from “the best ten out of the last 15 years” to average adjusted lifetime earnings, which will be effective as of 2017. Employees entering the workforce between 2001 and 2016 will be subject to a combination of the two formulas.
- Indexation of pension benefits
With the beginning of 2008 pension benefits are indexed to changes in the consumer price index and GDP growth. Previously benefits were adjusted according to the development of the minimum wage.
Contributions amount to 11% of income for employees and 23.75% for employers. The net replacement ratio is estimated to be approximately 69%.
The statutory retirement age is 65. Early retirement is possible at 55 in the case one has 30 contribution years with the pension being reduced for every year the pension is drawn earlier. For every year that retirement is postponed, the pension amount will be increased.
Occupational Pensions
Company benefit plans are not widespread, with only about 3.7% of Portugal’s 4 million workforce being included in occupational pension schemes. Especially large employers, formerly state-owned companies (electricity, telecommunication) and banks with a large staff provide voluntary occupational pension coverage. Only 1% of all Portuguese companies have a pension plan in operation.
In general, supplementary pension plans are provided on a voluntary basis. However, in several industries they were traditionally mandated by collective labour agreements, but this is no longer allowed in Portugal. State companies with public sector plans continued their schemes on a funded basis after privatisation. Therefore, the level of coverage may differ considerably between industries.
The vast majority of employees with a pension promise receive their benefits under a pension fund arrangement. Insured schemes are less important and are mainly used by small and medium-sized companies. Unfunded schemes are rarely found nowadays.
1. Pension funds
Occupational pension provision is provided by either a closed or an open fund. Closed funds relate to one single employer’s pension plan, groups of companies or by agreement between employers and trade unions. Open funds accept and invest money from any number of unrelated pension plans. Closed pension funds are the prevailing form providing benefits mostly of the defined benefit type.
Pension funds have to be managed by pension fund managing societies specifically created for this purpose, by mutual societies or insurance companies. Pension fund managing societies are prevailing and manage more than 95% of assets. The four biggest managing societies have a market share of nearly 70%.
Tax treatment of contributions and benefits
Employer contributions to a pension plan or an insured plan providing vested rights are tax-deductible up to 15% of salary. 25% of employee contributions attract tax relief up to an annual limit. The total amount of employer contributions will not be regarded as taxable income to the employee as long as:
- the plan is externally funded;
- the plan provides vested rights;
- the plan is non-discriminatory;
- benefits are paid as annuities;
- benefits are paid at the same time as social security benefits.
Annuities paid from a pension fund or an insurance contract are considered taxable income if the contributions to such a scheme are tax-exempt. Otherwise, only the interest earned and not the original contribution is taxable as pension income. In the case of lump sum payments upon retirement, the interest portion will be taxed as investment income.
Investment regulation
Portugal applies detailed quantitative investment regulations, but offers a comparatively generous scope for investment in equities, with a maximum equity exposure of 55%. This maximum exposure is far from being utilised by the pension funds.
Quantitative investment restrictions:
- Max. 5% in equity or loans issued by the same company;
- Max. 20% in equity or loans issued by the same group of companies;
- Max. 25% in property investments being used by the pension fund sponsor;
- Max. 10% in one single property investment;
- Max. 30% in stocks denominated in a foreign currency;
- Max. 55% in direct equity holdings;
- Max. 20% in bank term deposits and deposit certificates;
- Max. 60% in bonds and commercial papers other than those issued by a Euro country;
- Max. 30% in open or closed-ended, unitised or pooled equity bonds and mixed funds.
2. Group insurance contracts
Occupational pension schemes can also be funded by direct insurances. Small and medium-sized companies mainly use this funding vehicle.
Group annuity contracts are frequently used to fund benefits, but new insured plans now often choose the form of endowment plans.
Tax treatment of contributions and benefits
The tax treatment for direct insurance schemes is the same as for pension funds.
Investment regulation
The investment of assets by insurance companies is strictly regulated, imposing both minimum and maximum levels for investment in different asset categories.
Outlook
The process of pension reform can be expected to re-gather speed in the forthcoming years. The importance of the private sector will increase in future. The pension market is small and dominated by insurance products with a low coverage of occupational pensions. However, pension funds are legally established and are the prevailing funding vehicle for occupational pensions. Closed pension funds will be the main growth segment with a considerable inflow in the next years.