29 October 2015

OECD: Stocktaking of the tax treatment of funded private pension plans in OECD and EU countries

A different tax treatment between mandatory and voluntary contributions may be justified. Incentives to save for retirement through the income tax system may be necessary in voluntary pension arrangements as a way to encourage people to save in complementary funded private pension plans. In mandatory pension arrangements, the reasons for providing incentives may be less clear. Incentives may be useful in order to make people accept the policy of compelling them to save for retirement. Moreover, in countries with high informality, incentives may also be needed to increase contribution densities.

Most countries exempt from taxation returns on investment in private pension plans. When returns are taxed,  they  are usually  taxed  every  year  during  the  accumulation  phase.  However, some countries tax returns upon withdrawal only. Tax rates may vary according to the duration of the investments, the type of asset classes, or the income of the plan member. Most countries do not tax the accumulation of funds and impose no lifetime limit on the total amount that can be accumulated in a private pension plan.

The  tax  treatment  of  pension  income  is  identical  across  different  types  of  pay-out options  (life annuity, programmed  withdrawal or lump sum) in half of the  OECD countries and seven non-OECD EU Member States. Only two OECD countries incentivise people to annuitize their pension income through a more favourable tax treatment for annuities as compared to programmed withdrawals.  Conversely,  lump sums are tax-free up to a certain amount or only partially taxed in nearly half of the OECD countries and five non-OECD EU Member States in order to reach a more neutral tax treatment across the different pay-out options. A minority of countries discourage early withdrawals through the tax system.

Besides  the  personal  income  tax  system,  contributions  to  private  pension  plans  and private  pension benefits  can  be  subject  to  social  contributions.  In  general, contributions  paid  by  individuals  from  their after-tax  income  to  voluntary  personal pension  plans  are  also  subject  to  social  contributions.  Private pension  income  is usually  not  subject  to  social  contributions  or  only  a  part  of  the  social  contributions usually levied on wages and salaries is levied on pension income.

The  confusion  resulting  from the  complexity  of  the  tax  system may  have led some countries to introduce more  direct  financial  incentives  to encourage participation and contribution to  the  private pension system, especially for low-income people. Financial incentives considered here in include matching contributions  from  the  state  or  from  the employer,  state  subsidies  and  tax  credits.  These  incentives  are provided  to  eligible individuals  who  actually  participate  or  make  voluntary  contributions  to  the  private pension system. Such incentives can be found in 12 OECD countries and 2 non-OECD EU Member States.

This  stocktaking  exercise  will  be  extremely  useful  for  the  next  steps  of  the  project on  Financial Incentives  and  Retirement  Savings.  This  information  will  be  used  as input  to  calculate  comparable indicators across  countries assessing  the  value  of the tax incentive to  save  in  private  pension  plans  as opposed to traditional savings vehicles. Such indicators would allow for the examination of which design features may lead  to  higher  incentives  for  individuals,  whether  these  incentives  are  efficient  to promote retirement savings in private pension arrangements, and how much they may cost the Treasury.

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