Pension Reform: An assurance for a decent retirement or an additional tax burden?

Pension Reform: An assurance for a decent retirement or an additional tax burden?

Pension Reform: An assurance for a decent retirement or an additional tax burden?

The FINANCIAL -- On 6 August 2018, the Law of Georgia on the Accumulated Pension System was officially published in Georgia’s Legislative Herald, meaning that the law had already entered into force. The administration of the accumulated pension scheme and contributions will be launched from 1 January 2019.

Participation in the accumulated pension system is compulsory for employed people under the age of 40 years whilst it is voluntary for self-employed individuals and for those turning 40 years of age before the law had entered into force. All hired employees are automatically involved in the accumulated pension system with the exception of those individuals who turn 60 years of age (in the case of women, it is 55 years of age) before the law enters into force. However, an employee who turned 40 years of age before the law had entered into force is allowed to withdraw from the accumulated pension scheme. In order to do so, the individual has to send an official letter to the Pension Agency no later than within five months after joining the accumulated pension system. Otherwise, the individual will continue his participation in the pension scheme.

However, at least three months has to have passed before an employee is allowed to withdraw from the pension scheme.

The accumulated pension system envisions a 6% contribution. Specifically, an employee transfers 2% of his taxable salary to an individual pension account, an employer also transfers an additional 2% and the state budget contributes another 2%. A self-employed individual contributes 4% of his income to his pension account and the state contribution is again 2% in this case. If an annual salary of an employee or a self-employed person exceeds GEL 24,000, the state contribution decreases to 1%. Those participants in the pension scheme whose annual salary/income exceeds GEL 60,000 will not receive contributions from the state budget.

Participants in the pension scheme are allowed to receive money in their individual pension accounts after reaching the legal retirement age. A participant is allowed to receive accumulated funds monthly or withdraw all of the funds at once. Of additional note is that in the case of a disability (granting the status of a disabled person), a participant is allowed to request his pension before reaching the retirement age. In the case of the death of a participant, the money in his pension account will be transferred to his heir. Of further note is that a participant in the accumulated pension scheme will receive both the accumulated pension and today’s social pension as well upon reaching the legal retirement age.

In the nearest future, the Pension Agency LEPL will be established which will be in charge of administering and managing the accumulated pension scheme. Pension actives could be deposited in monetary forms, including in commercial banks, state bonds, debt securities or shares of enterprises, etc. The Pension Agency’s investment council will select pension assets management companies.

RISKS OF THE ACCUMULATED PENSION SYSTEM

Sustainability of the existing social pension system will be in question in the long run because Georgia is an aging nation and the number of pensioners increases annually. Therefore, budget expenses are also on the rise. In accordance with the state budget of 2018, nearly 18% (GEL 1,700 million) of total expenses are spent on pensions. The question arises as to whether or not the accumulated pension system is a solution. Today, the necessary precondition for the accumulated pension system to succeed – high figures of hired labour and income (average salary), as well as developed capital market – is absent in the country.

This reform will concern only a small part of the population. In accordance with the 2017 data of the National Statistics Office of Georgia, there are 1,706,000 employed people in Georgia. Of that number, nearly 52% (881,600) are self-employed. In accordance with sociological surveys, the majority of self-employed individuals considers themselves as unemployed. In addition, they usually do not have a stable monthly income.

Therefore, it is assumed that the majority of them cannot be involved in the pension scheme. Only 824,200 people are hired employees. Of those, only 327,700 persons are under the age of 40 years which constitutes only 21.8% of the total number of employed.

In accordance with the average salary of the employed, it is unlikely that the population will make any large savings with 6% contributions.

According to the National Statistics Office of Georgia’s data, the average monthly salary of hired employees is GEL 940 before taxation. FactCheck utilised an accumulated pension calculator created by GALTA&AGGART to give the following example. Hypothetically, an employee, whose salary is GEL 1,000 (before taxation), after making his pension savings for a period of 30 years (interest rate income is added to that amount) will receive approximately GEL 476 as a monthly pension for the next 15 years. This calculation also takes into account a 3% annual inflation. In addition, it is also assumed that the annual salary will increase by 10% every three years.

This reform will be an additional tax burden both for employees and employers. Pension contribution, in accordance with its official definition (mandatory, unconditional contribution to budget) is not a tax, because it is accumulated in a personal account and we receive the money once we reach the age of retirement. However, as pension contribution is mandatory for both the employed and the employers, it is indirectly an additional tax. Of note is that for an employer, it is an unconditional tax as opposed to an employee who gets his money back. This reform could make the workforce more expensive. Furthermore, additional tax will probably increase the number of informal labour contracts.

In the beginning, the accumulated pension system will increase budget expenditures because the state also participates in the pension contributions. In addition, the Pension Agency’s budget for the first three years will be fully provided by the state budget.

The Institute of Social Studies and Analysis studied the population’s attitude in regard to this pension system reform. In accordance with the survey, 88% of the surveyed respondents does not oppose the accumulated pension system although 64% supports the idea that participation in the accumulated pension scheme should be voluntary.

On the one hand, if participation in the accumulated pension system had been voluntary, the population’s participation therein would have been even lower and insufficient to secure any sustainability of the system. However, on the other hand, there was another choice – the state could have encouraged the population to join the pension scheme; for instance, by decreasing income tax. In this case, the accumulated pension system would have been voluntary whilst an employed individual would have had the motivation to join the system and participation would not have imposed an additional tax burden.