Over the past months, we have been asked several times questions about the upcoming pension reform. Here are some answers.
For whom is the contribution to the fund mandatory? Who can join/contribute to the fund?
All those individuals who receive their salary net of taxes because their employer pays the income tax for them are automatically enrolled in the fund. Those who are 40 or more years of age will have – after 3 months in the fund – the possibility to opt out. However, this “window” to opt out will close after the 5th month in the fund. Those who are self-employed and pay their own income taxes, can also choose to join the fund. No one else can join and/or contribute, even if he/she wants. This includes inactive, unemployed, workers receiving a salary unofficially (on which the employer is not paying taxes), and self-employed not paying taxes.
I am an employee. By how much will my monthly salary decline? I fear my employer will transfer the cost of his/her contribution to me.
The law prohibits the employer from decreasing your current salary to offset his/her contribution to your pension account. So, let’s assume that your employer will not cut your salary to transfer the cost of the employer contribution to you. Assuming you have a monthly gross income of 1000 GEL, you currently receive 800 GEL, net of taxes. After the introduction of the reform, 20 GEL of your gross income will go to the pension fund. Your employer will add another 20 and the government will do the same. Your taxes (20%) will be calculated on the remaining 980 GEL. This means that at the end of the month, you will receive 784 GEL instead of 800 GEL. The decline in your net disposable income will therefore be 16 GEL out of 800. To be fair, this is not a real cost, because the amount in the pension fund is still yours. Actually, if you consider also the amount in the pension fund (60 GEL) your total net labor income will increase from 800 to 844 GEL.
As time passes (when you sign a new contract or when you change jobs), however, an employer may consider contribution costs when deciding what salary to offer. This means that your salary may grow less than it would have in the absence of pension reform. The final outcome will depend on your bargaining power, and on the employer’s. In the worst-case scenario (the employer reduces gross salary enough to be in the same position, salary-wise, as he was pre-pension reform), and the decline in your monthly salary will be higher. If you were receiving 800 GEL net before, your net disposable income now would fall to 772 GEL. However, now you also have 59 GEL in the pension fund (for a total of 831).
By how much will my monthly earnings decrease after the introduction of the tax if I am a self-employed?
Assuming you have a monthly gross income of 1000 GEL, currently you receive 800 GEL net of taxes. After the introduction of the reform, 40 of your 1000 GEL will go to the pension fund (with the government adding another 20). Your taxes (20%) will be calculated on the remaining 960 GEL. This means you will receive 768 GEL instead of 800 GEL. However, now you have 60 GEL in the pension fund, for a total of 828 GEL.
What will be my monthly pension at the time of retirement?
The value of your monthly pension at the time of retirement will depend on many factors: the investment choices of the asset managers, the performance of government bonds and stocks in the domestic and international markets, the number of years you will have been contributing to the pension fund, your monthly labor earnings, your life expectancy at the time of retirement, and the amount of the flat state pension paid by the government. If you want to have an idea of the value of your monthly payment from the fund (in today’s GEL) you can go check it on ISET-PI’s website. We have prepared a calculator to answer this question.
Once you know the estimated value of the monthly payment that you should expect from the fund at retirement, add the current value of the state pension (180 GEL) to have an estimate of the overall pension you can expect.
When I get to pension age, if I receive money from the pension fund, will the government still pay me the flat state pension?
In the draft law there is no indication that the government will stop paying the flat state pension to those receiving payments from the pension fund.
Will the money I will put in the fund be indexed to inflation?
The return on the money invested in the fund will depend on the performance of the assets that will be bought by the fund managers, and from the amount of the management fees paid to the fund managers. It is fair to say, however, that in normal market conditions you can expect the return on your investment to exceed the inflation rate, especially if you consider the government contribution and that of your employer (to the extent that the cost is not “transferred” back to you), which already constitute gains for you.
Can I be confident that I will have back at least the capital I invested in the fund?
At this stage the draft does not include any information about whether the investment strategy of the fund will be designed to ensure capital is always protected, or whether the government will take this risk upon itself. However, as mentioned above, the risk of loss of the invested capital can be considered relatively low.
Is there any guarantee that government is not going to steal my pension, like happened with Soviet pension accounts?
There can never be such guarantee. The current government is doing what it can to make it as difficult and unlikely as possible that your money could be stolen, by creating a separate fund, not managed by the government, in which each contributor will have an individual account. Because it is an individual account, it becomes your personal property. Of course, there is still the (remote) possibility that a government in the future will decide to change the law regulating the pension fund, reducing the benefits or even expropriating the fund’s assets. This, however, would require a very strong government and (likely) the support of most of the population. The more successful the reform is, and the higher the number of individuals with significant savings in the pension fund, the lower the risk of such a development will be.
What happens to the money I have in my pension account if I die before retiring?
If somebody dies before reaching the retirement age, the amount will go to their heirs. This happens also in case the death of a beneficiary occurs before his or her individual account’s capital is totally distributed.
How large will be the cost for the government?
First, we have to distinguish between monthly gross incomes up to 2,000 GEL, and monthly gross incomes between 2,001 GEL and 5,000 GEL.
Nominally the government pays 2% of the gross income the employee or self-employed person receives, up to 2,000 GEL of monthly gross income. In reality, the impact on the public budget will be larger, because of the non-taxable nature of the contribution to the pension fund. The reduction in tax revenues associated with this provision will cause the government to lose an additional 0.8%, for a total budget burden equal to 2.8%.
The negative impact on the government budget associated with each GEL exceeding 2,000 GEL and up to 5,000 will be 1.8% (because both the employee and the employer will continue paying 2% - and getting a 0.4% tax credit – while government’s direct contribution will decline to 1%).
The cost for the government will be even higher for public employees, as the government will have to pay both its share and the employer’s share. In this case, the costs for the government will amount to 4.4% of gross monthly salaries up to 2,000 GEL, and 3.4% of gross monthly amounts between 2,001 and 5,000 GEL.
In aggregate terms, this reform will definitely increase government expenditures in the short and medium term, as tax revenues will decline and payments to the pension fund will increase.