Pension Saving / Individueel Pensioensparen / L’épargne pension individuelle – Belgium
Save a limited amount of money each year on a dedicated ‘Pension Savings’ account. You get a discount of 30 % on your income taxes.
Banks, insurance companies and government scream “30 % tax profits” to you. Seems like a no-brainer, no? But there are expenses, taxes (later on) etc. Let’s calculate the total picture instead of looking only at the 30 % upfront tax benefit.
Note: this post is applicable in Belgium only, it discusses the Belgian fiscal law in 2018.
I have started a pension fund in 2000. I am now 52 years old, and according to today’s law I can retire at age 67, so 15 years from now. I want to calculate the result of saving this year (2018), in my pension fund. Or are there better alternatives?
The rules of the game
Step 1- saving
- Use your personal (after tax) money to put into a pension fund.
- You cannot choose any fund, it has to be of type ‘pension fund’. You can choose between the category ‘TAK21’ (insurance fund, interests, no risk) and ‘TAK23’ (investment fund, risk, stock and bond market)
- The fund I have chosen in 2000 is “BNP Paribas B Pension Balanced Classic” of type ‘investment fund’.
- There is an entry fee of 3 % (for my specific fund, funds can have different fee’s). So you get a 30 % tax refund but you also immediately get a 3 % cost to pay. You do not receive any service or benefit in return for that entry fee. It is a commision for the bank.
- The amount to save is limited by government rules. In 2018 it is 960 EUR for the maximum benefit of 30 %. So you are encouraged by our government to save for the old day, but you are not supposed to save proper amounts, only tiny bits.
- After putting your 960 EUR of savings on your account, you can write this amount on your annual income statement and you will receive 30 % x 960 = 288 EUR discount on the income taxes + city taxes (‘opcentiemen’). For my town these city taxes are 7.7 %, so another 22 EUR is saved in city taxes.
- From now on, your money is blocked or locked-in on your account. You cannot touch it before age 60. That is one of the stupid things: you give away your hard earned after-tax money to lock it up into another account where you cannot use it and you will have to pay taxes afterwards a second time.
Step 2: wait, get old, and pay the bank
Each year, your bank will charge a fee to look after your savings. It is not clear what the added value of that fee really is, since most funds are less successful than the average passively / not managed index tracker fund. My Fortis fund charges 1,24 % per year. That seems peanuts but it is charged each year, so after 15 years you have paid more than 18% in bank expenses. Half of my tax advantage goes up in smoke before I receive back my savings!
For comparison: the best index tracker funds charge 0.04 % per year. Fortis charges 31 times this amount!
Step 3: taxes
This used to be step 3: taxes were charged when you retire; but governments have the tendency to want more money sooner. Therefore they have rewritten the rules and now started collecting taxes in 2015 (regardless of your age). From 2015 untill 2019, they take away 1 % of your fund each year. It’s called ‘anticipative tax’. Isn’t that a beautiful eufemismn? Our dear government anticpates that you would like to pay taxes, therefore you can already start paying now instead of waiting until you retire!
This anticipate duty is charged not only on the real savings, but also on a compounding virtual return of 4,75 % on your savings.
At the age of retirement you will pay another 3 % of taxes (to come to a total of 8 %).
During the years when your fund goes down, you are three times a looser: You have losses on your savings, you pay taxes on the savings (8 % in total), and you pay taxes on virtual savings which don’t even exist!
Step 4: retire
Starting at age 60 you are allowed to take your savings. The taxes are charged on the savings ( + taxes on 4,75 % virtual savings) at that moment. If you continu to save until 65 then there are no additional taxes on the added amounts. You are not allowed to take the money and keep on saving. It’s either collect your savings and stop, or keep all the money in the account and continu to save.
You can’t have your cake and eat it.
Case 1: I contribute to the pension savings account this year
I receive the tax benefit of 30 % + 2 %. But I also have to pay:
- 3 % entry fee to the bank
- 1.24 % annual bank expenses x 15 years
- 8 % taxes on savings + on virtual amount of 4.75 % annually compounding
My pension savings account looks like this:
|Age||Added Savings||Savings account||Taxed amount|
|53 --> 65||931 --> 2091|
|60||1491||1350 --> -108 € tax (8 %)|
|65 - received savings||2091|
My ‘contribution’ at age 52 is really 650 € (I put 960 in the savings account, but I receive 288 + 22 = 310 € back from less income taxes). At age 60, I will pay 108 in taxes. At age 65, I will receive a net amount of 2091. Before you start jumping up and down from excitement, realise that inflation by then (2032) will make everything 51% more expensive than today.
So the real return on investment is:
- net contribution = 650 €
- out (in real purchase power) = 2091 / 1.51 = 1385.
- That’s a return on investment of 1385 / 650 = 113 % over 15 years = 5.2 % annually or 2091 / 650 = 222 % = 8.1 % annually before inflation correction. Not too bad.
Case 2: I do not contribute to the pension savings account this year
…but I put the money (without the tax benefit of course) in an index fund. I took the most well-known and easily available index, the S&P 500 index, and calculated the annual total return for the 30 – year period from 1988 until 2018. For the same period my pension fund went up 7.0 % annually and the simple index tracker went up 10.3 % annually. The difference between these two is because:
- the pension fund takes a huge fee each year: 1.24 %. If you know that the annual return of the fund is 7.0 %, then this 1.24 % means 15 % ( = 1.24 / 8.24) of your profits go up in smoke each year!!
- the pension fund is not allowed to go 100 % in stocks, it keeps a certain amount of money in bonds and in cash. Over the long term, this makes a difference in performance. But you being a simple belgian citizen have no choice: you can only choose amongst the available ‘pension funds’ and none of them is an index tracker.
Anyway the result is this:
|52||650||649||0.12 % on ETF|
|53 --> 64||649 --> 2317||zero|
So we invest the same amount as case 1, and still end up with 2317 € after 15 years. On top of that, in case 1 the money in the pension fund is locked up until age 60 and in case 2 it obviously is not locked up.
Now you could wonder if the same is true if you would contribute at other ages. The older you are, the less benefit you have from the index fund, because the miracle of compounding needs some time to do is work. And the tax benefits occur immediatly. After 60, pension saving provides only tax benefits and no additional taxing. The evolution of your contribution through age is like this:
Until age 56, there is an advantage to not using the ‘pensioensparen’ and just invest yourself in an index fund. After age 56, pension saving has an advantage.
Bonus question: what to do at age 60: take the money or add contributions until 65?
- Saving in the pension fund gives us 288 + 22 = 310 € tax advantage. But we still have to pay the 3 % entry fee, and the 1.24 % fund fee each year. You can have this tax advantage 4 times, from age 60 till 64.
- Saving in an index fund gives us the full 10.3 % annual return. That is 3.3 % more than the pension fund. Depending on the amount of money in the pension fund, 3.3 % can be more or less than 4 x 310 € tax advantage. Where is the break-even point?
Using simple math, the break-even point is when the account x 3.3 % = 1240 €. Which equals to 1240 € / 0.033 = 37576 €.
More than 38 k € in the account? Better take it out and put in an index fund. Less than 37 k € ? Better keep it in and take the annual tax saving.
|Pension Fund||Index Fund|
|to Taxes||-310 + 108 = 202 tax gain (return)||no tax profits (miss the 310 tax advantage)|
|to Bank (Fund)||3 % + 15 x 1.24 % = 18 %||typically 0.1 % annual x 15 = 1.5 %|
|Saldo at age 65||2091 €||2314 €|
|Saldo inflation adjusted||1385 €||1532 €|
|Annual Real Return||5.1 %||5.9 %|
So despite the big tax savings at the start, this is like the story of the rabbit and the turtle.
The pension savings plan is the rabbit. It takes a huge 30 % leap at the start. But then it falls asleep: each year, it takes a chunk away from your savings for the benefit of the bank, and the total return is lower compared to a simple index fund.
The index fund is the turtle. At the end, the slow but steady and higher returns of the index fund wins the race.
Only if you’re close to retirement (from age 57 on), the tax advantage wins from the higher index returns and it is better to save in a pension savings fund.
Who is the big winner of pension saving? The funds! (banks, insurance companies, ..). They receive a large amount of money without having to do much commercial effort. The word spreads that pension saving is a ‘must’ and people come with their money to the fund without much questions. And if people have questions, they are easily waived with the explanation of the 30 % tax savings. No wonder that all banks happily remind you at the end of the year not to forget your pension saving!
Pro and Cons of pension saving
- You do save each year. You make it a habit. “Save and forget” can be good thing.
- You do receive a 30 % tax benefit (but you also pay 8 % extra taxes).
- At the age of retirement, you do have a nice extra bonus saved. 5.1 % real (after-inflation) return isn’t bad at all. It is actually good.
- You use after-tax money on which you already paid the world’s highest tax rates (30 % soc security employer + 13 % soc security employee + up to 50 % income taxes + city taxes). And you lock that hard-earned money in a fund and pay a second time taxes on the same after-tax money.
- If you need the money for a very good reason (suppose your kids want higher education and you desperately need the money, or you see a very good real-estate investment opportunity, or you want to start up a business, whatever, ..) you cannot touch it. It was your money in the first place but you agreed to lock it up.
- The returns are not that good compared to other saving or investing formulas, because of high bank fee’s and mandatory fund composition
Search in the above brochure of Belfius bank for their annual expenses on pension saving ? Oh, they forgot! Their annual expense ratio is between 1,61 % annually (!!) for their balanced fund, to 1,32 % + 3% entry fee for their ‘High’ fund.