Tõnu Palm, Chief Economist at Luminor Eesti

Tõnu Palm, Chief Economist at Luminor Eesti

The pension reform gives people more freedom and also greater responsibility in respect of their future retirement savings. More freedom of choice, whether in the world of investments or in the economy on a broader scale, is necessary for a functioning market economy and therefore certainly a good thing.

Healthy competition motivates entrepreneurs to constantly develop new, more attractive offers of value. Let’s consider the legendary first smartphone iPhone 1, which completely changed the global consumers’ understanding of a phone. All other manufacturers were forced to follow suit and all in all, everyone got their slice of the pie. People buy more phones, the volumes of data exchange are growing exponentially and the increasingly more exciting 5G and 6G solutions keep broadening our understanding of what’s possible. Most people cannot imagine their lives without smartphones anymore, because it’s an elementary fundamental need, as is the Internet. Those who don’t believe me should try turning off the Internet connections of their children’s smartphones for a day. I reckon they’ll really hate you for this.

Likewise, Tesla has jolted the giants of the automotive industry into thinking big, because the solutions that bring cleaner air and silence to modern cities will win in the end. So who will give us cheap aircraft (for the prevention of traffic jams), AIs that teach state governance as well as the art of living as such (see the film Ex Machina), or teleportation services?

Competition and innovation always go hand in hand and serve the interests of society. It’s clear that there will also be interesting technological changes in banking and pension systems that will benefit customers.

If we highlight the biggest positive impact of the pension reform planned by politicians (the extent of which is more than a billion euros), then paradoxically it’s not the tug of war about the service charges of funds, but the change in system of pension payouts, which will allow people to withdraw all of the money at once when they retire. It’s important that according to the reformers, this can be done free of income tax, which really makes sense.

This completely changes the competition in comparison with the present situation. The customer can now decide for themselves: if there are no attractive competing solutions on the market, they can invest their hard-earned savings themselves.

This is obvious to people who know a thing or two about the economy. However, very few people know right now what will happen with their savings when they reach retirement age. What will the returns on their investments be like and can they leave the invested money to their heirs, or will everything be thrown into one big pot to make soup? Ordinary people, especially younger ones, simply give no thought to what will happen to their retirement savings sometime in the distant future.

Withdrawal of money is a solution that creates competition. It makes service providers make an effort to keep the money people have already saved, as they may decide to withdraw the money and use it for consumption (medication and medical services) or buying property, put it in an investment account or invest it in funds of funds and pension insurance. We have clearly taken a step back to capitalism, which is clearly more successful than socialism and the lack of freedom of choice.

Using the option to work longer and to reinvest the money saved in the second pillar also during retirement allows people to earn real extra income, which will improve the lives or seniors. The possibility that pensioners can withdraw the money free of income tax in their retirement will create real competition, which will motivate service providers to offer attractive competing options for keeping money in funds for longer and earning real returns.

The accumulated price increase in the last 10 years was 26%, so added value is only created by returns that exceed this. Most funds have exceeded the price increase significantly and the funds that dominate among these are the aggressive ones that invest more in equities. Go to the pension fund website (pensionikeskus.ee/statistika/ii-sammas/kogumispensioni-paevastatistika) and you will see that is pays to save smartly. The world of investments depends largely on the ups and downs of the global economy and forecasting the future is a difficult and complicated job. It’s important to choose smartly at all times, which means that it pays to be informed about the developments in the global economy and to consult your friends and specialists. There will never be a recipe that always works in the world of investments, but young people should not try to avoid risks and opt for the most conservative fund. As people approach retirement age, they should become more conservative and start valuing money more than equities.

The second pillar will actually become considerably more attractive and people’s desire to contribute less to the pillar (for example, by paying envelope wages) will also decrease. Those who contribute honestly should not share their income in the pension pillars under the slogan of solidarity with those who are ‘optimising’ their taxes and therefore not contributing as much as they should. The dependence of pensions on income earned (not years worked) would motivate young people to make an effort and save whilst supporting the weaker ones with social benefits and offering them a minimum standard of living from the first pillar will create a safe and healthier society. If we take away the motivation to make an extra effort, there is no reason to expect people to want to save and be enterprising. Redistributing under the slogan of solidarity reduces the motivation to make an effort and contribute honestly to the development of the state. We must reward those who decide to contribute to the second pillar and save honestly for their retirement, which will reduce the number of voters who are dissatisfied and susceptible to populism.

People have loved telling pension funds off for their low returns, but this is generally not true. Everyone should also look in the mirror and think about the fund choices they have made.

The returns of many pension funds have been pretty good (I am certainly happy with the returns of the fund I chose) and service charges have been a relative non-issue for me next to the returns of the fund. If the fund did not earn an income that exceeds inflation, I would certainly be looking for an alternative.

Service charges are, of course, important in the case of long-term investments, but the selection and return of the investments are even more important. Investment service is not a free lunch – we also pay for medical services or having our cars fixed. Banking is expensive, there’s no way around it.

All in all, I want to say that the second pension pillar will become an even more attractive choice for the savers who don’t have the time, skills or interest to constantly keep themselves up to date with the somersaults of the global economy. Let’s imagine what would happen in the head of a private investor if the year 2008 came around again and the markets started the day with a 20% minus and the annual decrease would reach 50%.

Would we have the wisdom and guts to make the right investment choices in a situation like this? The fund managers who have seen the previous crises are probably better prepared for the turbulence that may occur on the financial markets. Also, funds cannot make emotional decisions, as the investment framework sets its own restrictions. We are currently experiencing the longest period of economic growth and, as well all now, growth is followed by decline.

However, these relatively rare risks don’t mean that we should keep the people who are saving for retirement on a leash. Coping in extraordinary situations is difficult for many funds as well. In the longer term, there are no free lunches and the systems that look the strongest can turn out to be inefficient or fail to work as intended.

My personal opinion is that allowing people to use investment accounts is certainly a positive initiative: competition will make saving solutions even better. Constant changes and developments are good for the clients as well as the market participants, because we will be competing with global solutions in the future. The world of investments changes constantly and we must keep up with the competition.

Even if a beginner investor has to suffer some small losses, it is better from the viewpoint of financial education and policies if the new generation started thinking about saving and investing as early as possible. Investing will keep the new generation interested in proper news and consuming educational media, which will mean better political choices in the future, whether they concern environmental protection or the climate. The only thing I don’t support is doing away with compulsory saving. Why create another opportunity to consume when people are already consuming too much!

The authors of the idea certainly deserve praise. For the first time, people will be able to withdraw their retirement savings when their reach retirement age and reinvest them as they choose (in their children, property, funds, medication and so on).

The consumers and providers of the service will win in the long-term from solutions that remain competitive among the solutions offered by other countries in the eurozone, as attractiveness will bring in more money.
This is a purely personal opinion and it may not be correct. I am not too knowledgeable about the area of pensions, because it does not feature among my interests and I don’t follow the discussions. At the same time, it gives me the angle of an observer. Most people don’t know right now to what extent investing in the second pillar will be made better and more profitable, because solutions depend on details. I also have many ideas of how to make the system even better, but let them wait for the future. All I can say is that Luminor will start offering interesting solutions that support investing. But more about them later!
Tõnu Palm
Chief Economist at Luminor Eesti