Tax-facilitated accumulation of individual pension wealth in the third pillar

An analysis of the consumer side based on CBS microdata

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Contents

Summary 3 01 Introduction 6 02 Data 7 03 Workers with contributions in the third pillar 9 04 Contributions in the third pillar over the years 20 05 Conclusion 22 References 23 Appendices UNDER 24 EMBARGO

Summary 3

In addition to the first pillar (AOW) and the second pillar (supplementary pension accrual via the employer), the Dutch pension system also includes the third pillar: individual supplementary pension provisions. The relevance of the third pillar may increase soon due to the planned expansion of fiscal space in the new pension system. The Pension Act for the Future (Wet toekomst pensioenen) takes initial steps to achieve a work-form-neutral pension framework for all workers by eliminating fiscal differences between the second and third pillars where possible. Given the increasing relevance of the third pillar, the AFM wishes to have a good picture of the market. However, little is known about the current size and usage of the third pillar. To obtain a more complete picture of the consumer side of tax-facilitated third-pillar products, we investigate which Dutch citizens use the tax deduction for third-pillar products and which do not.1

For this purpose, we use CBS microdata. Individuals are classified into socio-economic categories (SEC), such as employee or self-employed.

1. Strictly speaking, there are 'products' and 'services' in the third pillar. For the sake of readability, we use the word 'product' in this report.

Dutch workers appear to hardly make use of the opportunity to build up personal pension wealth in the third pillar in a tax-facilitated manner. Approximately 5% of employees and 11% of the self-employed2 had any amount contributed to the third pillar in 2020, for example by purchasing an annuity.3,4

11% 5%

• SEC: employee
• SEC: self-employed

5% of employees and 11% of self-employed build up pension wealth in the third pillar in 2020.

2 The results in this article for employees and self-employed are without any hybrid workers. Hybrid workers are defined as workers with income as both an employee and a self-employed person. 3 In 2016-2019, this share was comparable for both employees and self-employed. 4 A part of the employees (approx. 5%) and self-employed (approx. 17%) has no annual space by definition in 2020 because the income is lower than the AOW franchise. If they have unutilized annual spaces from the previous 7 years, they can make use of the so-called reserve space. For Dutch workers with a personal gross income of at least the AOW franchise, we find that 5% of employees with some accrual in the second pillar in 2019, 7% of employees with no accrual in the second pillar in 2019, and 13% of self-employed made any contribution to the third pillar in 2020. Without this income threshold, we find that in 2020 almost 5% of employees with some accrual in the second pillar and 6% of employees with no accrual in the second pillar built up pension in the third pillar.

Summary 4

Self-employed and employees seem to contribute money to the third pillar for multiple years. Of the Dutch citizens who used the fiscal scheme to build up personal pension wealth in 2020, almost 9 out of 10 did so at least 2 times earlier in the period 2016-2019. Individuals who contribute for multiple years often do so with the same (or a comparable) amount as the previous year.

Older people and people with higher incomes make more frequent use of the fiscal opportunities in the third pillar. Of the employees who are 50 years or older, 8% made any contribution to the third pillar (compared to 3% of the group of 21-49-year-old employees). Of the self-employed who are 50 years or older, 14% made a contribution to the third pillar (compared to 8% of the group of 21-49-year-old self-employed). Also, workers with higher incomes make more frequent use of the fiscal opportunities in the third pillar. Of the employees with a gross personal income of at least 1.5 times the median5, almost 10% made any contribution to the third pillar (compared to 3% of the group earning less than 1.5 times the median) and of the self-employed almost 20% (compared to 7% of the group earning less than 1.5 times the median).

• SEC: employee
• SEC: self-employed

Older people and people with higher incomes make more frequent use of the fiscal opportunities in the third pillar.

5 In this study, 1.5x median is equal to €54,750 (= 1.50 * 36,500).

Moreover, the contributions are often limited. Approximately 4 out of 20 employees (with any contribution in the third pillar) contribute less than €500 per year, 14 out of 20 employees contribute an amount between €500 and €2,500, and 2 out of 20 employees contribute more than €2,500. For self-employed (with any contribution in the third pillar), 1 out of 20 contributes less than €500, almost 10 out of 20 self-employed contribute an amount between €500 and €2,500, and approximately 9 out of 20 self-employed contribute more than €2,500. Besides absolute amounts, we are also interested in the relative contribution for individuals with any contribution in the third pillar. Employees contribute (median) 1.8% of their gross personal income above the AOW franchise to the third pillar. If we break this down by pension accrual in 2019, it appears that employees without pension accrual in 2019 contribute (median) 4.8% of their gross personal income above the AOW franchise to the third pillar. For employees with pension accrual in 2019, this is (median) 1.6%. Self-employed contribute (median) 6% of their income. For comparison, in large pension funds, the premium is usually between 25 and 30% of the pensionable salary. This comparison comes with an important caveat, namely that the maximum premium space for third-pillar pension products is currently 13.3%.

< €500 own contribution per year

• €500 - €2,500 own contribution

• €2,500 own contribution

1.8% 6%

Left: Employees contribute 1.8% of their income above the AOW franchise to the third pillar in 2020, for self-employed this is 6%. Right: Amounts that employees and self-employed contribute to the third pillar in 2020.

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5

There are various explanations for the limited use of the opportunity to build up personal pension wealth in the third pillar. Possibly, people have no money left, find it important to maintain flexibility, or find it (too) complicated. Other data sources also show that about 7 out of 10 working respondents state they are not aware of the annual space to supplement pensions.7

Also, part-time employees often have little to no annual space compared to full-time employees with a comparable income because the AOW franchise, unlike the fund-specific franchise, is independent of the part-time factor. Additionally, there are other opportunities to build up pensions. For example, self-employed could use the old-age reserve until the end of 2022.8

7 Own calculation based on data from the AFM Consumer Monitor: Representative Netherlands. 8 It is not possible for users of CBS microdata to investigate the use of the old-age reserve by self-employed. The Central Bureau of Statistics (CBS) conducted research on this itself in early 2021 – see Accumulated income in own enterprise (cbs.nl). This research showed that in 2019, 78 thousand persons who earn profit in their own name (e.g., a sole proprietorship or as a freelancer) built up an old-age reserve via their own enterprise (average €5.7 thousand; median €5.5 thousand).

Also, people who may expect a low pension income relative to their current income make more frequent use of the fiscal opportunities in the third pillar. The expected pension income in this study is defined as a fully assumed AOW benefit (first pillar) increased with the old-age pension to be achieved (second pillar). Of the self-employed with an expected pension income that amounts to a maximum of 60% of their current income, 15% make any contribution to the third pillar. This is while 6% of the group of self-employed with an expected pension income between 60 and 80% of their current income make any contribution.6 A comparable picture is seen among employees. We first look at the group of employees who did not build up pension in the second pillar in 2019. Of these employees with an expected pension income that amounts to a maximum of 60% of their current income, 11% make any contribution to the third pillar. This is while 3% of these employees who expect a pension income between 60 and 80% of their current income make any contribution. Next, we look at employees who did build up pension in the second pillar in 2019. The percentages for these groups are 8% (pension income <60% of current income) and 4% (pension income between 60 and 80% of current income).

6 These two groups are not directly comparable. The share with a current income of at least 1.5x median is significantly higher among self-employed with an expected pension income that amounts to a maximum of 60% of their current income (almost 50% versus almost 5%).

Summary

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01 Introduction 6

The relevance of the third pillar may increase soon due to the planned expansion of fiscal space in the new pension system (Memorie van toelichting Wet toekomst pensioenen, 2022). In contrast to employer pension (second pillar), little is known about the current size and usage of the third pillar. To obtain a more complete picture of the consumer side of tax-facilitated third-pillar products, we investigate who makes use of the tax deduction for products in the third pillar and who does not. For this, we use CBS microdata.9 Below, we give a brief overview of relevant studies previously conducted and then clarify the focus of the present research.

Earlier policy-related research among Dutch workers focused mainly on employees and/or self-employed with low accrual in the second pillar – see for example CBS (2018, 2022) and Biesenbeek et al. (2022a). In 2022, De Nederlandsche Bank (DNB) looked at the characteristics of workers without accrual in the second pillar for the period 2016-2020 (Biesenbeek et al., 2022b). This group appears very constant over time. Shortfalls are hardly compensated with other forms of wealth, and the third pillar appears to be mostly a supplement to the second pillar, not a replacement. Deloitte had previously looked at self-employed without employees to investigate whether they compensate for reduced pension accrual (Deloitte, 2020). This research shows that this group of self-employed can count on earlier pension claims to a limited extent, has significantly more wealth on average than employees, and can fall back on their partners' pensions to a lesser extent than employees.

9 In addition to the first pillar (AOW), second pillar (employee pension), and third pillar (voluntary, individual pension products), the Netherlands also has a fourth pillar. This consists of free savings and investments, as well as accumulated wealth in one's own home (Biesenbeek et al., 2022b).

01 Introduction

There is also academic research on voluntary pension accrual in the Netherlands. Beusch & van Soest (2020) identify seven different groups of self-employed. There appears to be much variation between these groups in terms of income, wealth, and pension accrual. Notably, permanent self-employed do not necessarily have to fare worse during retirement than employees, despite the lack of employee pension. Beusch & van Soest (2020) use data from the income panel research of the Central Bureau of Statistics for the period 1989-2017. This dataset contains information on a (representative) part of the Dutch population, in contrast to the integral picture of the present research.

To determine the adequacy of pension accrual in the Netherlands, Knoef et al. (2016) and Knoef et al. (2017) use the same dataset as Beusch & van Soest (2020). They include various wealth components, including contributions to the third pillar. From Knoef et al. (2016), it appears that the role of the third pillar in the total predicted pension benefit is small, but nevertheless, a considerable part of the Dutch population has made any contribution since 1989, namely 33%. Until a major tax reform in 2001, everyone could do this under tax-favorable conditions, but afterwards, this was only possible for self-employed and individuals with incomplete pension accrual.

In the present research, we do not estimate the total accumulated wealth in the third pillar. We look at the tax-facilitated contributions in absolute amounts and relative to the gross personal income reduced by the AOW franchise. This measure approximates the contribution of an individual to the employer pension. The focus of this research is on the characteristics of individuals with any contribution in the third pillar and not on whether this is sufficient. Also, investigating why people do not fully utilize the possibilities of the third pillar is not part of this research.

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02 Data 7

In this chapter, the various steps to arrive at the analysis dataset are briefly described. Additionally, we present the definition used in this study for gross income and annual space.

Selection of individuals

The starting point is persons belonging to the population of the Netherlands on January 1, 2020. Subsequently, we take the following steps in sequence:

• Selection #1: We remove persons in institutional households,10 private households without observed income, and persons without personal income.
• Selection #2: Based on the socio-economic category (SEC) determined by the CBS, we select workers and self-employed and identify hybrid workers. Hybrid workers are defined as individuals who have received income both as an employee and as a self-employed person. We remove hybrid workers from the dataset. The results presented in this article for SEC: Employees and SEC: Self-employed are therefore exclusive of hybrid workers. SEC: Self-employed can be further split into SEC: Director-majority shareholder, SEC: Self-employed entrepreneur, SEC: Other self-employed, and SEC: Working family member. The share of these groups with any contribution in the second and/or third pillar is presented in Table 7 in the Appendix.
• Selection #3: Since wealth components are only available at the household level, we select only the main earner without partner, main earner with partner, married partner, and unmarried partner. We exclude children, other household members, and individuals whose household is unknown.

10 This refers to institutions where persons (in principle) will stay for a longer period and are provided with daily necessities in a commercial manner. For example, nursing homes, prisons, etc.

02 Data

• Selection #4: We remove all individuals younger than 21 and older than 66 years on December 31, 2020.

The effect of each of these steps on the number of observations is presented in Table 1.

Table 1. Effect of the applied selections on the number of observations (x 1000) in the dataset in 2020.

Selection	Total	SEC: Employee	SEC: Self-employed	Hybrid workers
Start	17,408	Not applicable	Not applicable	Not applicable
Selection #1	9,784	Not applicable	Not applicable	Not applicable
Selection #2	Not applicable	6,471	1,141	338
Selection #3	Not applicable	5,777	1,080	307
Selection #4	Not applicable	5,749	1,029	303

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02 Data 8

Annual space for people working part-time

In contrast to the franchise used for employee pension, the height of the AOW franchise is independent of the part-time factor. As a result, the annual space for people working part-time is lower than for people working full-time with the same pensionable salary.

A considerable part of workers works part-time, see Figure 1. Of the employees with a gross income between the AOW franchise and 1x median (€36,500), about a quarter has a part-time factor of at most 0.60.

Figure 1: Part-time factor (y-axis left) by income for employees in the Netherlands in 2020.

Part-time factor Avg. Obs. (x 1,000) Count (x 1,000)

0.0 0.2 0.4 0.6 0.8 1.0 1.2

Gross personal income [17500; 20000) 0 100 150 200 250 300 350 50 [20000; 22500) [22500; 25000) [25000; 27500) [27500; 30000) [30000; 32500) [32500; 35000) [35000; 37500) [37500; 40000) [40000; 42500) [42500; 45000) [15000; 17500) [45000; 47500) [47500; 50000) [50000; 52500) [52500; 55000) [55000; 57500) [57500; 60000) [60000; 62500) [62500; 65000) [65000; 67500) [67500; 70000) [70000; 72500) [15000; 17500)

In a stylized example where we assume an accrual rate of 1.875% with a fund-specific franchise of €13,500 and no contribution for the fiscal old-age reserve, a person with a total income of €36,500 and a part-time factor of 1.0 has an annual space of almost €500. A comparable person, but with a part-time factor of 0.6, has an annual space of €0. Without pension accrual (i.e., factor A is equal to 0), this is almost €3,200 in this example.

Applied definition for gross income

In this report, we follow Knoef et al. (2017) for the definition of personal gross income. This implies that we reduce the personal gross income as defined by the CBS11

“The personal gross income includes income from labor, income from own enterprise, and benefits from income insurance and social provisions. The gross income includes the contributions of employees, employers, benefit recipients, and benefit institutions in the premiums for social insurance.”

by the contributions of employers and benefit institutions in the premiums for social insurance.

Annual Space

When we speak in this article about contributions to the third pillar, we mean everything that can be deducted in the income tax return as a deposit for pension and/or annuity.12 The height of the contribution depends on the available annual space.13

The available annual space can be calculated using the following formula:

annual space = (13.30% x premium basis) – (6.27 x factor A) – F

• The premium basis is the total income minus the AOW franchise. The AOW franchise was €12,472 in 2020. The maximum pensionable salary was €110,111 in 2020. The maximum premium basis in 2020 is therefore €97,639 (= €110,111 – €12,472).
• Factor A is the amount by which the employee pension has accrued.14
• The term F stands for the fiscal old-age reserve.

11 See Personal gross income and section 4.5 of 4. Income concepts. 12 This concerns the variable INPPH770OUP from the microdata file INPATAB. 13 To be precise, the height of the contribution depends not only on the available annual space but also on the reserve space. We do not distinguish between these in this study. We are only interested in the height of the contribution. 14 In a premium scheme, this is slightly different; here you multiply the pension premium for the accrual of a lifelong old-age pension by an age-dependent factor.

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03 Workers with contributions in the third pillar 9

In this chapter, we present the results of our analyses. We start this chapter with the share of workers who built up any (tax-facilitated) pension in the third pillar in 2020. Subsequently, we investigate whether groups can be identified based on observable characteristics that contribute more or less frequently any amount. We end this chapter with the height of the contribution.

Both in absolute amounts and related to gross personal income and the expected pension to be achieved.

Share of workers with any contribution in the third pillar

Almost 6% of workers made any (tax-facilitated) deposit to the third pillar in 2020. For example, by purchasing an annuity. If we break this down by socio-economic category, it appears that approximately 5% of employees and 11% of self-employed made any contribution to the third pillar. As indicated in Chapter 2, hybrid workers are not included in these percentages.15

Characteristics of workers with any contribution in the third pillar

On an individual level

Some groups of employees and self-employed contribute more or less frequently than average to the third pillar. Summarized, we can say that older people, persons with a high level of education, persons with a high income, and men make more frequent use of the fiscal opportunities in the third pillar. For example, about 8% of employees and 14% of self-employed older than 50 years made any contribution to a third-pillar product in 2020. Furthermore, Figure 3 shows that especially persons with a high level of education make use of tax-facilitated pension building in the third pillar. Additionally, it appears that persons with higher incomes make more frequent use of the fiscal opportunities in the third pillar. Of the employees with a gross personal income of at least 1.5x median, almost 10% made any contribution, whereas this is almost 20% for self-employed. Women appear to be underrepresented. Approximately 2% of female employees and almost 7% of female self-employed made any deposit to a third-pillar product in 2020.16

Figure 2: Share contributing to the third pillar in 2020 split by age.

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%

Age: 21-39 Age: 40-49 Age: 50-59 Age: 60+

• SEC: employee
• SEC: self-employed

16 The differences between men and women are (likely) attributable to composition effects. Women in the Netherlands often work part-time, meaning they have little to no annual space – see Chapter 2 for a more extensive explanation.

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Figure 5: Share contributing to the third pillar in 2020 split by gender.

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0%

Gender: female Gender: male

• SEC: employee
• SEC: self-employed

At the sector level

Besides age, gender, education level, and income, there are also differences between the sectors in which one works. Figure 6 shows that employees in the sectors 'Wholesale', 'Business services', and 'Government, defense' contribute more frequently to the third pillar, while employees in the sectors 'Health, spiritual and social'...