Lowering Barriers in the Third Pillar

Insights from the AFM research into the risks for participants in the third pillar

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Summary

The Authority for the Financial Markets (AFM) signals that there are multiple barriers for consumers when purchasing a product in the third pillar. These barriers can hinder consumers or even lead to making unsuitable choices. By 'third-pillar pension,' the AFM means all products and services (referred to simply as products in this paper for readability) intended for the tax-facilitated and individual accumulation or payout of pension capital. In addition to the third pillar, there is the 'first pillar': a payout based on the General Old Age Pensions Act (AOW), and the 'second pillar': a pension via the employer.

The barriers identified by the AFM include low awareness, low accessibility, and low comparability. The AFM calls on providers of third-pillar products to think sector-wide about solutions to lower these barriers and to implement improvements. Currently, there are limited sector-wide initiatives involving all types of providers: banks, insurers, investment firms, (managers of) UCITS, and investment institutions (collectively referred to as providers in this paper). However, the barriers identified in this paper require a sector-wide approach. This paper is therefore addressed to all providers of third-pillar products.

This publication by the AFM is based on two studies recently conducted by the AFM: (1) an exploratory study into risks for consumers when purchasing a product in the third pillar, and (2) a study into the third pillar using CBS microdata (AFM 2023, 'Tax-facilitated accumulation of individual pension wealth in the third pillar'). The latter study shows that few consumers use the third pillar. For example, only 11% of self-employed individuals use the third pillar. These are primarily older workers and those with above-average incomes. It also appears that contributions are often limited and likely insufficient for an adequate lifelong payout.

Low Awareness

AFM research shows that approximately 7 out of 10 workers are unaware of the possibility of accumulating pension in the third pillar (AFM 2022, Consumer Monitor). The AFM sees several ways to increase awareness. Consistent naming of products can contribute to this. The AFM observes that different terms are used by providers for third-pillar products. Additionally, pension administrators in the second pillar could point participants to the possibility of building supplementary pension in the third pillar, for example, if pension accumulation is lower than the tax-allowed limit.

Low Accessibility

The accessibility of the third pillar is low due to complex fiscal rules and difficult choices, as revealed by the research. Consumers must first realize there is a pension shortfall, make a choice regarding the contribution amount, and ensure compliance with fiscal rules. Providers can assist with this. For instance, by providing an indication of the contribution needed to achieve a pension payout. Providers can also indicate the payout that follows from the capital. It is important that consumers have correct expectations about the payout they can purchase.

Low Comparability

Low comparability arises due to the variety of providers, the large number of products, and cost structures. Research shows that it is difficult for a consumer to see the big picture. Comparability can be improved by sector-wide, consistent explanation of product properties and their pros and cons.

Summary

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01 Background

The third pillar gives consumers the opportunity to build up or supplement a pension if they have no or insufficient opportunities in the second pillar mentioned above. There are many different products in the third pillar. The law distinguishes between life insurance, annuity accounts at a bank (bank savings) or at an investment firm (investing via execution only (EO) or asset management), and the annuity investment right. All these products are part of the third pillar due to fiscal conditions (such as maximum contributions, tax deductibility, and the inability to payout early without a fiscal 'penalty'). Anyone who can purchase a third-pillar product, i.e., both self-employed individuals and employees, is referred to as a consumer in this publication.

Reason for AFM Research

New fiscal developments may lead to growth in the third pillar. With the entry into force of the Future Pensions Act (Wtp), the maximum contribution to the third pillar is increased from 13.3% to 30%. Consequently, the fiscal space for consumers to build pension in the third pillar has increased significantly. Additionally, the Fiscal Old Age Reserve (FOR) was abolished for self-employed individuals as of January 1, 2023, and they are now dependent on the third pillar to build a pension tax-efficiently.

AFM Research in CBS Microdata on the Consumer Side of the Third Pillar

Due to the adjustment of fiscal rules, the AFM conducted research into which consumers use the third pillar and which do not. For this, the AFM used CBS microdata containing pension data at the individual level.

In the occasional paper 'Tax-facilitated accumulation of individual pension wealth in the third pillar,' the findings are presented. It appears that consumers make little use of the third pillar.

Exploratory Research into Risks When Purchasing a Product

In addition to the CBS microdata research, the AFM conducted an exploratory study into the risks for consumers wishing to purchase a product. In this research, the AFM spoke with various providers and other stakeholders. Reports regarding third-pillar products received by the AFM were also analyzed. This paper presents the findings and recommendations from the exploratory research.

Scope of the Sector

The research indicates that insurers and banks manage the most wealth in the third pillar. The AFM estimates the total size at €45 to €70 billion. This is small compared to the second pillar, which has a size of approximately €1,500 billion. Most pension payouts in the third pillar are temporary and not lifelong. Furthermore, consumers often invest with an investment firm or via the annuity investment right.

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02 Findings

The AFM research shows that the limited use of the third pillar is attributable to various reasons. Some consumers have insufficient financial or fiscal space to build pension in the third pillar. Others may have other income sources after retirement. Additionally, consumers' willingness to delve into pension matters and actually set aside wealth is limited. The AFM notes that barriers to purchasing a product in the third pillar do not facilitate this. The chance that a consumer is hindered or makes an unsuitable choice is increased by three barriers identified by the AFM: low awareness, low accessibility, and low comparability of third-pillar products.

1. Low Awareness

Approximately 7 out of 10 workers are unaware of the possibility of building a pension tax-efficiently themselves (AFM 2022, Consumer Monitor). Other research shows that nearly two-thirds of freelancers do not know what fiscal annual space is (GfK 2017, GfK Research on Knowledge of Annual Space).

The AFM believes that divergent naming within the third pillar among different providers does not contribute to awareness. The AFM observes that different terms are used, such as 'annuity,' 'individual pension,' 'bank savings,' 'supplementary pension,' and 'freelancer pension.' The use of different terms can be confusing for consumers.

2. Low Accessibility

Research shows that the third pillar has low accessibility. It is difficult for a consumer to make suitable choices. This includes the choice of a product, but also the initial realization that there is a pension shortfall, the choice to use the third pillar to fill this gap, and the amount of a sufficient contribution to fill the gap. When purchasing a payout product, consumers must also make various complex choices, such as the choice of payout duration. Few consumers use financial advice during the accumulation phase choices.

Fiscal conditions lead to additional complexity. For example, in the accumulation phase, the consumer must consider the maximum allowed contribution. In the payout phase, there are rules regarding the maximum height of the payout and the moment the capital is converted into a payout. Fiscal matters are complicated because certain data is sometimes unavailable or difficult to obtain for the consumer or provider, such as factor-A (the annual increase in the second pillar) from the past or the fiscal conditions under which capital was accumulated. Complexity is also increased because fiscal rules have been adjusted over the years. The AFM does observe initiatives by providers to help customers with fiscal complexity, such as accessible tools to determine annual space and assistance in finding factor-A.

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3. Low Comparability

A complicating factor in the third pillar is the low comparability of the offer. The offer is extensive and varied, for example, in the degree of security (saving, investing, insuring), the extent to which the consumer makes choices themselves (EO, advice, asset management), and additional product choices (such as counter-insurances, reinvesting after pension date with or without 'periodic fixed decrease,' self-investing, automatic risk reduction, rebalancing, and the payout duration of the payout). Additionally, seemingly identical products can differ, such as a temporary payout at a bank versus at an insurer. In the event of death, the remaining balance at a bank goes to the heirs, while the capital at an insurer reverts to the insurer (unless a counter-insurance has been taken out).

The large number of possibilities with complex consequences in the third pillar does not benefit comparability and accessibility.

Research also shows that the comparability of costs is low. Costs are incorporated in various ways and are often dependent on future investment results, interest rates, the number of transactions by the consumer, or the amount of the contribution or accumulated capital. Regulations regarding cost transparency also differ between different types of providers. It is difficult for consumers to make a cost comparison for the entire range of products in the third pillar.

Fiscal benefits do not apply to everyone. Providers in the third pillar often promote their products by pointing out fiscal benefits: a lower tax rate on payout after retirement (thanks to the 'reversal rule') and the absence of wealth return tax (vrh) on accumulated capital. Although the absence of vrh can have significant benefits for higher capitals, there are no fiscal benefits for every consumer. For example, when the consumer has little wealth in Box 3 and when the tax burden after retirement is hardly lower than before retirement (this can be the case for freelancers with lower incomes). Additionally, freelancers with lower incomes pay both on contributions and on payouts the contribution under the Health Insurance Act (Zvw).

Low accessibility can lead to suboptimal choices by consumers, for example regarding the type of product or the amount of contribution chosen. AFM research shows that savings products are relatively large in the third pillar. There may be reasons to choose saving instead of investing, such as a short term, high risk aversion, or a large financial dependence on the capital in the third pillar. However, various studies show that investing for the longer term with periodic contributions can yield higher pension capital than saving. If investing is chosen, the investment risk must match the risk an individual consumer wants and can take.

AFM research in CBS microdata also reveals that the average contribution to the third pillar is low. Employees without pension accumulation, for example, contributed a median of 5 percent of their gross personal income above the AOW franchise to the third pillar in 2019. Self-employed individuals contributed a median of 6 percent of their income. Such contributions are likely insufficient to purchase an adequate lifelong pension payout and may indicate a suboptimal choice. It should be noted that consumers may have other income sources after retirement or may not aim for a lifelong payout. However, AFM research shows that consumers struggle to determine a suitable contribution amount to achieve a specific pension payout. This contribution depends on many factors, including the type of product, product choices, and the consumer's financial situation.

03 Recommendations

With the adjustment of fiscal rules and potential growth in the third pension pillar, it becomes even more relevant to lower barriers for consumers wishing to purchase a product in the third pillar. Based on its initial findings, the AFM makes several recommendations that contribute to improving the awareness, accessibility, and comparability of the third pillar. Additional research into the influence of different barriers on consumer behavior can contribute to effective solutions. The AFM calls on providers to implement sector-wide improvements.

Show Indication of Pension Payout

It is important that consumers have correct expectations about the pension they can purchase from a contribution or from accumulated capital in the third pillar. The focus in information provision is usually on the capital. This can be improved, for example, by providing indications of the payout that can follow from a contribution or from the capital. Sector-wide agreements can be made on how the payout is calculated and presented to consumers in a uniform manner.

Provide Total Overview of Pension

There is added value in providing an accessible total overview of the financial situation after retirement. This can be done in various ways, including by the legislator expanding the mandate of Mijnpensioenoverzicht.nl by adding third-pillar pension. The total overview offers opportunities to improve the consumer's perspective for action and can increase awareness of the third pillar.

Use Consistent Naming

Consistent naming of the offer contributes to increasing awareness. Consistent naming also prevents confusion among consumers: it must be clear that it concerns a third-pillar product.

Provide Information on Fiscal Conditions

Information provision regarding fiscal matters in the third pillar must be clear and not misleading. As noted earlier in this paper, fiscal benefits can fall short, and fiscal conditions can change. Providers of products must take this into account in their information provision.

Inform Consumers About the Pros and Cons of a Product

Inform consumers sector-wide and consistently about the properties of a product and its pros and cons. This increases the comparability of the offer. Information should also be provided upon expiration regarding the different options available to the consumer. See also the AFM document: 'Guidelines for Information Provision on Third-Pillar Pension Products'.

Provide Perspective for Action from the Second Pillar

Pension administrators in the second pillar can point participants to the possibilities of building supplementary pension in the third pillar. This is especially important if pension accumulation in the second pillar is unforeseen or expected to be lower than the tax-allowed limit. For participants with these arrangements, it is extra important to point out the consequences of low pension accumulation and provide them with a perspective for action.

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The text of this publication has been compiled with care and is of an informative nature. You cannot derive any rights from it. Due to changing legislation at the national and international level, the text may not be up-to-date at the time you read it. The Authority for the Financial Markets (AFM) is not liable for any consequences – for example, incurred losses or lost profits – arising from or in connection with actions taken based on this text.