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Pension reforms in Latvia: background summary

Pension reforms in Latvia

Characteristics of the Latvian system

  • Soon after regaining independence in 1991, Latvia started to reform its pension system. Today Latvia has a three-pillar pension system. The first pillar is a compulsory, unfunded state pension scheme. All those who pay social contributions are included in this pillar. The contributions are used to pay the pensions of the existing generation of pensioners. The second pillar is a state-funded pension scheme. Part of the compulsory social contributions are channelled into this pillar and then channelled into the investment plan chosen by the individual; the pension plan manager then invests this in the financial markets. The savings and any increases in the value are accumulated in an individual account for each person. The third pillar is a voluntary pension scheme which allows one to make contributions personally or through the employer to private pension funds (this pension is accessible from the age of 55). Specific to the Latvian system is that there is no ceiling for the state pensions and retirees are allowed to work after reaching the retirement age while already receiving a full pension. Finally, income tax is applicable to pensions over 235 EUR (rate is 23%).
  • The available data (from 2014) show that the average old-age pension in Latvia is 266.26 EUR. Overall there are approximately 472,000 people who receive the state pension, a number which has to be looked at in the light of some particularities of the Latvian pension system. Since there is no ceiling for pensions, there are some who receive large pensions (it has been reported that the biggest pension in Latvia reaches up to 19,000 EUR per month. At the same time, in 2016 it was reported that more than 20,000 pensioners receive a pension that is lower than 100 EUR per month. The data show that a large majority of the retired population receive a very small pension and the vast majority of pensions are below the average rate. For example, in 2015 more than 300,000 pensions (by far the majority) were between 200 and 300 EUR per month. Overall, this shows the remarkable level of inequality in the pension system and how it contributes to the overall level of social inequality in the country. In addition, pensions in Latvia are small due to the fact that the ‘pension floor’ (minimum pension) is dependent on the individual’s work record, and the pension rates for less than 41 years of work are relatively low.
  • Under the first pillar (compulsory, unfunded state pension scheme) the logic of funded pensions has been transferred to public pensions by giving participants a hypothetical or virtual account which contains all the contributions made throughout their working life. These notional contributions are accumulated at a given rate of return. At the time of retirement, the benefits are calculated by dividing the amount in the account by the cohort life expectancy. Participation in this pillar is mandatory for all in employment and self-employment (but voluntary for those who do not work). Overall, employees pay 7.5% of their salary towards their pensions and employers pay 12.5% of employee’s salary towards pension. Benefits paid under the state pension scheme are subject to income tax (23%).
  • The second pillar, which began operating in 2001, works on a defined contribution basis. Participation in this pillar is mandatory for new labour market entrants and employees under 30 at the time of entry. The mandatory contribution rate to this pillar was reduced from 8% to 2% during the financial crisis; then in 2013 and 2014 it was raised to 4%, in 2015, 5%, and in 2016, 6%. The contributions to the second pillar were initially managed either by the State Treasury or by private companies, who then invested these funds in various financial mechanisms (securities, investment funds, equities, etc.). However, the option of State Treasury management was eliminated in 2007 and since then only private company management is available. Private asset management companies (usually banks) can offer three funds with different risk/return policies (conservative, balanced or active funds). In contrast to many other CEE countries, in Latvia there is no requirement for pension funds to guarantee a certain minimum income; on the contrary, doing so is explicitly prohibited. Since the pillar is considered to constitute part of the state pension system, lump sum payments are not allowed. Instead, when reaching retirement age, participants have to choose between using the accumulated capital to purchase annuity from an insurance company or moving the investment to the ‘first pillar scheme’ and via a special scheme the payout can be received together with the normal state pension. The contributions to this pillar are also taxed (at the ordinary income tax rate).
  • The third pillar is a voluntary pension savings scheme. Here the pension plan is concluded directly between the participants and providers. However, occupational plans are very unpopular among Latvian employers. It has been reported that only about 5% of Latvian companies offer their employees voluntary occupational arrangements. Nevertheless, there are recent indications that the third pillar has become more popular and the contributions paid into this scheme have significantly increased in recent years, reaching record heights in 2015. There are tax advantages to contributions to the third pillar, with contributions up to 10% of the employee’s annual income being tax-deductible. Investment income is taxed, while benefits are tax-exempt up to a certain limit. The investment rules for the third pillar are similar to the second pillar but more flexible, allowing, for example, investment in real estate; however, guaranteeing a rate of return is similarly prohibited.

The main changes in recent times:

  • The retirement age is being gradually increased (a process which began in 2014) by three months per year until 2025 when it will reach 65 years. In 2016 the retirement age was 62 years and nine months, meaning that in January 2017 it has already increased to 63 years. The early retirement age (two years before reaching the normal retirement age) is also being gradually adjusted.
  • Under Latvian law, retirement is possible five years before reaching the retirement age in cases where a person has raised five or more children (or has been a guardian to five or more children) or has raised a child with a disability. In 2014, the insurance period (the period for which social contributions have to be paid in order to retire) was reduced from 30 to 25 years.
  • For situations where an individual has not requested their pension on time (i.e. at the moment they became eligible), the legislator introduced the right to request the pension retroactively for payments from (up to) the six preceding months.
  • In 2014 the minimum insurance period requirement for obtaining an old-age pension was increased from 10 to 15 years. From 2025 the minimum required insurance period will be 20 years.
  • In 2015 the parliament introduced a united pension scheme for state security enforcement officials. According to the amendments, the right to the special retirement pension for such officials begins at the age of 50 if the length of service has been at least 20 years, of which at least the last five have been served in the position of state official. This scheme covers the employees of the Constitution Protection Bureau, the Defence Intelligence and Security Service and the Security Police, and while the old regime was applicable only to some employees within these institutions, the new scheme covers all of them.
  • In 2016 the parliament adopted changes to the disability pension system in order to remedy the situations where, due to delayed disability expertise, a person loses their pension for a period of time. The new law provides for an automatic extension of the pension for six months in cases the expertise is delayed. The legislator also aligned the disability pension with the old-age pension in situations where a person starts to receive the latter instead of the former. In such situations the new (old-age) pension cannot be lower than the disability pension which has been received up to retirement age. A similar adjustment was introduced in the summer of 2016 for state officials who have a right to the special early retirement pension (those working in security institutions, the police, etc.).
  • Since 2016, in cases where the individual has not worked the necessary minimum period of time to receive their old age pension (15 years), there is no longer an obligation to exceed the retirement age (63 years) in order to receive the social insurance benefit (64 EUR per month; only 6.3 EUR lower than the pension of a person who has worked 15 years).