Pension to depend on years worked

Photo: Toomas Huik

The government decided yesterday to change the system of pensions to tie I pillar pension to years worked instead of level of income. Ministers also reached an agreement on the special pensions reform that will abolish special pensions of Defense Forces members, prosecutors, police and border guard officials from January 1, 2020. All current special pensions and those of people who take office before December 31, 2019 will be retained.

“It is our task to give people certainty they are protected against poverty in their old age. This means the system of pensions must ensure sufficient income that does not reflect great differences in wages,” said Minister of Social Affairs Kaia Iva (IRL).

In order to ensure solidarity, the government has agreed to change the system of calculating pensions. This means that instead of the current insurance component based on income, people would only collect the so-called seniority component that depends on years worked after a transitional period.

“The result is a system of pensions that consists of the I pillar based on length of working life, II pillar that depends on social tax, and the voluntary contributions a person makes to the III pillar,” the minister said.

The ministry told Postimees that existing I pillar units will not be recalculated.

The reform will also make it possible to choose when to retire, take out only a part of pension, freeze pension payments and resume them at will. The national retirement age will be tied to average life expectancy in 2027 to keep the pension system in line with demographic developments and make it possible to pay equivalent pensions as the population shrinks.

Changes will not concern today's pensioners or existing pension units. The latter will not be recalculated, while pensions will be calculated based solely on the seniority component as from 2037.

I pillar pension is currently made up of the base component, seniority component – collected before 1998 – and from 1999 the insurance component. The base component is a fixed sum that is the same for everyone.

The base component has historically made up around one-third of the average pension. The insurance component depends completely on salary, while the seniority component takes into account years worked. Income inequality of pensioners has so far been four times lower compared to the working-age part of the population.

This difference would be translated into pensions in the future. Average sums of the highest 20 percent and the lowest 20 percent of pensions would differ up to fourfold in the future (the difference is currently 1.7 times).

Reduced solidarity would lead to a situation where people with modest income today would be paid very low pensions.

Pensions are limited by the state's financial capacity that depends on the number of working-age people and the social tax they pay.

The population is estimated to fall from the current 1.3 million people to 1.11 million by 2060. The number of 18-36-year-old people will fall by 256,000 or 32 percent. Number of people over the age of 63 will grow by 106,000 or 41 percent.

Comparing the number of workers and pensioners suggests that if over the past 20 years Estonia has had more than two workers per pensioner, that coefficient will fall below 1.3 by 2060, higher retirement age taken into account.

The social and finance ministries will now put together draft legislation to amend the State Pension Insurance Act to be presented to the government in the first quarter of 2018.