Today marks five years since the first second pillar payments were made following the pension reform. Whilst the money withdrawn from the second pillar before retirement age has been used primarily for consumption, the portfolios of investors who have continued to save have grown on average more than twice in size over five years.
If a person had accumulated 10,000 euros in the second pillar by September 2021, their average gross salary over the last five years had been 2,000 euros, they have consistently contributed 6 per cent to the second pillar (a personal contribution of 2 per cent and a state top-up of 4 per cent*), and their second-pillar fund achieved an average market return (8 per cent**) over the period from 1 September 2021 to 31 August 2026, the 10,000-euro portfolio has grown to more than 23,000 euros as of today. The person who decided to withdraw their saved 10,000 euros, however, received 8,000 euros in their bank account after paying income tax.
“Money withdrawn from the second pillar before retirement age has mainly been spent on consumption, meaning that the financial security of a great many Estonian people has taken a significant hit,” said Vahur Vallistu, Chairman of the Management Board at LHV Varahaldus.
He emphasised that past performance is no guarantee of future outcome and that the strong growth in portfolios in recent years has been driven primarily by the very rapid rise in global equity markets. This certainly illustrates the importance of consistency when investing.
“The average return on second-pillar pension funds of Estonia has been below inflation only three times in the last twenty years. In other words, its purchasing power has increased,” said Vallistu.
The return of pension funds fluctuates in line with the economy. In some years it may be very good, whilst in others it may be a little more modest. At the same time, there are periods when actively managed funds outperform, and then again when index funds do. According to Vallistu, the most important thing is for investors to invest their second pillar savings in a fund that is in line with their actual risk appetite.
“Saving in the second pillar and building financial security for your retirement is a process that takes place over decades. In most cases, people remain motivated when they know exactly what strategy is being used and in which asset classes their assets are being invested,” noted Vallistu.
From 2024, it became possible to increase personal contributions into the second pillar. Estonians who have already embraced this solution have taken the next step towards long-term growth of their portfolios. However, there are also nearly 280,000 people in Estonia who have withdrawn money from the second pillar.*** According to Vallistu, there are many who regret their decision and, under the current conditions, are waiting for 10 years to pass before joining the second pillar scheme again.
“It is definitely worthwhile for those who have left the second pillar to continue saving independently, for example, in a tax-efficient way through the third pillar and, at some point to consider saving again in the second pillar. The train hasn’t set off to build a secure future,” said Vallistu.
Contributions to the III Pillar qualify for an income tax refund of up to 15% of your annual gross income, but not exceeding €6,000 per year.
For example, over a period of twenty years, a person earning the Estonian average gross salary of 2,200 euros can, by making a 10 per cent contribution (6 per cent personal contribution and 4 per cent state top-up), based on the average annual nominal return of second-pillar funds (4.6 per cent since 2002****) and an average annual wage growth of 3 per cent (the Ministry of Finance’s long-term forecast), will have accumulated over 100,000 euros by retirement age.
According to Vallistu, mainly due to the demographic situation in Estonia, coping with the future is increasingly the responsibility of each person.
“Analyses indicate that Estonian employees face one of the sharpest falls in income upon reaching retirement age in the European Union, and in the future, the average state pension will amount to just under a third of the average gross salary. That is probably enough to meet only basic needs, but not for a dignified retirement,” said Vallistu.
* For those who have joined the Second Pillar, the portion of social tax transferred to the First Pillar is 16% (as 4% is allocated to the Second Pillar), compared to 20% for non-members. For Second Pillar members, the value of the solidary component per year is up to 0.8, while for non-members it is up to 1.0.
** Geometric mean annual rate of return on the second pillar overall index for the period from 1 September 2021 to 31 August 2026.
*** Source: Pensionikeskus statistics on applications for fund withdrawal and suspension of contributions.
**** Source: Pensionikeskus average annual return of the Second Pillar main index (EPI-II) for the period from 01.07.2002 to 31.12.2025.
Source: lhv.ee
