From January 2024, you can apply to increase your second-pillar contributions from 2% to 4% or 6% of your salary. Contributions based on your application will be made starting from 2025. This change is to your benefit, as it allows you to take better advantage of tax reliefs when saving.

I am definitely going to increase my second-pillar contribution to 6%, because I follow the principle of taking advantage of investment opportunities that come with tax reliefs first. For the same reason, I already make payments to the third pillar and recommend to my friends that they do the same.

Calculate how much you will gain with a higher contribution and the 2025 income tax reform:

Calculate your gain

Although the 2-4-6 reform is brand new, some members have already asked us what it’s all about. Also, should you fill-up the third pillar or increase your second-pillar contributions first

The simple answer: Why choose when you can do both! Below you will find more information about the reform and also some considerations to take into account if you do want to choose between starting saving by increasing your second-pillar contributions or by saving in the third pillar.

What will change and when?

Before this change, people have contributed 2% of their gross salary to the second pension pillar. On top of this, the state has added 4% from the social tax paid on the person’s salary.

From 1 January 2025, however, people will be able to contribute either 2%, 4% or 6% to the second pillar. Other contribution rates, such as 3% or 5%, are not available. The change only concerns the person’s own contribution, while the state continues to add 4% from the social tax regardless of the person’s own contribution rate.

By default, the contribution rate remains at 2%. An application to increase or decrease the contribution rate can be filed at any time, but the change takes effect once a year, on 1 January, based on the applications filed by the end of November of the previous year at the latest.

To increase your contribution rate from 1 January 2025, you must file an application between 1 January and 30 November 2024. Both the state and management companies are prepared to receive applications and conduct information campaigns.

Should I increase my second-pillar payments?

It goes without saying that pensions are low in Estonia. The average pension is almost 40% of the average salary in Estonia, while the average in the European Union is almost twice as much. (2) We are among the last in the European Union on this indicator. So, when preparing for retirement, you have to rely on yourself and, if possible, to accumulate savings.

How much should you save? Unfortunately, there is no right or wrong answer here. It all depends on your possibilities and your expectations for retirement. The earlier you start, the less you need to save every month. In any case, in the future, you will be grateful for every euro you save.

What is certain, however, is that it pays to invest smartly and take advantage of all the tax reliefs available. In Estonia, income tax is refunded on the money invested in the third pension pillar. For every 100 euros you invest in the third pillar, the state will refund 20 euros of that as your income tax refund. Therefore, you should start saving for retirement in such a way as to take advantage of this opportunity. Second-pillar contributions are also exempt from income tax.

A smart investor takes advantage of both opportunities, saving 15% of their gross salary in the third pillar and increasing their second-pillar contribution rate to 6%, to which the state adds another 4%.

All this holds true if your second pension pillar is in a low-cost index fund. If you’re still paying high fees, fix that first. There is no reason why you should pay more than 0.5% per annum in pension pillar fees. This is especially important if you increase your contributions.

Second or third pillar?

If you cannot currently invest as much in your future as the second and third pension pillars allow, that’s okay – increase your savings step by step.

What should you do first, increase your second-pillar contributions up to 6% or save money into the third pillar every month? There is no significant difference. Both options are good.

The options are almost identical in terms of taxes and the choice of funds. Also, in order to save money in either pillar, you have to make the effort of filing an application. This distinguishes both options from regular second-pillar contributions, which are made automatically. For the third pillar, it is reasonable to additionally set up a standing payment order (it only takes two minutes). However, the advantage of the third over the second pillar is that your decision takes effect immediately, not at the end of the year.

Key difference: Exit conditions

The key difference between the second and third pillar is the flexibility of withdrawals.

You can take out money from the third pillar at any time, either all or a part of what you have saved. If you are younger than 60 (or 55 if you started saving before 2021), you will have to pay 20% income tax on the withdrawal; if you are 60 or older, you will have to pay 10%. The money will be paid out within four working days after submitting your application.

Second-pillar payouts, however, are limited. The purpose of the limitation is to reduce inappropriate use of the 4% contributed by the state. However, this also makes it difficult to use the assets you have saved yourself before you reach retirement age.

For example, the money collected in the second pillar cannot be withdrawn in part. If you want to withdraw your second-pillar savings, you can only withdraw the entire amount saved and must pay income tax on that in full. Payments become flexible only from early retirement age.

You should also consider that after withdrawing money from the second pillar, contributions will be suspended for the next ten years. This means that you will miss out on the tax relief and state contribution that you would otherwise receive toward your further pension savings.

Finally, payments from the second pillar are made five months after application. Therefore, in practice, it is impossible to use these sums for unexpected expenses.

How should the investor behave?

How should a saver behave? It depends on the individual. The flexibility of using money can be both an advantage and a disadvantage.

Sometimes, individuals may need to access their pension savings before reaching retirement age for very important reasons. While the emergency fund should cover such expenses, knowing that there is an option to access funds from somewhere else adds to the sense of security. Money accumulated in the third pillar can be withdrawn more affordably, flexibly, and quickly compared to assets in the second pillar. This doesn’t mean that funds from the third pillar are frequently or casually used before retirement age. The purpose of saving for retirement is still to accumulate assets for retirement, not for unexpected expenses. However, having this option is an advantage. If ease of accessing funds is important to you, you should first make contributions to the third pillar and then consider increasing contributions to the second pillar.

Others see restrictions on withdrawing money as an advantage. Everyone knows that more savings are needed for retirement, but it’s challenging. If you put money into the third pillar at the end of the month, there may be nothing left. If you withdraw money from the pension pillar for unexpected expenses, there may be nothing left in retirement. That’s why it is recommended to make saving automatic and stopping it difficult. This is exactly how it works in the second pillar. Restrictions on withdrawing money help maintain discipline and ensure that the pension pillar is not emptied by the time you reach retirement age.

Act today

There is one simple formula for successful long-term saving: the earlier you start, the better.  Both this year and the next, the choice is still very simple: to save tax-efficiently for retirement, you have to contribute to the third pillar. Make sure to take advantage of this opportunity.

1. Pension sustainability analysis
2. OECD https://data.oecd.org/pension/net-pension-replacement-rates.htm
3. Pension sustainability analysis
4. https://pension.sotsiaalkindlustusamet.ee/calculato

Performance is the buzzword of pension fund marketing. Swedbank writes: “The bar is high. And fees low.” LHV claims to be the only one to increase the value of funds since early 2022. And Tuleva says its “performance will never lag far behind the average of the world securities markets”. How do you know who is right in this mishmash of messages?

To quote a classic, “In God we trust. All others must bring data.” If in doubt, check the performance of your pension fund yourself instead of blindly trusting your fund manager. Just remember two things:

First, past performance does not guarantee future performance. Second, banks have an incentive to overstate performance and may sometimes use dishonest techniques to do so. With that said, here are three rules of thumb to stay on track.

1) Check the annual yield. Swedbank’s online banking portal proudly tells me that my second pillar yields 26.89%. Awesome! I’m doing great!

But wait, for which period? Over a period of 5 years, it would be about 5% per year. Over 10 years, it would be around 2.5% per year, and over 20 years, just 1.2% per year. World stock market indices, meanwhile, have fared much better. Therefore, 26.89% doesn’t really tell me much. It would be more accurate to look at the annual yield, which is to say, how much my pension assets have grown on average each year. (1) This also allows for comparisons between different investments.

2) Look at the long-term performance. One pension fund does better one month, another the next month. A month, a year, or even five years is a rather short period to accumulate a pension, and the impact of a month’s return on the eventual pension is tiny. We accumulate our pensions over a long period, which is why we are only interested in long-term returns. Be clear about the timeframe you are examining and look at periods that are as long as possible when comparing pension funds.

Unfortunately, this advice is often overlooked. Frequently checking performance is exciting, especially when you are doing well. (2) Checking your relatively stable long-term return is boring. This is probably why the media keeps talking about short-term performance, for example, that covers the past 1.5 years. (3)

3) Look at how you have done, not the fund. Your personal return may differ from the fund’s return. Your return depends on when you made your contributions, how long you’ve accumulated them, and in which funds.

Pensionikeskus.ee shows the performance of funds over the past 3, 5, or 10 years. In other words, it shows whether the 100 euros you invested in a pension fund exactly 3, 5, or 10 years ago has become 95, 105, or 125 euros. Statistically, this is correct, but it’s not the entire story. Your pension fund consists not only of the money you initially invested 3, 5, or 10 years ago but also includes all the monthly payments you have made over time. To get a more accurate result, you should find the return on each payment and judge it as a whole.

Every online bank in Estonia presents pension statistics, but they never tell you the full story, as no bank follows all three rules of thumb. If you have the time and the Excel skills, you can request the data from Pensionikeskus.ee and do the calculations yourself. But if you don’t, you can check your pension assets’ performance in the Tuleva online app. We did the calculations for you, following these rules.

Log in my pension account

P.S. It’s okay if you don’t constantly track your pension asset performance. As Bogle recommends, put your money in a low-cost fund and don’t peek.

(1) You can find a more detailed explanation here.

(2) Interestingly, people tend to behave like ostriches. When financial assets are doing well, people check their performance frequently. When investments do badly, people bury their heads in the sand and stop looking at the figures. It’s a kind of self-defence mechanism to avoid negative emotions. Read more in the article The ostrich effect: Selective attention to information (Karlsson, Loewenstein & Seppi, 2009)

(3) For example, the newspaper Postimees recently compared pension fund returns from 31 December 2021 onwards and drew some sweeping conclusions. If Postimees had chosen, for example, a start date six months earlier or six months later, it would have arrived at very different conclusions; investor Toomas did the same.