Pillar III has gained significant popularity – it’s become the most common financial asset among people in Estonia. (1) Still, only around 20% of them use pillar III as a state-supported, tax-advantaged way to save. Many investors are put off by confusing information. There are several common myths about saving that need to be dispelled.
1. Retirement’s a long way off, and the money’s locked up in pillar III until you’re old.
Wrong – pillar III is flexible, and you can use the money you’ve saved at any time. Don’t let the word “pension” in the name mislead you. It’s worth reframing your view of pillar III: it’s an investment with good liquidity, as you can get the money from the pillar into your bank account in just a few days if needed.
You can continue saving again at any time in pillar III, regardless of intermediate withdrawals – unlike pillar II, where you have to wait 10 years after taking money out before you can start saving again.
2. It’s not really a tax advantage if I have to pay back income tax to the state when I take the money out, is it?
Well, yes and no. If you take the money out at retirement age, you can opt for regular payments, which are completely tax-free. If you wait until your 60th birthday to use the money you’ve saved (2), a reduced income tax rate of 10% will apply when you withdraw it.
If you really need to use the money earlier, you’ll have to pay income tax on the withdrawal. But that doesn’t take away the leverage your portfolio growth got from the state’s 22% “loan” in the meantime. (3) A simplified example: if you transfer 1,250 euros to pillar III and the state returns 250 euros to you as an income tax refund, your own contribution is 1,000 euros, but your pillar III portfolio is already worth 1,250 euros.
But still, if you get an income tax refund on the contributions but have to pay it again on payouts, the tax advantage disappears altogether, doesn’t it? That’s true, but none of us can predict exactly when we’ll actually need the money we’ve saved. In any case, it’s better to have built up some capital ahead of time. Pillar III is still the only tax-advantaged investment option, and as long as you don’t withdraw any funds, the “leveraged” portion of your portfolio can also generate returns.
3. I don’t know anything about investing and it’s too complicated!
Investing doesn’t have to be as complicated as some banks or financial gurus often make it seem. Success comes from sticking to simple rules that everyone can stick to: save regularly, don’t overpay on fees, and stay the course through good times and bad.
And as John Bogle, the creator of index investing, put it: “Don’t look for the needle in the haystack. Just buy the haystack.” The most convenient thing about saving in a pillar III index fund is that you don’t have to pick your investments yourself but can own small shares of thousands of listed companies around the world that operate in various sectors and regions, driving global economic growth. This way, you earn a slice of their profits without having to spend countless hours reading investment books and analysing companies.
4. The stock market’s hectic and who’s to say I won’t end up losing my pillar III investments altogether?
It depends – stock market fluctuations are inevitable. This is why it’s worth spreading your portfolio as widely as possible across different stocks (which is exactly what an index fund does) to avoid the excessive risk that comes with individual stocks. One of the rules of investing is that without risk, there is no return. Over the long term, it’s indeed been stocks that have delivered better returns than other asset classes.
By investing in the stocks of thousands of companies driving the whole market, i.e. in an index fund, you ensure that your assets are invested in the industries and countries that grow the fastest.
Regularly invest a small part of your income into a broadly diversified portfolio of companies around the world, so that at least part of your money is invested in the stocks of the next NVIDIA or a fast-growing economy.
5. Real estate and gold are tangible, after all, but the stock market is complicated, and who knows which stocks will actually perform better in the end.
Wrong – don’t forget that stocks have real value too. They’re ownership stakes in companies around the world, including their assets, and the profits they earn. Historically, equity stakes in the world’s leading companies have delivered returns that outpace inflation and go hand in hand with global economic growth. By saving in a broad-based index fund that invests in global stocks, you can be sure you’ve got shares in tech firms, real estate companies and gold miners.
- Assets and liabilities of Estonian households: results of the 2021 survey.
- If you started saving before 2021, you’ll be eligible for tax relief on your pillar III payouts as early as your 55th birthday.
- From 2025, the income tax rate is 22%.
