The authorities have granted temporary dispensation to withdraw private pension savings (also referred to as supplementary pension savings) as a measure to assist individuals who suffer loss of income due to the Covid-19 pandemic.

21. apríl 2020 - Ólafur Páll Gunnarsson

Before deciding to withdraw private pension savings, it is worth noting that this will reduce the amount available upon retirement. It is also likely that the withdrawn amount will be fall into a higher tax bracket if the individual has other income at the same time. Withdrawal of pension savings may affect the income-linked instalment on student loans from LÍN.

One of the most advantageous savings forms

Paying premiums towards private pension savings is one of the most advantageous savings forms available. If an employee pays 2-4% of wages toward a private pension, the employer contributes another 2% of wages. These 2% from the employer in fact constitutes a raise the employee would otherwise not get.

Should I withdraw my savings?

Private pension savings are generally restricted until the beneficiary reaches 60 years of age. The government's new provision, in response to Covid-19, involves temporary authority to withdraw these savings regardless of age, to the maximum amount of ISK 12 million. The solution is intended to assist individuals who have suffered loss of income due to the Covid-19 pandemic.

It is important to keep in mind that disposable income decreases upon retirement in most cases. Private pension savings are a good way to make up the difference. The savings can also be useful if an individual chooses to reduce his or her working hours after 60, or even quit work, before reaching retirement age.

Private pension savings is fully owned by the beneficiary and is inheritable. Another important factor is that private pension savings cannot be seized to satisfy debt in the case of bankruptcy much as other assets, such as real estate, cars and bank deposits.

Under usual circumstances, individuals cannot withdraw private pension savings until 60 years of age. This also applies to foreign nationals who relocate from Iceland to another EEA country. The government's temporary solution allows for the temporary withdrawal of private pension savings by foreign nationals who have relocated to another EEA country. Foreign nationals, who move from Iceland to a non-EEA country, can as before withdraw their entire private pension upon relocation.

Important to think it through

It is up to each individual to decide whether to take advantage of this temporary authorisation to withdraw private pension savings. The importance of the opportunity to withdraw these savings in full or in part to individuals who suffer loss of income due to Covid-19 is indisputable, especially where no other savings exist.

Individuals who have not suffered loss of income but are nevertheless considering withdrawing their private pension to use the funds to make other investments, pay off loans or other consumption should consider the advisability of such action carefully. Ask yourself certain key questions before taking a decision. Is it economical to withdraw the savings at this time? How much do I reduce my pension for the future by withdrawing it now in part or whole? What is my current balance and what will it be by the time I reach 60 or 70 years of age? Will I pay more taxes if I withdraw my savings now? Will I get a high bill from LÍN, the student loan fund, later if I withdraw now?

When making the decision whether to withdraw or not, it is important to review the position well and see how much pension has been accumulated. A balance that is not withdrawn will continue to accrue interest.

Example 1


Assumptions

  • Age: 35 years
  • Salary: ISK 400,000
  • Current private pension savings balance: ISK 2 million.
  • Interest: 3.5%
  • Own contribution to private pension scheme: 4%.
  • Possible development of balance - amounts in ISK million - 60 years - 65 years - 70 years.

The balance has reached ISK 16.1 m at 60 years of age and ISK 26.2 m at 70 years of age if no withdrawal is made. If the individual maintains the same wages throughout his/her carrier and smooths disbursement over 10 years from age 70 onward, he/she can add ISK 258.000 per month pre-tax to other pension benefits.


Example 2


Assumptions

  • Age: 50 years
  • Salary: ISK 800,000
  • Current private pension savings balance: ISK 12 million.
  • Interest: 3.5%
  • Own contribution to private pension scheme: 4%

The balance has reached ISK 23.8 m at 60 years of age and ISK 40.4 m at 70 years of age if no withdrawal is made. If the individual maintains the same wages throughout his/her carrier and smooths disbursement over 10 years from age 70 onward, he/she can add ISK 398.000 per month pre-tax to other pension benefits.



Taxes withheld upon withdrawal

Another factor to consider is the taxation of withdrawn pension savings. Premiums toward private pension savings and contributions from employers are exempt from taxable income and no income tax is withheld. Upon withdrawal, private pension savings are taxed much as any other income. Iceland has a tiered income tax system. There are currently three tiers, as illustrated in the accompanying table.

Tax tier and rate

Tax tier Income bracket Tax rate
Third tier On income exceeding ISK 945,873 46.24%
Second tier On income between ISK 336,917 - 945,873 37.19%
First tier On income between ISK 0 – 336,916 35.04%

Upon withdrawal of private pension savings, the amount is added to other income and, as a result, a significant portion of the withdrawn amount may fall in a higher tax bracket. This of course depends on each person's income. Here are two examples of the impact of taxation. For further information, visit the website of the Directorate of Internal Revenue, rsk.is, and use the calculator for withholding tax on individuals.

Example 1

Assumptions

  • Monthly salary: ISK 400,000
  • Amount withdrawn from private pension: ISK 400,000 per month.

Income tax on private pension savings (withholding tax): 37.2%.


Example 2

Assumptions

  • Monthly salary: ISK 800,000
  • Amount withdrawn from private pension: ISK 800,000 per month.

Income tax on private pension savings (withholding tax): 44.6%.


All individuals who earn monthly salaries exceeding ISK 946,000 pay 46.2% in tax on the withdrawn amount.

Note: The above examples do not have regard for mandatory pension premiums. The examples are based on taxation of an individual and full utilisation of personal tax allowance. Income tax can change upon calculation of final tax and the municipal tax rate varies between municipalities.


Withdrawal will not impact social benefits - may increase LÍN repayments

Withdrawal of private pension savings based on this solution will not affect children's benefits or interest subsidies. Withdrawal will not affect other social benefits, in accordance with the Act on Social Security and Social Assistance. As mentioned above, private pension is treated as taxable income and will as such impact the income-linked repayment of student loans. It is important to consider this to avoid unexpected bills later on.

Pros and cons of withdrawing private pension now


Pros

  • Can be of material help if income decreases
  • Withdrawal does not affect other social benefits

Cons

  • Reduces future pension payments
  • Possible higher tax bracket
  • income-linked repayment to LÍN

There is no need to make a hasty decision

The application period for this solution is from April 2020 to 1 January 2021. An individual applying in December 2020 is just as entitled to payment as earlier applicants. For those not in immediate need of funds, there is no need to decide now. It should also be borne in mind that there is a great deal of uncertainty about the ramifications of Covid-19, both as regards health and the economic side. It is good to have a reserve fund under such conditions.

Further details about withdrawal of supplementary pension savings are available on Landsbankinn's website.

The author is managing director of the pension fund Íslenski lífeyrissjóðurinn.