Recently I've been finding myself having to make more and more adult decisions.
Not too long ago, I read a quite nice article by Firedk on pension. Didn't really think much more off it after that. I thought that this FIRE journey I've just embarked on kinda was the opposite of RE, as pension funds are locked up forever (not really, but age 65+ seems to far away) -- I've found it to be not quite as simple as I initially thought.
After a quick chat with my accountant, I maxed out my Ratepension for this year on his recommendation due to me digging a bit into the lovely top-level income tax of way too many percentages in Denmark.
A couple of days ago, I got bit by a bug. Started looking into all the possibilities of pensions in Denmark and thought I'd outline my findings here. Sit tight, this is going to be a long one.
Disclaimer: I'm in no way a financial advisor or accountant. This should in no way be taken as solid advice, but merely as my findings as an entry point for your own research.
There are 5 types of (relevant) pensions (I'm not going near all the weird solutions for people older than 30):
Folkepension is the awesome free kind of money that the government gives to everybody that's been living in Denmark for long enough.
ATP is a mandatory small supplement that's automatically withdrawn from your paycheck every month.
Most companies provide pension plans which require you to pay a certain percentage of your salary and the company often matches it by 100 - 150%. Usually, government employees get as much as a total of 12-15% in pension contribution while private companies give as low as 5-6%. A company pension plan can be either of the three remaining types, so you'd have to check the specifics from your pension provider.
Aldersopsparing is getting quite a change in the recently approved law that's going into effect from January 1st, 2018.
In 2017, you can contribute 29.600kr, but it's not deductible. It's PAL-taxed like the Ratepension at 15.3% yearly. From 2018 the yearly contributions are limited to 5.000kr 5.000kr until 5 years before Folkepension kicks in, at which point the limit is raised to 50.000kr and continues until the first withdrawal is made -- even if you're receiving Folkepension, you're able to contribute to your Aldersopsparing.
A major upside to this type is, that it doesn't affect how much you're able to receive in Folkepension additions.
My accountants favourite and with good reason. It's 100% deductible, which is a pretty sweet deal for everyone paying marginal tax. Livrente is deductible as well, but more on that in a second.
Ratepension is paid out in rates over a period of 10 to 25 years, with recent changes increasing that to 30 years. Payouts are being taxed as regular income, gains are being taxes by PAL-tax (15.3% per year). Payouts from Ratepension will decrease the bonus from Folkepension, so you have to plan carefully if you want to optimize your income during retirement (not the RE kind, but the government's definition of it).
In 2017 there's a contribution cap of 53.500kr, being raised to 54.700kr in 2018.
My least favourite type. It may be a good deal if you live long, a bad deal if your life is cut short, but none inherits anything from it -- at least not without buying into some sort of insurance for that.
I'd like to provide my heirs with something, nevertheless, I'll scribble down the information I found regarding this type.
Contributions to a private Livrente, is deductible for up to 49.300kr in 2017. This amount if regulated every year. There's, however, a wrinkle.
You can actually contribute any amount you wish, deductible, but you have to commit contributing the same amount, every year, for the next 10 years -- there's no limit or commit requirement for self-employed, but they're not allowed to contribute more than 30% of their company's profits.
Contributions from your employer are, however, not limited and without a requirement for contributing the same amount for the next 10 years.
ATP is a mandatory addition to the Folkepension, which is paid by almost everyone working more than 9 hours per week. For self-employed, it depends on which company form that's being used.
You don't have to worry about payouts. They're automatically given to you when the time is right. ATP is lifelong. Literally. From you start to receive Folkepension to the day you're no longer on this earth, you'll receive ATP (given you've actually contributed to it).
So how much will you get? That depends on your contributions. You can get upwards 2.000kr per month, for the rest of your life since your Folkepension-age. But the amount is taxed.
For us in our mid-twenties, this amount might be closer to 1.600kr adjusted for inflation, unfortunately.
As a full-time employee, you'll contribute 94.65kr as your 1/3 of the amount, and the other 2/3's being 284kr.
ATP is the government's attempt at a solution to reduce the social responsibility for the elders, as it would have no chance of supporting every single person in Denmark on a government paid pension. They recommend saving a little yourself in one of the many possible ways you can but forces the ATP as history has shown that people really suck at thinking of their own old age.
Everyone who has lived in Denmark for at least 3 years since the age of 15 until the age of retirement, live in Denmark and be a Danish citizen -- as a rule of thumb. There's also a rule about living in Denmark for at least 40 years and even if you haven't, you might be eligible for a fraction of Folkepension. Apply and see if you're eligible.
Folkepension is regulated every year, and the age at which you can start receive it depends on when you were born and it might even be even later for us in our twenties.
The base, which is guaranteed for all who's eligible for Folkepension, is 75.000kr per year no matter which other pensions or incomes you might have.
There's an added bonus of 80.000kr per year that's dependant on your income. The deductions start to kick in when your income exceeds 69.800kr for singles and 140.000kr for couples and completely vanishes when your income exceeds 324.000kr if you're single or 381.800kr if you're married to someone on a pension or 260.900kr if you're married to a someone who's not receiving a pension.
Nykredit has a very nice overview table for a quick comparison between the different pension types.
Taxation of pensions
Aldersopsparing, Ratepension, and Livrente are all PAL taxed, meaning you pay 15.3% tax on any gains or losses every year -- if you're using Nordnet for your Aldersopsparing or Ratepension, they charge your account automatically for the proper PAL tax.
At first, the PAL tax might seem like a nasty bugger. Paying taxes every year have a huge impact on your long-term returns as it reduces the lovely compounding interests.
Exchange Traded Funds (ETFs) are even worse in Denmark. ETFs are often praised by the FIRE community, especially in the US, as they're usually quite cheap compared to indexes or various types of funds.
Investing personally in ETFs in Denmark is treated as regular income like an accumulating index fund and is taxed based on the inventory principle. So it's basically an even meaner form of PAL tax.
Ratepension or brokerage?
Firedk has a neat little calculator, but I've found that it only compares a single contribution to each on whatever time horizon you pick.
With his default values, you're getting 9.88% more from the brokerage than the Ratepension over a 45 year period. I've modified his sheet and added an inflation-adjusted regular yearly payment, with the same settings as his defaults. Turns out to give Ratepension 1.04% more than the brokerage.
This calculation is before any optimizations, however!
The sheet assumes a constant 27% taxation on realized gains for the brokerage without considering the 42% taxation bracket that kicks in at 51.700kr (2017, 52.900kr in 2018).
For the sake of simplicity, let's assume that 27% taxation on realized gains for the brokerage is realistic, either because the government changed the law or you optimized your realizations.
One of the benefits of Ratepension is that you can decide over how long a period you want the payouts -- from 10 to 30 years. If we change the calculations to assume we pay over such a long period that we are below the top level income tax for the entire duration of the payouts, we'll be taxed at 37.6% instead of 52.6%. Doing so will increase the value of our Ratepension roughly 31% -- a whopping 33% increase over the brokerage!
You can check my math here or check your own numbers.
Aldersopsparing.. why the f?
5.000kr.. that's like peanuts? Yea. I thought so too. I still do. The thing that lures me in though, is the fact that the amount is so small. A mere 416kr per month (2018 limit).
Using the same values for cost, inflation, growth, and inflation as the spreadsheet above, those 5.000kr per year will get you roughly 400.000kr, tax-free, around your retirement age. PAL tax may be a turn-off, but at the same time give access to the relatively cheap ETFs for massive diversification.
That's a pretty neat trip to a warm country, a new kitchen or some pretty darn nice presents to the grandkids.
- As contributions already have been taxed, payouts from an Aldersopsparing is tax-free.
- Payouts don't affect the Folkepension bonus
- ETFs are viable and low cost
- High flexibility for payout schedules which may help your advisor optimize your pension payouts even more
- Protected from personal bankruptcy and divorce
Can I contribute my every penny?!
So you like benefits of Aldersopsparing, Ratepension and/or Livrente and wondering if you can max the shit out of them?
Hold your horses. There may be a cap on your yearly contributions for Aldersopsparing and Ratepension, and a conditional cap on Livrente, but that's a shared cap.
A shared cap between you and your employer. If your employer's pension plan is a Ratepension, which gets a total contribution from you and your employer for 24.000kr per year, that leaves a 29.500kr gap up to the allowed amount of 53.500kr (2017). You're then allowed to contribute 29.500kr to a private Ratepension, for instance on Nordnet so you can invest in stocks.
If you contribute, in total, more than the allowed 53.500kr, you're going to be hit with a 20% fine on the amount above the allowed threshold.
As stated previously, there's a limit for yearly contributions. 2017 is closely coming to an end and the last call for optimizing contributions is close.
If your employee pension isn't maxed, you can use the remaining deductible amount to fund your private pension.
Drop the pension provider
It's a bit bold and controversial statement, but hear me out. There's quite a bit of money to gain, but there's no such thing as a free lunch.
The pension provider or company is charging some percentage for administering your pension investment, which most employer pensions have you locked into.
If you're either self-employed, contribute to a private pension on the side or lucky enough that your employer allows you full control of your pension investments, keep reading.
There are a few disadvantages of administrating your pension yourself:
- You might have higher risk due to lower diversification
- Investment cost is usually more expensive when done yourself
- Takes time
A pension provider is able to buy larger positions at a time on behalf of all its customers, thus reducing the price per transaction. Due to their number of customers they can also more easily diversify their investments (you can too using ETFs or funds though).
You shouldn't, however, even consider managing your pension yourself, unless you're willing to invest some time into researching stocks, ETFs, funds or whatever, before placing an order.
If you're willing to put in the effort, the advantages may be worth it;
- You pick your assets
- Higher returns
- Less to no administration cost
According to pension expert, Anders Valdemar Juhl pension providers usually charge between 1% and 1.5% per year in administration cost. Depending on the type of assets and investment accounts you choose, those saved administration costs can add up to a substantial amount over the years.
Manage the payouts
Probably the least relevant section of this post as there are quite a few years before this is relevant for me, but useful info to keep in mind nonetheless.
Some pension types are taxed, some are tax-free. Some are one-time, some can be split into smaller parts and some are regular payments. Some cut the Folkepension bonus while others don't.
If you work during retirement, that may impact your receivable amount too. You can keep contributing to some type during retirement and some can be paid out before the Folkepension-age.
There are too many possibilities to name, and I'll strongly advise a consultation with an advisor that can help with your unique situation when the time comes.
I do know, however, that it's possible to schedule and shuffle a lot of stuff around to maximize and evenly distribute the payments.
When to start and what to do
Start by checking your current situation. All employer pensions are required to report your pensions so that you can see them on PensionsInfo. I'm not sure private pensions are reported to the service, but it's a good place to start.
So you're intrigued by the advantages a pension may give and now wondering when you should start. Yesterday. Like, now.
I bet you, like most of the Danish population, doesn't save enough already.
Is it even worth it..?
So many rules. So many options. But they cut my Folkepension bonus!
Yes, indeed, maybe. The government is aware of the so-called interaction problem (loose translation of Samspilsproblemet).
Basically, you should be aware that saving up too much may impact the amount of Folkepension bonus you'll be able to receive. Many Danes have a mandatory pension via their employer, which may or may not cause this "problem" on its own.
This doesn't necessarily mean that it's useless to save some on your own. It just means that you have to think about how you do it and plan your payouts when the time comes.
Many pension advisors are able to help this problem by scheduling the different pensions you might have, such that they minimize the Samspilsproblem.
For example, an advisor might say that your Ratepension should be paid out over 20 years, instead of 10 years, to reduce the yearly payments so that you may receive a larger Folkepension bonus or reduce the taxation. Another added bonus of scheduling your pensions better may result in a more even financial retirement instead of having years with more or less money than your average.
Another thing to be aware of is your current tax bracket versus the bracket you will end up in during retirement. People that don't pay top-level income tax today should be wary of how much they contribute to Ratepension and/or Livrente. They may just end up saving with a loss.
When I started out researching for this topic, I had a vague idea of some of the various options and concepts. Some of my assumptions turned out to be flat out wrong. I've even been surprised by some of my findings.
Based on my research I've decided that I'll be maxing out my Ratepension and Aldersopsparing.
Aldersopsparing gives a nice little extra something sometime in the very far future, at the very low cost of ~400kr. I can live with that even though it isn't deductible. The PAL taxed account means, that I can invest in ETFs without having to worry about the skewed ETF tax in Denmark -- I'm looking at you RBOT.
Ratepension is going to be my bread and butter. I'm self-employed and toying with the top level income tax thanks to the skills of my amazing accountant -- It really pays off to have one of those optimize your tax.
I'm not very fond of the Livrente, that's basically a bet on how long you'll live. Having to pay some extra insurance to let your family inherit something if you die too early is a turn off for me as well. So it'll be a pass for me.
An overview latest changes related to pensions can be found here.
This has been my findings and should in no way be taken as advice or at face value. Consult your financial advisor and have him look into your unique situation.