Actualités/Reform of the second pillar

    • Reform of the second pillar

    The reform of the law of 1999 governing occupational pension plans in Luxembourg was finally approved by parliament on 16 July 2018 and will enter into force on 1 January 2019.

     

    Scope

     

    1. At its core is the extension of occupational pension plans to the self-employed and to independent professionals, who had been excluded from such plans previously. The framework of occupational pensions, including the existing tax regime (taxation of contributions at entry and the corresponding exemption of benefits) remains in place and has been adapted for this type of plan. We would expect that potential providers of such plans (insurers, potentially also professional associations) will present their offerings for the self-employed and independent professionals in the autumn of this year.

       

    2. The reform does not include an extension of the plans for personal contributions to all employees, even where the employer does not offer a company pension plan; the possibility of such an extension had been mooted in the government program for 2013-18. It does, however, now offer public sector employers the possibility of setting up company pension plans without the restrictions imposed by the previous legislation.

     

    Rights of employees

     

    1. Another principal driver of the reform was the need to implement the “Directive 2014/50/EU on minimum requirements for enhancing worker mobility between Member States by improving the acquisition and preservation of supplementary pension rights” (mobility directive). As with the 1999 law, the following changes are not only applicable to cross-border situations, but apply to all employees in Luxembourg:

       

    2. Reduction of vesting periods to three years: The main provision of the mobility directive has been implemented by two distinct rules:
      1. The rights of employees joining a company pension plan from 21 May 2018 must vest within three years of entry into service; shorter vesting periods remain, of course, possible.

      2. The rights of plan members active on 21 May 2018 will vest at the latest on 21 May 2021, even if they had remained unvested at that time on the basis of existing plan rules.

         

    3. The requirement to provide a minimum guaranteed return for personal contribution plans is being abolished in favour of the option to be able to invest such contributions into unit-linked plans (as is already the case for the employer plans). Both employer and personal contribution plans will in future still need to offer an investment option with capital guarantee, though.

       

    4. Determination of vested rights: There are a number of fairly technical changes to the method of calculating vested rights and their treatment in case of termination of employment before retirement. Depending on the precise definition of vested rights in the existing plan rules, certain of these changes can have a significant impact on the value of such rights. It should be noted that the initial proposal for the mandatory indexation of dormant pension rights has been retracted.

       

    5. Certain plans currently provide for the lapse of dormant rights if the former member does not reach retirement age. For these plans, an option to provide survivor benefits (in return for a reduction of these dormant rights) at the choice of the former member will need to be offered.

       

    6. Transfer of vested rights: When vesting or vested rights are to be transferred from an existing defined benefit plan to another plan at the instigation of the employer, it must be ensured that at least the same vesting or vested rights are maintained; this will render the transfer of defined benefit plans to defined contribution plans much more difficult, if not impossible.

       

    7. Payout of vested rights before retirement: Currently the law allows three options for such payouts to be provided in pension plans. The option of payout in case of termination of employment after the age of 50 will be abolished from 2019. The conditions for the other two options have been somewhat simplified:
      1. Payout is now possible if the former employee or the self-employed is no longer obliged to pay social security contributions in Luxembourg - rather than having to prove employment outside Luxembourg.

      2. Payout is also possible if the vested savings do not exceed three times the current minimum salary (this is currently approx. € 6.000) – rather than ten times the expected minimum salary at retirement.

         

    8. The information rights of plan members have been strengthened in several respects. This will principally manifest itself in more detailed annual certificates and in more information being available on a timelier basis upon termination of employment – the corollary of this is obviously that administration of pension plans will become more complex in the future.

     

    Internally funded pension plans

     

    1. Most importantly, the fiscal discrimination of such plans will end in 2019, when the annual interest charge for pension provisions will no longer be subject to entry taxation. The reduction of entry tax may amount up to 1% of Lux-GAAP pension provisions per year.

       

    2. Secondly, we expect that new mortality tables (probably DAV2004R) and a reduced technical interest rate will be introduced in the near future. These new technical bases will affect the value of vested rights and thus pension provisions under Lux-GAAP. Depending on the characteristics and the population of these plans, the impact of the change in mortality tables alone may reach up to 25-40% of existing reserves. A transition period for the amortization of this impact is foreseen. Unfortunately, the level of the technical interest rate, the timing of these technical changes and details of the transition period are not known at the time of writing.

       

    3. Finally, but probably of limited importance in practice, the prohibition of transferring vested and vesting rights to internally funded plans for certain business transfers has been removed.

     

    Conclusion and next steps

     

    1. Apart from the introduction of second pillar plans to the self-employed, the reform does not introduce major changes to occupational pension plans in Luxembourg.

       

    2. However, several modifications to the rights of current and former members and the impending changes to the actuarial bases of internally funded plans will require a review and an assessment of the impact of the reform for all existing pension plans.

       

    3. PECOMA has provided consultancy and management services to pension plans in Luxembourg for nearly twenty years. Through our contacts with the relevant authorities and our involvement in industry associations, we are well placed to provide advice on the impact of this reform to existing and future pension plans for employers and for the self-employed.