Retirement, 3rd pillar

To be completely clear, I personally think the third pillar is an absolute failure and is essentially the state subsidizing banks that are burning money doing absolutely unreasonable things in terms of fund management. (You might notice that I’m quite disappointed at how badly the system currently works.)

This is obvious from the following statistic:

  • S&P 500 over the last 5 years – +87% (the annualized numbers are impressive as well)
  • Best 3rd pillar fund over the last 5 years is barely touching 9% annualized

Third pillar idea in theory

On paper the idea of the third pillar looks great. You can set aside up to 15% of your gross income (tax-free), so that’s an automatic return of 20% on the money invested. Seems amazing, right?

In theory the third pillar could be an amazing way to motivate people to save up for their future. 15% saved on top of the 1st pillar that comes from the state + the 6% that you get from the second pillar is likely to help you quite a bit in retirement.

Third pillar in action

If you look at the returns on the third pillar for an average citizen then the situation is less drastic than when looking at the funds benchmarked against indexes. The reason for this is the fact that the contributions get put in tax-free and people don’t personally get a feel for the amount of money that the state loses through this.

What this means in reality is that the state is subsidizing banks that are literally burning money. People get OK returns, but this isn’t because of how well the market is doing (and we’ve had three solid years of an absolute bear market which could have made incredible returns even with a relatively conservative strategy). People get returns because the state is “absorbing” a huge amount of the losses that bad fund management is causing.

My personal opinion

As the third pillar is right now, I wouldn’t go anywhere near it. In addition to the way the system works overall, the way you can start cashing out is complicated enough that I don’t see the point.

I think the idea of allowing such a huge amount of tax-free contributions is great. However right now the main benefactors are banks and the biggest loser is the state.

If the third pillar allowed better choices (as with the second pillar, I’d be super happy with just an ordinary index of some sort as opposed to active management) I’d consider it. Right now, however, I see no reason to give away such a huge amount of money for terrible fund management.

I understand that the third pillar would otherwise be a great idea for people who lack incentive to invest otherwise (in some ways it is a relatively safe way to invest). However, as I’m more than OK with making active reasonable choices the third pillar will get little support from me as it is right now.

11 thoughts on “Retirement, 3rd pillar

  1. I totally agree. The third pillar is pretty useless for us who are willing to manage our own investments. I may not be a very clever Investor but the mistakes I do are my own and I think my returns are at least decent. Besides it’s fun to invest.

    In Sweden we have a similar third pillar and I too have never gone near it. Might have if I had been a top earner, which I’ve never been :(. We have a progressive tax-system in Sweden, there are some tax-benefits for top-earners to use the third pillar.

    The third pillar might also be ok for people who are uninterested in saving and managing money. Like you say the returns are often at least ok, despite inefficent management from the banks. People will no doubt be better off during retirement than they’d been if they’d wasted that money on caffee lattes, vacations and useless stuff.

  2. So in third pillar you have only option to choose from funds specially made for that? Or is there possible to choose any fund you like?

    1. No, you can only choose between the allowed funds. There are currently a bit over 10 funds to choose from but they’re all equally bad when it comes to returns.
      If you could manage your money on your own and take any fund that’s on the market then that would be a huge improvement to the current system.

  3. ”This is obvious from the following statistic:

    S&P 500 over the last 5 years – +87%
    Best 3rd pillar fund over the last 5 years – +9%”

    It looks like there is some mistake in ”Best 3rd pillar” return calculation. Seems, you have taken Annualized return or smth for third pillar.
    Although I don’t have info about all 3rd pillar funds, I found out one of Swedbank’s performance for 5 years was 46.2%
    http://files.ee.omxgroup.com/pensionikeskus/raport/SWT100/eng_SWT100_raport_20140831.pdf

    1. Though you are correct I messed up due to some returns being annualised in statistics while some aren’t. It was a careless mistake, thanks for pointing it out.

  4. In my opinion the biggest problem with the 3rd pillar is that the tax savings is the main argument banks use to get people to join and invest into these. It happens every time at the end of the year like clockwork.

    “Invest now and get income tax back!”

    However, who cares if I get 20% of my money back now, if I lose 50x more on management fees and losses over the next 30 years, before I get to retire.

    On performance, I remember that they performed almost as bad as the 2nd pillar so not much difference there?

    1. They are equally bad when compared to the second pillar. And the fees are incredible, I could swear when I was looking over the list of funds then I saw one that had 2% fees!

  5. Hi Kristi,
    I just started reading your blog and found this topic.
    I’ve got various active pension saving contracts (coupled with life insurance or work disability insurance) from back in Germany, now I live in Estonia. I invest a significant amount each month through these, 12% of my gross salary. I have thought about cancelling them for a while now, the only thing keeping me from is the tax advantage:
    1. From what I paid this year, I get back 20% next year. I see it as an immediate 20%, reinvestable return. Not easy to beat through own investments.
    2. Payout will be tax-free when I retire (if done in regular payments) or 10% (if done at once) – any other investments that I want to take out are taxed at whatever the income tax will be then.

    So the real downside is that the money is not available for other investments, it’s not liquid (the contracts are not exactly customer-friendly).

    Still, what is your take on the 20% return p.a.?

    Thomas
    (fan of your blog since yesterday :) )

    1. I have two issues with the third pillar.

      1) The payout systems are very rigid. You are essentially at the mercy of the insurance company that manages the payout. In the case of someone who wants to go for early retirement you’re stuck waiting for some of the investments. In addition to that, from what I know once you set the contract for how you get paid the money there aren’t any significant changes you can make. (Plus, there is the issue of how ordinary investments get inherited, but with the insurance company they definitely make their profit, from what I recall not all your investments get passed on.)

      2) The 20% instant return is, in essence the government subsidizing 3rd pillar to make up for the lack of actual returns. While, for an ordinary person that 20% return is all good, then this is still missing tax money that could be spent on improving everyone’s lives instead of compensating for bad returns on the 3rd pillar funds. (3rd pillar is making <8% annualized for the past 5 years while S&P500 has been doing 15%+ annualized!) So, while from an individual's perspective the 20% is good, then it is literally removing value from potential public sector investments.

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