Global: Pillars / Systems / Investments / Risks

3 Pillars

All around the world pensions can be funded in three different manners:

  • A) Pillar 1: Governmental Pensions

    Essentials

    • In some countries expats are obliged to participate in the National Social Security Services and acquire State Pension Claims. In other countries they can choose whether or not to participate and can even acquire additional rights due to a lack in the past.
    • Regarding the desirability of participation it seems advisable to beforehand calculate the cost versus pension claim ratio. As these days the interest rate is historically low, this often makes participation expensive.
    • The height of existing coverages can differ substantially per country. The coverage is for example rather modest in the U.S. and more elaborate in certain parts of Southern Europe.
    • Regarding the UK and Brexit is relevant that it is not yet decided if UK expats who receive UK State Pensions while based in the EU will still receive annual indexation after Brexit implementation.
  • B) Pillar 2: Corporate Pensions

    Essentials

    The nature of corporate pensions differs per continent/country. Essential issues are:

    • Is participation voluntary or mandatory?
    • Is the coverage individual or collective?
    • Is the coverage standard or a special expat plan?
    • Is the nature i.e. DB/DC/CDC/Hybride?
    • Is there a maximum for the amount of pension earning wages?
    • Is the next of kin coverage risk and/or capital based?
    • In case of guaranteed pension claims, is there (un)conditional indexation?
    • Does the employer finance the whole premium?
    • Is there substantial tax benefit?
    • Is there the possibility to invest additionally in case of tax benefit?
    • Is it possible to transfer pension capital from or to another expat plan?

    Trends

    Even though corporate pension plans differ substantially on global level, there is a trend towards the decrease of guaranteed Defined Benefit (DB) plans and the increase of not guaranteed Defined Contribution (DC) plans. The latter often still combined with a guaranteed next of kin coverage before retirement age.

  • C) Pillar 3: Private Coverage

    Essentials

    The most common private coverages all around the world are:

    • Private life annuities
    • Death risk insurances
    • Investment plans
    • Real estate and life based mortgages
    • Bank savings

    New EU Plan

    In 2017 the EU proposed a new kind of private coverage: The Private European Pension Plan.

    The idea is that as many countries have different corporate pension systems, it is wise to introduce a within the EU transferable private annuity plan. We will wait and see if this idea will materialize and if the cost/claim ratio is interesting.

    Relevant issues to determine how desirable these coverages are:

    • Is there a tax benefit?
    • Is it possible to determine the profit/cost ratio?
    • Is it difficult to judge the nature and content of these possibilities?
    • Are advisors by law required to have a license?
    • How is the reputation of each possibility?

    Conclusion

    It is in the interest of the expat to compare the after tax gain/cost ratio of the 3 pillars per residency.

Pension systems

There are several kind of pension plan systems:

  • A) DB: Defined Benefit
    • These pension plans provide guaranteed pension terms at pension age. There is no investment/ interest rate risk. These plans often also have a conditional right to indexation in order to correct for inflation.
    • DB can be based on the actual Annual Wages. In case it is based on the Final Wages every wages increase creates a substantial premium back services as it also works towards the past employment. These aspects make these plans extremely expensive as the interest rate is historically low.
    • DB plans were popular in Europe but have as of 1995 often been exchanged rapidly for DC pension plans.
    • It is expected that in the near future final wages DB systems will be prohibited in several countries.
  • B) DC: Defined Contribution
    • These pension plans provide guaranteed amounts of pension premium. At pension age an annuity will have to be bought with the total pension capital. There are no guaranteed pension terms. There is a substantial investment risk until pension age and a substantial interest rate risk at pension age.
    • The investment risk might be mitigated by good Life Cycle funds which automatically decrease the risk as the age increases.
    • The costs and performance of investment funds are highly relevant for DC systems. In certain countries like Holland there are new totally IT based providers who excel in low costs and high flexibility.
    • In certain countries like Germany a pure DC system is not allowed and there is a modest guarantee to protect participants.
    • In certain countries like the UK it is as of 2015 allowed to completely drawdown the total capital as of age 55 and even have a 25% non-taxation.
    • In certain countries like Holland it is allowed to within DC partially keep investing pension capital as of pension age. The risk profile has to focus on the period before and after pension age.
  • c) CDC: Collective Defined Contribution
    • In this system with the DC guaranteed amount of pension premium guaranteed amounts of pension annuity are acquired. In case the premium is not sufficient to provide the desired amount of annuity, then the latter will be decreased to a lower and affordable level.
    • It is called the best of both worlds but as the interest rate is currently historically low, one can wonder if the price for certainty is not (way) too high.
  • D) Hybrid

    A hybrid system has DC/DB/CDC elements. A popular hybrid system is to have a DC system for the old age pension coverage and a DB system for the next of kin pension coverage.

  • E) Trend in Europe

    The trend in Europe is towards more individual and DC based solutions.

Investments

Due to the historically low interest rate an increasing number of pension plans is based on Defined Contribution (DC) and Investments. We will now pay attention to the related Investments. For even more information about Investments, feel free to visit our Brochures about Investments.

    • A) Correct Risk Profile and Investment Horizon?

      Due to the often substantial investment period until pension age, it is highly relevant that the investment is done in the best possible way. The bases thereof is to use the correct personal risk profile.

      It makes sure that your risk acceptance is defined in a highly accurate manner and that the deemed suitable investment categories are coupled with this profile for the correct period of time.

      If you might have any doubt it your pension plan uses a correct profile, feel free to visit our site and use our elaborate risk profile form.

      Type of Risk Profiles

      • Very Defensive
        Totally risk averse. Not all investment categories are allowed.
      • Defensive
        Risk averse. More investment categories are allowed.
      • Neutral
        Risk is tolerated as long as there is a long enough investment horizon.
      • Offensive
        To go for higher profit, substantial risk is allowed with a shorter investment horizon.
      • Very Offensive
        To go for the highest profit, the highest risk is allowed with an even shorter investment horizon.
    • B) Investment Categories

      There are the following Investment Categories with the related risk indication:

      1] Derivatives

      • Extremely high risk which only focusses on change in value and not to buy a certain object itself.
      • For example Options/Warrants/Futures.
      • Thus only for those with a Very Offensive risk profile and a high level of knowledge.

      2] Equity/Stock

      • High risk even though the exact amount of risk can be different due to the kind of sector and global location.
      • Equity requires an investment horizon of at least 7 years in general.
      • For those with a (very) offensive risk profile, a slightly shorter period might be acceptable.

      3] Real Estate

      • Depending on the type of Real Estate, similar or slightly less risk than Equity.
      • Thus requires an investment horizon of in general 5-7 year horizon.
      • For those with a (very) offensive risk profile, a slightly shorter period might be acceptable.

      4] High Yield Bonds

      • As these kind of Bonds go for the higher return on investment and risk, they require an investment horizon of at least 5 years.
      • For those with a (very) offensive risk profile, a shorter period might be acceptable.

      5] Solid Bonds

      • As these kind of Bonds aim for a regular return on investment and risk, they require an investment horizon of at least 3 years.
      • For those with a (very) offensive risk profile, a shorter period might be acceptable.

      6] Savings

      • No real investment risk as long as not at a fixed term.
    • C) Split Pension Capitals?

      The standard situation is that the capital grows and is used at pension age to get the desired and legally and taxwise allowed pension:

      • Lump Sum(s) and/or
      • Temporary/Lifelong Annuities and/or 
      • Flexi Draw Down

      In some countries it is possibe to split the pension capital in several different sections and each with a separate focus: For example one for early retirement, one for standard retirement and one as an increase of the standard old age pension during the first few years of retirement.

      In such a situation, you have to adjust your investment mix and risk to the different time tables and needs.

    • D) Investment Mix regarding Old Age Pension and Next of Kin Pension?

      Often the Old Age Pension capital is also used as funding for the Next of Kin Pension in case the insured person passes away prematurely.

      This is no problem but be aware that both types of pension can have a very different investment horizon. As the Next of Kin Pension horizon can be much shorter, please take this into account while creating the overall coverage. It might be a reason for acquiring an additional and in time declining risk coverage.

    • E) Funds or Individual Objects

      The essence of investing is to get the highest return on investment at the lowest risk.

      One of the best ways to reduce risk is to spread the capital over many investments within each investment category. You will always have the risk of investing in a certain category. But if you spread the capital over many different kind of investments within that category, you will optimally reduce the risk of having a certain investment object.

      Thus we advise clients to only invest in Investment Funds. As thus you spread your capital not only between Investment Categories but also in the best way possible within each Investment Category. In general it will also improve the liquidity of your investment.

      As of now we will only focus on Funds

    • F) Fund Selection

      It speaks for itself that it is relevant to only use the best investment funds regarding expected return on investments and low costs. There are several kind of funds:

      Active/Vision Funds

      • These kind of funds try to generate a higher return on investment than by just following the index.
      • As they often charge (high) additional costs for their services and as the positive outcome is not guaranteed, it is advisable to be critical about these funds.
      • They often have a specific focus on certain sectors and locations.
      • Our brochure on this topic provides much more details which additional insight might be welcome.

      Passive/Index Tracker Funds (ETF)

      • These funds do not believe that it’s possible to each year outperform the index.
      • Thus their focus is to follow the index at the lowest amount of costs possible. That is their challenge and added value.
      • Due to the huge effect of compounded annual return on investment, it’s a fact that a low cost level is highly relevant.

      Life Cycle Funds

      • These funds are mix funds that automatically reduce the risk as the owner ages.
      • The positive aspect is that thus you have no risk problem if you forget to pay attention to your portfolio.
      • These funds are often used in pension related investments and can be advisable if implemented correctly.
      • Most providers offer several type of funds with each a different personal risk profile.
      • They can be fine if they are implemented correctly. Please have this checked as it is not advisable to presume that they will all be fine.

      Our brochure on this topic provides much more details which additional insight might be welcome.

    • G) Fund Cost Categories
      • Costs related to opening and having an account. (Often none.) :
        Paid directly by investor
      • One time transaction costs: As of 0,15%:
        aid directly by investor
      • Annual management costs: As of 0,2%:
        Paid directly by investor
      • Fund costs: processed into the capital of the fund:
        Not paid directly by investor
    • H) Private Annuity Investments

      Private annuity investments deserve additional attention due to the following often existing risks:

      • High costs due to individual nature;
      • Often limited investment opportunities;
    • I) Separate Investments

      Many expats have investments separate from official pension plans. It often strikes us that not all implications have been researched. For example the risk profile might be different from the pension plan related risk profile.

      Please make sure that you are aware of all legal, tax and investment regimes and opportunities.

    • J) Investment Results in Time

      For an accurate oversight of the investment results in time plus a prediction of future results, feel free to look at our Brochure: ‘Investment Results in Time’.

    • K) Conclusion
      • Which investment within Pillar 1-3 will provide the highest consecutive (after tax/costs) gain?
      • Are there such possibilities in other countries with higher expected consecutive gain?
      • Which of the Active/Passive/Index tracker/Life Cycle/Sustainable approach provides the highest consecutive (after tax/costs) gain and fits within the expat’s risk profile?
      • Are the Life Cycle funds tailor-made to the personal risk approach?
      • Too often funds focus on indeed low costs but not on the much more relevant expected consecutive height of the annual gain.
      • If you like to have an oversight of the essence of investments, feel free to look at our Brochure: ‘The Essence of Investments’.

    Risks

    Global expat pension optimization has many risk aspects. Expats often are not aware of these risks or their related effect. Thus we will now mention the most essential risks.

    • A) DC Investment Risks

      Due to the historically low interest rate an increasing number of pension plans is based on Defined Contribution (DC) and investments. We will now pay attention to the related risks.

      Correct Risk Profile?

      Due to the often substantial investment period until pension age, it is highly relevant that the investment is done in the best possible way. The bases thereof is to use the correct personal risk profile.

      It makes sure that your risk acceptance is defined in a highly accurate manner and that the deemed suitable investment categories are coupled with this profile for the correct period of time.

      If you might have any doubt it your pension plan uses a correct profile, feel free to visit our site and use our elaborate risk profile form.

      Fund Selection?

      It speaks for itself that it is relevant to only use the best investment funds regarding expected return on investments and low costs.

      Life Cycle Funds can be fine if they are implemented correctly. Please have this checked as it is not advisable to presume that they will all be fine.

      Split Pension Capitals?

      The standard situation is that the capital grows and is used at pension age to get the desired and legally and taxwise allowed pension:

      • Lump Sum(s) and/or
      • Temporary/Lifelong Annuities and/or 
      • Flexi Draw Down

      In some countries it is possibe to split the pension capital in several different sections and each with a separate focus: For example one for early retirement, one for standard retirement and one as an increase of the standard old age pension during the first few years of retirement.

      In such a situation, you have to adjust your investment mix and risk to the different time tables and needs.

      Investment Mix regarding Old Age Pension and Next of Kin Pension?

      Often the Old Age Pension capital is also used as funding for the Next of Kin Pension in case the insured person passes away prematurely.

      This is no problem but be aware that both types of pension can have a very different investment horizon. As the Next of Kin Pension horizon can be much shorter, please take this into account while creating the overall coverage. It might be a reason for acquiring an additional and in time declining risk coverage.

      Interest Rate at Retirement Age?

      Just before retirement age a DC pension claim often requires that an annuity has to be bought. In that perspect the height of the interest rate is highly relevant. At the current historically low interest rate this means that buying an annuity is not that interesting and that if possible it seems advisable to look at other options.

    • B) DB Risks

      These Defined Benefit kind of pension claims provide guaranteed pension pay-out. No investment risk until retirement age nor interest rate risk at retirement age. Does this mean there are no risks? No.

      Transfer of Value?

      In case there is a (often conditional) annual indexation of the existing pension claim and it is also possible to transfer the value to the new occupational pension claim, you have to choose whether or not to transfer.

      Which means you have to make a projection: Will the existing annual indexation end up with more old age pension pay-out? Or will this be provided after a transfer of value?

      As this regards the comparison of many technical aspects, it seems wise to seek advice. One misunderstanding we already like to address: Some consultancy companies prefer clients to transfer in order to ‘earn’ money on commissions and future investments. They often state that ‘pensions is about having the freedom to decide yourself about your own pension capital’.

      Which statement is wrong. Pensions is about getting the highest pension at the lowest cost and risk.

      So please let yourself not get side tracked.

    • C) Legal/Tax Risks

      Double Tax Treaties?

      Expats who live in one country and receive pension pay-out from other countries are advised not to forget the impact of Double Tax Treaties.

      They are often created between two countries in order to prevent or limit the negative effect of double taxation and are highly relevant for pension optimization.

      Expats who plan ahead are advised to compare several countries in this respect.

      Future Legal/Tax Regime?

      No one knows what the rules will be in the future. Some countries, like for example The UK, have a tendency to change the pension related legislation and not always in favor of the person entitled to pensions. Please take this uncertainty into account when planning ahead.

      Conflicting International Regimes?

      Expats often have pension claims in several countries. One of the most relevant aspects of pension optimization is to make sure you use all tax benefits. In that regard each country has its own rules. As we have seen many times that national regimes can conflict in a serious manner, please take this into account when planning ahead.

      For example: In Swiss certain pension pay-outs are Lump Sum based. Holland does not allow pension Lump Sum pay-out. Without additional attention this will result in the situation that a possibly substantial Swiss pension capital is not treated as such by Holland and could be taxed completely and up front at pay-out at a very high progressive tax rate.

      Risk versus Ruling?

      We sometimes hear from new clients that they know what a certain international tax situation constitutes as they have done their homework.

      We always stick to our own approach which means that we do our own research and prevent not needed risks. Regarding international tax issues this means that we in general ask the National Tax Authority to in writing agree with our view on a certain matter.

    • D) Next of Kin Pension Funding

      Regarding how to fund the Next of Kin Pension coverage, there are three options:

      Capital Based

      This means that there is a capital with which the Next of Kin Pension coverage will be funded. As Next of Kin Pension often is about lifelong pension annuities, this will often require a substantial capital for funding.

      Risk Based

      This means often that an insurance company provides coverage if the insured person passes away during the contract. As this is only about risk coverage and does not require capital, the costs are substantially lower. If the insured person has not passed away at the end of the contract, you have paid premium that will not anymore provide any result.

      Combination

      Often the capital used to build a fine Old Age Pension is also used to fund the Next of Kin Pension, which capital based funding is suplemented by an additional (often temporary) risk coverage.

    • E) Next of Kin Pension before Retirement Age

      In order to see if the coverage meets your demands, please look at all existing State/ Occupational/ Private coverages. The funding can be capital and or risk based. Due to the current historically low interest rate, additional risk coverage is not that expensive if you get it in time and at the right place and at the right age.

    • F) Next of Kin Pension as of Retirement Age

      Additional risk coverage is often either not possible or very expensive. So in order to have your demands met, to be frank you should have provided for enough capital back in the day.

    • G) Disability Risk Coverage

      This coverage often does not get the attention it deserves.

      When you are looking at the existing coverage please take into account that you have to look at all existing State/Occupational/Private coverages. To the extent that the existing coverages do not meet your whishes, you can opt for additional risk coverage. The collective rate is often substantially lower than the individual rate.

    • H) Risk of Additional Clauses

      Expats who participate in a pension plan are often asked if they would like to choose certain additional clauses. While this might sound great, please first check in depth the exact meaning of such clauses.

      What does it provide at what (annual) cost? In the past we have seen that many expats opted for additional disability clauses without checking the cost, exact meaning and if they really needed the addition in the first place.

    • I) State Pension Optimization Risks

      In many countries it is possible to buy additional State Pension Claims.

      This might sound attractive as expats often lack a certain pension build up capacity regarding a certain period. Please be aware that you often have the risk of paying a too high premium for such an addition.

      Furthermore it is also not sure if the additional infusion of premium will indeed result in more State Pension pay-out in the future as regimes and State Pension Systems can and do change.

    • J) Private Annuity Risks

      Private annuities deserve additional attention due to the following often existing risks:

      • High costs due to individual nature;
      • Often limited investment opportunities;
      • Inflexibility due to standardization;
      • Limited or no tax advantages.

      If the right product is chosen it might sometimes prove to be a fine addition to the total planning. It all depends on your circumstances and the type and amount of product.

    • K) Supernational Institutions: Increased Risk

      In general Expat Pensions have the familiar 3 Pillar Division:

      1. State Pensions;
      2. Occupational Pensions;
      3. Private Pensions.

      Expats working for Supernational Institutions like for example ESA will see that there is no such division and that you have to look carefully at the exact kind and amount of coverage with often also a special and unique tax regime. This all provides an increased risk for mistakes.

      Regarding the issue whether or not to transfer the value of existing pension claims to such a new plan, please be very cautious and seek advice.

    • L) Separate Investment Risks

      Many expats have investments separate from official pension plans.

      It often strikes us that not all implications have been researched. Please make sure that you are aware of all legal, tax and investment regimes and opportunities.

    • M) Wills: Don’t take the Risk

      Many expats have a Will in another country than the country in which they currently reside. This is not advisable as the exact same clause can have a different meaning in another country. As it is advisable not to have risks that can be prevented, please always have a Will in the residing country.

    • N) Advisor Risk: You have been advised correctly in the past?

      During expat pension optimization projects, we always see how expats have been advised in the past and if that advice was correct.

      Rest assurred, there are fine advisors in many countries. However, that does not mean that every advisor provides the best possible advice.

      We urge you to be critical. The right type of advisor will understand and respect you for it.