A] The Pension System
Spain has a classical three-pillar pension system.
The State Pension provides 90% of the pensions and can be supplemented by voluntary Workplace and/or Private Pension Plans. Which does not happen that often. The pension market is rather small compared to other EU countries and includes especially private retirement options.
In order to reduce dependency on State Pensions and reduce its very high costs, the government has increased the retirement age and make early retirement more difficult. Compared to other EU countries, the (tax facilitated) options for Workplace and Private Pension Plans are still modest.
B] Pillar 1: State Pensions
The Spanish State Pension is funded through mandatory contributions to the Spanish Social Security System. It includes two type of pensions:
- A contributory pension based on Spanish Social Security Contributions;
- A non-contributory modest pension to ensure mere basic income for the needy.
The government spends 11,4% of GDP on Pensions. Substantially more than the global OECD average of 8,2%. The pension system is financed by a payroll tax on wages. The employees pay 4,7% of their wages while employers pay 23,6% of the employee’s wages.
In order to qualify for the minimum State Pension, you need to have paid Spanish Social Security Contributions for at least 15 years. In order to meet those 15 years, years of participating in other EU countries can be included. Furthermore at least two of those years have to be within the 15 year period immediately preceding the pension claim.
If a person has met the minimum period requirements but does not have the full coverage, he will receive a pro rata pay-out. To claim a full pension, you need to have paid Spanish Social Security Contributions for at least 36 years. Which will rise to 38,5 years after 2027.
Self-employed workers in Spain can claim a pension, providing they have registered and paid social security contributions into Spain’s self-employed social security fund.
The minimum/maximum/average gross monthly pension pay-out amounts to indicative € 700,- / € 3.000,- / € 1.300,- for men and € 800,- for women. Which amounts are not any longer directly corrected for inflation.
Earlier/later start of the pension will lead to a decrease/increase of the pension. Which flexibility we do not see that often regarding State Pensions in other EU countries.
The pension calculator can provide exact information regarding your personal situation:
For more information: https://www.inclusion.gob.es/en/web/guest/home
C] Pillar 2: Occupational Pensions
Company and employee pensions depend on the employer for availability and conditions. Due to the fine State Pensions there was no incentive to create a broad network of company pensions.
Up to 7% of the companies provide a pension plan. Mostly by large and international companies. 75% of the plans are available to the entire workforce and 25% only cover management.
Like in the rest of the EU guaranteed Defined Benefit (DB) plans are often substituted for investment based Defined Contribution (DC) pension plans. DB plans were often solely funded by the company whereas DC plans often also include a 20%-35% employee contribution.
Now it is becoming quite usual to link company contributions to the employee's contribution. Then the plan foresees different contribution levels (minimum, medium and maximum), which are available at the employee's choice.
II. Income Tax Treatment of Company Pension Plan
There is a limit to the provided income tax benefit. In order to decrease dependency on State Pensions and increase popularity of Workplace Pensions, it might be an option to increase these currently modest maximum tax benefits:
- The maximum combined employee/employer contribution amount that benefits tax relief may not exceed € 10.000,- for employees aged 50 and younger or 30% of earnings, whichever is lower.
- For those aged 50 and over the amount was reduced to € 12.000,- or 50% of earnings, whichever is lower.
- Pension pay-out is taxed as income. The employees can choose to get a Lump Sum and/or Annuity. To encourage employees to opt for the annuity payment, the tax advantage of Lump Sum payments was removed. (Which is understandable but in other EU countries we see a trend towards more flexibility and more Lump Sum options.)
III. Pension Funds
These separate legal entities function as a repository for assets of one or more tax-qualifying Occupational Pension Plans. Since 2007 it is allowed to provide two different investment strategies within one scheme.
The Pension Fund is required to have an Investment Manager and a Custodian. The Investment Manager is either a registered pension fund manager, which can only be a specialist company legally domiciled in Spain, or an Insurance Company.
There are requirements for minimum funding level and solvency margin for guaranteed Defined Benefit (DB) schemes. Surpluses cannot be recovered and contribution payments are irrevocable.
Finally local financial entities are the dominant providers on the market. The ten leading institutions control 85% of all funds.
IV. Direct Insurance
Direct insurance plans play an important role even though they are subject to an adverse tax regime. Group contracts are often used to fund benefits for pensioners.
The 1995 insurance legislation required group insurance contracts to back pension arrangements to meet a series of requirements.
The most important of these demands is that surpluses can only be recovered by the company if:
- Sufficient coverage of existing pension liabilities is in place;
- Surplus relates to premiums that have not been treated as employees taxable income;
- The funding vehicle is changed from group insurance to a pension fund in order to integrate the provisions into the pension fund.
- The tax treatment of contributions and benefits depends on the choice made by the employer.
V. The Future
As Spain needs to reduce the costs and dependency on the State Pension Plan, we hope and expect that the tax benefits related to Occupational and Private Pension Plans will increase substantially in the near future.
D] Pillar 3: Private Pensions
Private Pensions are voluntary and have more flexible conditions than the Spanish State Pension. Some even allow the participant to withdraw savings before the formal Spanish pension age.
A Private Pension Plan can be acquired through a pension fund or the direct insurance channel of banks/insurance companies. It enables participants to make individual contributions at an agreed rate.
In general any contribution of up to € 1.500,- per year to a Private Pension Plan can be tax-deductible. Any amount above that can be taxed. Contributions to a Private Pension Plan may not exceed 30% of the annual net income. Before getting the plan, it is always advisable to check the exact applicable max tax benefits.
The most relevant aspects of the Private Pension Plan are;
- The tax benefits;
- The flexible pay-out options;
- A pay-out even before the formal Spanish retirement age.
Thus the Private Pension Plan can be an interesting option to complete the existing coverages if the related costs are no too high and the investment options meet the requirements.
E] Retirement Age
The formal retirement age is increasing in line with other EU countries.
The retirement age for a full pension was age 65 years and ten months in 2020 if a person had less than 36 years and six months of contributions to the Spanish Social Security System. The legal retirement age will further increase to age 67 in 2027 for all genders.
It remains possible to retire at age 65 if a person has paid 37 years of Spanish Social Security Contributions. Which will increase to 38,5 years by 2027.
Finally partial and flexible retirement remain available and can have their own conditions.
F] Pay-Out Flexibility
The pension pay-out flexibility in Spain is better then in several other EU countries.
State Pensions tend to be inflexible regarding starting age but the Spanish State Pension has the option to start sooner or later. The Spanish Private Pension Plan also has the option to if so desired start before the formal retirement age.
Occupational and Private Pension Plans often have the option to choose between a standard annuity and/or Lump Sum pay-out.
G] Tax On Pensions
I. Double Tax Treaty
If you have retired in Spain and receive pensions from another country, it seems advisable to check if there is a Double Tax Treaty between both countries which will state which country may enforce its existing national taxation on the pay-out.
II. Spanish Tax
If the Spanish taxation is applicable, the progressive tax rates are between 8%-40%.
The Spanish personal tax free allowance is age related and amounts to:
- Under age 65 : € 5.550,-
- Age 65-74 : € 6.700,-
- As of age 75 : € 8.100,-
H] Transfer of Value
If you retire in Spain and have pension claims in other countries then the transfer of pension capital/claims can be a relevant issue.
State Pensions can never be transferred. Occupational And Private Pension Claims can be transferred if both related countries agree with this procedure and if the applicable providers also agree. Within the EU this has more chance of succeeding.
Please never make a transfer if there a negative tax aspects or high costs or negative investment implications. Due to the technical and international complexity, it seems advisable to seek professional advice.
I] News July 2022
Spain’s left-leaning coalition government is planning to introduce an auto-enrolment system for pension saving, mimicking some aspects of the UK NEST system.
The government first revealed its intentions last year, and has now committed in the 2021 general budget law to pass legislation before the end of 2021, with first contributions into the system being made in late 2022.
Little detail has been announced; informal discussions are continuing between the government, unions and the pensions and asset management industries and unions.
The plans – aimed at the self-employed and small and medium-sized enterprises (SMEs) – underline the government’s belief that private retirement savings are likely to succeed on a collective rather than an individual basis.
Last year, the government dramatically reduced the annual contribution limit for individual plans from € 8.000,- to €2.000,- per year. Meanwhile, it raised the contribution limit for corporate pension plans from € 8.000,- to € 10.000,- per year.
The changes took effect from January 2021.
“The new [auto-enrolment] law is intended to provide that all the active population will have to contribute part of their salary into this pension scheme, and company contributions will also be mandatory,” David Cienfuegos told IPE. “It’s a good idea,” he added. “At present, only the larger companies provide pension schemes.”
The government has committed to growing the system to reach 9% of GDP ($130bn in assets) covering 13 million people by 2030, as part of its response to European Commission requirements to provide recovery funds for Spain, following the pandemic.
At end-March 2021, Pillar 2 assets amounted to €36bn, according to the country’s Investment and Pension Fund Association (Inverco).
The new Spanish public pension fund will be government-sponsored but privately run in terms of fund management and administration, prime candidates being the banks and insurance companies.
The national framework will be administered by a single pensions manager, but the asset management will be outsourced to a limited number of approved fiduciary managers, possibly with each one responsible for a different risk profile.
It is not yet known if there will be a default option. But Cienfuegos said there has been no clarity on how the investment management will work, although company sponsors will decide which manager to appoint.
A public tender will take place next year. Meanwhile, the government also intends to set up a digital platform allowing members more control over their individual plans.
Cienfuegos suggested that while the basic proposal is being driven by the federal government, the scheme might operate on a sector-specific basis agreed by the unions and government.
He also said that the model is likely to include a board of trustees for each scheme, to include independent members.
Nacho Hernández Valiñani, chair, Pensions Caixa 30, told IPE: “It’s good news – it will be more efficient for people to save for retirement through corporate pension plans.”
He also believes the new scheme’s structure will improve on current rules.
“We think the level of responsibility and independence of asset owners should be greater,” he said. “The new model will include a board of trustees for the whole scheme, and the mandate tenders will be launched under European regulations. The government wants to copy the north European model, which is good.”
And Hernández Valiñani thinks that auto-enrolment will be a harbinger of further developments.
“We’re seeing a real revolution in the Spanish pensions industry,” he said. “At present, corporate pension fund managers have to be Spanish. We also cannot appoint independent members of a board of trustees. But we think that’s going to change.”