Pension System in Spain

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Updates and reforms

Between 2013 and 2027, the retirement age will increase from 65 to 67 years. Withsocial security contributions rising from 15 to 25 years. and thelegal age of early retirement will increase to 63 from 61 years
From 1 January 2014, pension increases rise by a minimum of 0.25% and will only increase more if Spain's social security system is in surplus. The increments will be capped at 0.5% above the rate of inflation.

From 2019, the 'sustainability factor' will be used to calculate state pensions. So instead of using inflation, the calculations will be based on variables such as life expectancy, the number of pensioners, the level of pension payments over a duration of time and the financial situation of the social security system.

The reforms proposed a committee should be appointed to produce a report regarding the sustainability of the pension system and that the sustainability factor should be periodically reviewed.

Pension System
Spain operates a three-pillar pension system composed of a generous and dominating state pension system and voluntary occupational and private pension arrangements.
The country has a relatively small pension market, which is dominated by third pillar insurance products.

Public Pensions
The state pension system contributes about 90% (for low and average wages) towards pensioners' incomes. It features the following components:

- A means-tested non-contributory old-age pension granted to persons aged 65 and older, who have not acquired enough pension contributions or are not entitled to a contributory old-age pension at all. It is required that the person has lived in Spain for at least 10 years after reaching the age of 16 and for five consecutive years just before claiming the pension. This pension is financed solely from tax revenues.

- An earnings-related, contributory pension system that is mandatory for all employees and self-employed persons. The assessment base is at least 15 years of earnings and contributions, with a maximum pension being attained after 35 years of contribution. For benefits under the earnings-related pension system a means-tested minimum and maximum pension applies. It is financed through contributions paid by employees (4.7%) and employers (23.6%).

Early retirement is possible at the age of 60 for those who started working before January 1, 1967, with a minimum of 30 years of contributions. But the pension benefit is reduced by 8% for every year of retirement before the age of 65 (maximum reduction: 40%). In the event of postponing retirement after reaching the age of 65, and having accumulated 35 contribution years, two percentage points are added to the multiplier for every further year in employment. Individuals that postpone retirement after the statutory retirement age and have at least contributed for 40 years see an increase of the pension benefit multiplier of four percentage points instead of only two.

The state retirement age is to be phased upwards to 67 by 2027, the number of contribution years raised from 35 to 38.5 and the assessment base raised from 15 to 25. This aims to reduce government spending on pensions in the face of demographic challenges, but the Spanish government has been urged to reform even further by the IMF.

Occupational Pensions
There has been no perceived requirement for additional benefits, and occupational pension plans have not been highly developed as Spain's first pillar provides good security.

Up to 7% of companies are at present offering some kind of retirement plan, although these are more common among larger employers and in companies with international exposure. Currently, the majority of plans are available to the entire workforce, but about 25% of plans are reserved only for executives.

Traditionally, pension plans have been of the defined benefit (DB) type. DB plans are usually 100% financed by the employer. Defined contribution (DC) plans are gaining in popularity where, typically, the employer bears 65-80% of the total plan cost and the employees contribute the rest. Now it is becoming quite usual to link company contributions to the employee's contribution. In this case the plan foresees different contribution levels (minimum, medium and maximum), which are available at the employee's choice.

1. Pension funds
Pension funds in Spain are separate legal entities created to serve as a repository for assets of one or more tax-qualifying pension plans.

Since November 2007, it is now possible to offer two investment strategies under one plan. Previously, only one investment strategy was allowed.
The appointment of an investment manager and a custodian is required. The choice of the investment manager is restricted in that it has to be either a registered pension fund manager, which can only be a specialist company legally domiciled in Spain, or an insurer.

There are rules regarding a minimum funding level and solvency margin for defined benefit (DB) plans. Furthermore, surpluses cannot be recovered and contribution payments are irrevocable.
Local financial entities are at present the main players on the market, with the ten leading institutions managing about 85% of all funds.

Tax treatment of contributions and benefits
The maximum combined employee/employer contribution amount that attracts tax relief must 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.
Benefits are taxed as income. To encourage employees to take an annuity payment instead, the tax advantage of lump sum payments was removed.

2. Direct insurance
Direct insurance plans play an important role in the overall market, although they are subject to an adverse tax environment. Group contracts are commonly 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 is that surpluses can be recovered by the company (policy holder) if:
- Adequate coverage of the existing pension liabilities is maintained
- Surplus relates to premiums that have not been treated as taxable income to the employees;
- 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.

Additional sources:
The Organisation for Economic Co-operation and Development (OECD) -