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Surviving pension reform

The recent pension reform has created a challenging environment for those who want to live on a decent income during their golden years. Hungarians are now looking for alternative sources of income for their retirement, in a brave new world of personal responsibility.

“By being scared,” replies Gabriella, a 42 year-old economist, when asked how she is preparing for her retirement years. When pressed a little more, she recalled that she has a voluntary pension fund account and “some unit-linked product,” both of which she failed to transfer funds to since she lost her job a few months ago. While being scared does not help much, there are a handful of alternative options on the Hungarian market that could help secure a sufficient income for retirement.

Fill the gap

Social security, the state pillar of the Hungarian pension system, is dwindling more every year. The number of workers relative to the number of retirees is expected to decline in the upcoming years in line with an aging population and the decreasing number of children.

The difference between the expected income from a state pension and the income necessary to maintain an acceptable standard of living is the gap that prudent Hungarians are now trying to fill. A recent analysis by insurance company Aviva shows that across the European Union, the annual pensions gap is €1.9 trillion, or around 19% of GDP in 2010. This indicates that, on average, people need 70% of their pre-retirement income to provide an adequate standard of living in retirement and a 5% return on investments in pension funds, Aviva said. The pension gap in Hungary alone is worth €9.5 billion, according to the study.

Self-provision, which has long been ignored, is becoming the hottest topic as Hungarians are forced to think long and hard about their financial stability. There are promising developments, though. According to a recent survey by Budapest Bank, the willingness to save among those with above-average incomes has increased.

Pension savers

In the wake of the reduction of the personal income tax rate to 16%, high income earners surveyed plan to save HUF 60,000 per month, HUF 11,000 more than before. Extra incomes resulting from the lower taxes will be put aside in reserves or for housing and pensions. The survey shows that bank deposits are still favored over other types of savings, mentioned by 67% of respondents, followed by voluntary pension funds (43%) and investment funds (43%).

The survey points out that long-term thinking is still not common, with only 12% of respondents planning savings with a time horizon of over ten years. Savers typically start putting money aside for their retirement years at the age of 36. The basic long-term saving options in Hungary include voluntary pension funds, retirement saving accounts (Nyesz), long-term investment accounts (Tbsz) and unit-linked insurance products.

“An investor with a longer time horizon has to focus on minimizing both costs and taxes,” according to Márton Radnai, CEO of software developer Ramasoft Zrt. “We Hungarians do not like paying taxes and are willing to make great efforts to find ways to avoid them,” he added. Ramasoft operates investment portal, which published one of the most popular retirement income calculators after the announcement of the pension overhaul.

Voluntary pension funds

Voluntary pension funds, the second pillar of the new pension system, have not been affected by the reform. These are joint ventures created by the members of the fund based on independence, mutuality, solidarity and voluntary participation in order to supplement, replace, or substitute social security pension services.

There are altogether 61 voluntary pension funds in Hungary, according to data provided by financial watchdog PSZÁF. Voluntary pension funds had assets of HUF 864 billion at the end of September 2010, up from HUF 783 billion one year earlier. The top three market players are OTP, Allianz and Aegon. The number of members continued to drop to slightly more than 1.3 million at the end of Q3 2010.

Most funds offer various investment policies to enable members to pick the most suitable one to balance risks against potential returns. These typically include a conservative, a balanced and a dynamic portfolio. According to the Stabilitás Pension Fund Association, the majority of members chose one of the lower-risk portfolios.

“When choosing a pension fund, investors should look at the Risk Adjusted Return (RAR) of the specific fund,” Radnai pointed out. “Comparing the simple return of the funds can be misleading, as it does not take into account the risks undertaken by the fund managers,” he warned.

Occupational pension funds

A new feature on the Hungarian pension services market is the introduction of occupational pension funds. These schemes have a long tradition in the US and Western Europe. Through these funds, employers can participate directly in their employees’ pension savings. The institution provides services after the member’s retirement. The pension service can be a one-off pension payment, a fixed-term pension payment, an annuity, or the combination of these.

Although establishing occupational pension funds in Hungary has been possible since 2008, the first such fund was launched only in February 2011, by investment company Quaestor, with HUF 1.05 billion registered capital. Quaestor targets the entire Hungarian corporate sector with the new service. Occupational pension funds will enable multinational firms to introduce their global retirement plans in Hungary, while Hungarian businesses will be able to improve the loyalty of their employees, thus reducing fluctuation. SMEs could reduce their labor costs, as contributions to such schemes qualify for tax relief.

Retirement saving accounts

The Act on Personal Retirement Savings Accounts allows private individuals to put aside money for their retirement years in a combined cash and securities account opened at financial institutions. The account can be used to submit orders for the sale or purchase of fund certificates, stocks and government securities.

The Nyesz account is recommended for those who want to manage their savings over the long term, and would like to receive assistance offered as a part of the government's drive to promote self-provision. The state provides a 20% tax refund (capped at HUF 100,000) on funds deposited on the account each year, as long as the tax base provides sufficient coverage after other deductions. For those who will reach retirement age before January 1, 2020, the maximum annual amount of the rebate is HUF 130,000.

Gains on financial assets held in a Nyesz account enjoy tax exemption if the account holder is entitled to receive a pension, and the withdrawal of funds takes place at least three years after opening such account. In all other cases, a personal income tax payment obligation may arise, and 120% of the tax refunds provided by the government must be repaid. Savings in Nyesz accounts can also be inherited.

Unit-linked insurance products

“Clients have lately shown an increased interest in long-term savings and are more open to new products, such as our euro-based life insurance,” a spokesperson for insurance firm Groupama told the BBJ. “We believe that it is our responsibility to inform customers about their options,” she added. Groupama has developed a new retirement income calculator, but it has not put it on the company’s website. “This is a very sophisticated program, so we have trained our agents to assist our clients in finding the best solution for each individual together,” the spokesperson said.

Life insurance companies sold new policies in the value of HUF 62.8 billion in 2010, up 51% from 2009, according to data provided by the Association of Hungarian Insurance Companies (Mabisz). Unit-linked life insurance policies, with an 83.7% market share last year, continued to drive sales, with growth of 76% to HUF 52.5 billion in 2010 in terms of new acquisitions. The total revenue of the unit-linked market grew by about 6% to HUF 267 billion.

Life annuities

Another, less common option to increase retirement income is obtaining a life annuity either by reaching an agreement with a private counter-party, or through a financial institution. The latter is a relatively new and small market with only a few thousands contracts, while the market size is estimated to be 120,000–130,000 potential customers. The market was hit especially hard by the global financial crisis and falling real estate prices. There are only three major players on the market, including mortgage bank FHB, OTP Bank and Hild Zrt.

Besides the traditional property-based life annuity, FHB introduced a more flexible product in 2006, which enables customers to keep ownership of their own home. The scheme provides a lump-sum upfront payment, a monthly, inflation-indexed annuity income, property insurance and a predefined scope of maintenance work.