Luxembourg’s tax reform encourages private pensions

Luxembourg’s tax reform package introduced at the beginning of this year was designed in part to make the country more attractive for companies looking to invest, including changes to the rules on corporate income tax. But equally important are changes to the tax rules designed to encourage people to save more for their retirement, including a big increase in tax-free allowances for pension contributions.

The government is thinking about how to deal with pension funding in the future, a conundrum for countries around the world. As over-indebted governments face a struggle to support ageing populations and companies are no longer ready to take on the burden of providing pensions for their employees, the emphasis is shifting to private pension schemes in which individuals take personal responsibility for their financial well-being in old age.

This is also becoming more important because people are living longer, which means their accumulated assets and retirement income must support them, on average, over a longer period. To encourage people to save and invest more, governments are making tax incentives to do so more compelling.

Building the third pillar

The so-called ‘third pillar’ of Luxembourg’s pension provision, personal pensions, has taken on greater importance even though the employment-based pension system (the ‘first pillar’) is relatively well funded, with annual contributions equivalent to 24% of gross salary, split three ways between the individual, the employer and the government. Company pension schemes represent the second pillar.

To encourage individuals to build up the third pillar of private pensions, the government has improved the tax regime for contributions. Pension savers have always benefited from a reduction in their taxable income for pension contributions, but previously this varied according to their age at the start of the year. For those under 40, the maximum annual deduction was €1,500, rising in five-yearly steps to €3,200 for those aged between 55 and 74. Now the tax reform has introduced a single €3,200 rate of tax allowance for everyone, regardless of their age.

The deduction is subject to certain conditions. The payment of benefits may not begin until at least 10 years after subscription to the pension scheme, and the start of retirement benefits must take place after the age of 60, but before recipients reach 75. In addition, at least 50% of the total benefits must come in the form of a monthly annuity payment.

More benefits at retirement

There are other incentives for private pensions which individuals can take advantage of upon retirement. Single lump-sum withdrawals are subject to a reduced tax rate, and may be completely tax-free or taxable at half the average rate, depending on the nature of the premiums paid.

Further changes to Luxembourg’s pension landscape may arise from moves by the European Commission, first announced in June this year, to create a regulatory framework for a pan-European personal pension product, which could prove a useful development for international people working in the grand duchy.

In the meantime, the Luxembourg government is continuing to focus on encouraging people to save more and to start the process younger to ensure they are in a more comfortable financial position once they have stopped working.


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