@curvoeu how does investing in a pension account (« épargne pension ») compares to investing in index funds for Belgians? Since these accounts are pre-tax contributions + tax deductible, I’m wondering how they compare.— Gary Gaspar (@GaryGaspar) August 21, 2019
“Épargne-pension” (or “pensioensparen” in Dutch), is a pension-saving scheme offered by the Belgian government. It’s a way to put aside funds additional for your pension, on top of the state pension. It’s sold as an attractive option to save for retirement because it comes with a considerable tax break. But how does it compare to saving for your pension through passive investing? Do you end up with a higher pension with “épargne-pension”? Or are you better off managing your own investments through passive investing?
That is the question that Gary, co-founder and CEO of Marker.io, asked us on Twitter. We thought it was particularly relevant for the Belgians among you. In fact, the findings of this article led Curvo co-founder Yoran to change the way he saves for his pension!
How does “épargne-pension” work?
First of all, we couldn’t find a good English translation of “épargne-pension’. As far as we know, it’s a very Belgian concept. So despite its Frenchness, we will continue to use this word throughout the article. We could have used the Dutch word “pensioensparen” but we chose to use Gary’s native language.
As we said in the introduction, “épargne-pension” is a way to put aside extra money for your pension, on top of the state pension that every Belgian worker starts receiving when reaching retirement age. It is voluntary, meaning that you’re free to choose whether you want to contribute to an “épargne-pension” account. Furthermore, it is done on an individual basis and not through your employer.
Every year, the Belgian state defines a maximum amount that you can contribute towards your “épargne-pension” account for that year. This amount was set to €1,260 for 2019 and grows every year with inflation. To start with “épargne-pension”, you simply go to your bank and tell them that you want to start contributing to an “épargne-pension” account.
This account will be either:
- an insurance. You earn a fixed interest rate every year. The return will be low but predictable.
- a fund. The bank invests your contributions in stocks and bonds through special funds. Compared to the insurance, you can potentially achieve a higher return. But the returns carry more risk because of the unpredictability of the markets.
The great thing about “épargne-pension” is that it comes with a tax break set at 25% of your contribution. For example, if you contributed the maximum amount of €1,260 this year, you will earn €315 back through your tax returns. Essentially, this means that you contributed only €945 out of your own pocket and the state subsidises the remaining amount. Free money, we like that!
We previously explained why passive investing is also a great way to save for retirement. Which one will result in a higher pension: passive investing or “épargne-pension”? Let’s find out!
We are simulating the case of Nathan. Ever since he started working at age 23, he’s been contributing €1,260 every year towards his pension, until his retirement at age 67.
We compare three scenarios:
- His contributions go towards an “épargne-pension” insurance. For the simulation, we chose the Belfius Life Plan. This account is offered by Belfius, a major Belgian bank (we don’t have any affiliation or connection to Belfius). It yields a yearly interest rate of 0.60%.
- His contributions go towards an “épargne-pension” fund, namely the Belfius Pension Fund High Equities fund. Using historical data, we calculated that this fund yielded a yearly return 2.67% between 1999 and 2019. We will use this return for the simulation.
- His contributions go towards an MSCI World index fund (passive investing). To account for the tax break offered by “épargne-pension”, Nathan contributes only €945 every year in this scenario. Between 1999 and 2019, the MSCI World index yielded an annual return of 5.40%.
We are interested in knowing how his savings evolve for the three different scenarios. This is shown in the chart below.
The first observation is that all three scenarios result in a bigger pension than the sum of Nathan’s yearly contributions if he had kept them in a savings account (green line). So both “épargne-pension” and passive investing are a better option compared to a savings account.
Secondly, it shows that passive investing wins over “épargne-pension” in the long run. Up until the age of 41, the 25% tax break compensates for the lower return of the “épargne-pension” fund compared to that of the MSCI World index. However, from the age of 42, the tax break is not enough to counter the much higher return achievable through passive investing.
By age 67, Nathan can retire with:
- “épargne-pension” insurance: €56,000
- “épargne-pension” fund: €98,000
- passive investing: €162,000
Those are considerable differences!
The reason why the “épargne-pension” fund underperforms the MSCI World index is mainly due to regulations. The Belgian state imposes rules such that “épargne-pension” funds do not have total freedom in their investment strategy. For instance, 80% of the entire portfolio must be invested in companies and bonds from within the European Union. Such regulations reduce the possibility for diversification and therefore put a limit on the yearly return that can be achieved for these funds.
Finally, you can notice a sudden decrease at age 60 in the evolution of the “épargne-pension” graphs. This is due to a 8% tax that you must pay when you reach the age of 60. This is a way to partially compensate for the yearly tax breaks. In the case of the “épargne-pension” fund, this resulted in a €3,714 loss at age 60.
Other disadvantages of “épargne-pension”
Besides ending up with a smaller pension than through passive investing, “épargne-pension” imposes other constraints that further reduce its attractiveness:
- Your savings are locked up until the age of 60. You can withdraw the funds at an earlier age but it comes at a severe 33% tax penalty. Therefore, this option not recommended. When passively investing, you’re free to withdraw funds at any time, for example when buying a house.
- “Épargne-pension” insurances and funds have an entrance fee. For instance, the Belfius Pension Fund High Equities fund has an entrance fee of 3%. This means that you have to pay the bank €50,40 for each €1,260 contribution that you make every year. In contrast, there are no entrance fees when passively investing, even when going through a service like Curvo.
- “Épargne-pension” funds are expensive. “Épargne-pension” funds are actively managed, which results in high ongoing fees. The Belfius Pension Fund High Equities fund has yearly ongoing costs of 1.31%. A service such as Curvo charges only a 1.00% advisory fee, and you can do it even cheaper if you manage your investments yourself through a broker.
- You cannot save more than the maximum imposed by the state. If you want to save more than €1,260 every year, you have to figure out a way to invest the excess amount through another way.
The simulation showed that passive investing results in a higher pension than saving through the “épargne-pension” scheme offered by the Belgian state. Furthermore, it’s also more flexible. You’re not bound to the yearly limit set by the Belgian government and you can withdraw your funds at any time.
As we said in the introduction, Curvo co-founder Yoran changed the way he’s saving for his pension as a result of this article. His bank had previously sold him an “épargne-pension” insurance, which he now cancelled. Instead, he’s going to passively invest by putting his contributions towards his portfolio of index funds.
The 5.40% return rate was calculated using the data for the MSCI World index from Backtest.
We ran the simulations with the Belfius Pension Fund High Equities fund, which is their most offensive fund and therefore will earn the highest potential return in the long run. The 2.67% return rate was calculated using the data from Candriam.
We ran the simulations with the Belfius Life Plan, which has a fixed interest rate of 0.60%.
We built a Google Sheets spreadsheet to run the simulations. It takes into account the entrance fees, ongoing fees and taxes that are relevant for each scenario.