New retirement savings account opportunity

[wood]

The government in my country (Norway) are soon launching an opportunity to save extra for retirement.

One can transfer a maximum of $5000 per year to a locked personal account, and get 24% ($1200) in tax deductions the following year. The government basically gives you "free" money if you do this. One can choose the risk profile on the savings account, ranging from a safe 2% high interest account setup to a more risky stock portfolio.
The account is not included when calculating net worth taxation (individuals with networth over a certain threshold get taxed by a small percentage).

The downsides:
- One cannot start withdrawing money from the account before age 62.
- The withdrawals must last for 10 years minimum (cannot withdraw all at once).
- The withdrawals must last until you are atleast 77 years of age.
- Withdrawals are taxed 24%.

Would you take advantage of such an arrangement?

Should I?

I'm 32 years old and hope to retire in the next few years, or at the very least semi-retire with a part time job. Estimated annual income of $15k in which most will be spent on living expenses. Coming up with an extra $5k for this account will either postpone my retirement with a few more years or require me to make an extra $3800 income from working every year ($5000 minus the $1200 tax deduction you get).

I'm leaning towards an opportunistic approach; should I have some extra income in a given year I can put it towards that account. Another approach could be to transfer those $5000 from my nest egg every year, only to have it locked until age 62 and reaping those extra $1200 in tax deductions annually.

One can get pension payments from age 62 here and we have a well developed social security and welfare system. These savings would come on top of that. I plan to live independent from any potential pension payments.

Any other considerations I might not have thought of?

[Jean]

So you basicaly have to pay back those24% at the en?

[wood]

Basically yes.

[vexed87]

Hard to consider it in a vacuum, what are your alternatives?

How safe is the 2%, is it fixed, or pegged 2% above inflation? 2% earning could be wiped out overnight by increasing cost of commodities. You'll be in for a rough retirement. How many degrees of freedom are there in the riskier portfolio? Can you choose asset classes and stocks, or are you stuck with a government 'portfolio'.

It's hardly free money, you're essentially looking at an 24% income tax on your pension. Is it an annuity? What happens to the funds in the account if you die? What is left for your family? Will payouts continue until your funds are depleted? Will your children inherit your money, or does the fund cease payments if your partner passes?

Can you choose how much to withdraw and when? The fact that your funds are locked up is my biggest concern from an ERE point of view. You couldn't retire early unless you had other funds to tie you over until retirement age. Will the goal posts (retirement age) change?

Offsetting your taxes like this will mean you can save more earlier than you might otherwise which means you kind of leverage your savings for higher returns (or losses).

I don't contribute to my employer pension in the UK, so I miss out on these kind of tax breaks, but earnings and withdrawals in the UK ISA are currently tax free, and I can take as much or little as I need, whenever I want. The ISA wasn't designed to be a pension scheme, which makes me nervous the rules might change in the future, or the account type may disappear entirely, but I have taken steps to mitigate that (i.e. not depending 100% on financial capital).

[henrik]

Will you actually have to pay the 24% when you withdraw? Is there something like the UK's personal allowance (tax free yearly limit) that would let you get to it tax free if withdrawn slowly enough? Otherwise it doesn't seem to make much sense - you just lock up your money for no apparent benefit. If your withdrawals (contributions + gains) are taxed at the same rate you can use for your deductions, there really is no free money, is there?

We have something like you describe in Estonia. Max 6000€ per year contributions and you get a tax refund worth a flat 20%. The difference is that I can get to it at 55 and it will then be taxed at 10% (or 0% if taken as an annuity). An even bigger difference is that I can also get to it right now, I just have to pay full income tax. So I treat this as an emergency / early-ish retirement fund. I can get it if I need to at the expense of losing the tax benefit. If no emergency occurs, I can get to it for less tax earlier than the normal pension age (which is currently at 65).

Your option seems to be a lot less beneficial except for the fact that you can shield some assets from the wealth tax.

[TheWanderingScholar]

Will you actually have to pay the 24% when you withdraw? Is there something like the UK's personal allowance (tax free yearly limit) that would let you get to it tax free if withdrawn slowly enough? Otherwise it doesn't seem to make much sense - you just lock up your money for no apparent benefit. If your withdrawals (contributions + gains) are taxed at the same rate you can use for your deductions, there really is no free money, is there?

We have something like you describe in Estonia. Max 6000€ per year contributions and you get a tax refund worth a flat 20%. The difference is that I can get to it at 55 and it will then be taxed at 10% (or 0% if taken as an annuity). An even bigger difference is that I can also get to it right now, I just have to pay full income tax. So I treat this as an emergency / early-ish retirement fund. I can get it if I need to at the expense of losing the tax benefit. If no emergency occurs, I can get to it for less tax earlier than the normal pension age (which is currently at 65).

Your option seems to be a lot less beneficial except for the fact that you can shield some assets from the wealth tax.

*starts scribbling down notes for a future post and tax optimization*


@wood
Seriously though, the Norwegian system sounds not exactly beneficial to your situation, as it seems just lock up money in the future with no real benefit, making it a non-liquidous asset.

Honestly the only reason I imagine this being useful is a situation as a back-up asset for twilight years if things go royally peer-shaped in Norway, which I don't know enough about the current politically situation let alone the possible future political situations.

However if thing remain the same, it does not seem to be worth it as it locks up assets with very little benefit except in exceptional or disaster situations.

Things to Not:
I am a 22 year old with a mild interest in finance and just starting ERE.

[Jean]

It looks bad then. I wouldnt.use this at all.

[wood]

Hard to consider it in a vacuum, what are your alternatives?

How safe is the 2%, is it fixed, or pegged 2% above inflation? 2% earning could be wiped out overnight by increasing cost of commodities. You'll be in for a rough retirement. How many degrees of freedom are there in the riskier portfolio? Can you choose asset classes and stocks, or are you stuck with a government 'portfolio'.

It's hardly free money, you're essentially looking at an 24% income tax on your pension. Is it an annuity? What happens to the funds in the account if you die? What is left for your family? Will payouts continue until your funds are depleted? Will your children inherit your money, or does the fund cease payments if your partner passes?

Can you choose how much to withdraw and when? The fact that your funds are locked up is my biggest concern from an ERE point of view. You couldn't retire early unless you had other funds to tie you over until retirement age. Will the goal posts (retirement age) change?

My alternative is to continue like before; put money into stocks, bank account and real estate investments that I have.

The 2% is a number taken out of thin air. In practice, you transfer $5k into this account. You can then tune it to be low, medium or high risk. You can change risk profile whenever you want. Low risk means the money will stay in a bank account with high interest (about 2% is my best guess). Medium and high risk means a mix between stocks, bonds and other assets depending on what the bank will want to offer. Sort of like picking a stock/bond fund. All banks are required to offer this new retirement savings account scheme.

It is not an annuity per se, but I suppose it works just like one with the terms dictated in my first post. I do not know exactly what will happen in case of death, nor do I really care. The interesting part to me is that I can get 24% tax deduction today, continue saving, and not having to pay taxes on withdrawals until 30 years from now. For someone contributing $5k every year this can be a massive tax advantage, provided you don't need those $5k today.

All else being equal, I'd have to save another ~$110k as a buffer and transfer money from that buffer into this retirement account if I want to make full use of it. I'm 32, saving upwards of $27k per year and expecting to retire at around age 36. So I'm effectively trading another 4 work years in order to have an extra $150k pension fund (the $110k buffer + 30 annual tax deductions @$1200) + expected yield 2%+) at my disposal, which will be taxed 24% upon withdrawal. The withdrawals starts earliest at 62 and ends earliest at 77, so an example would be to withdraw an annual $10k for 15 years between age 62 and 77. After tax would be $7600 annually.

In other words. Contribute $110k today. Get $150k 30 years from now. 30 years is alot of time.

@YoundAndWise & Jean: I tend to agree.
@henrik: Yes there seems to be no exceptions from paying the 24% tax upon withdrawal. Our previous scheme had 24% tax deduction upon contribution, 40% tax upon withdrawal (!) No one used it, but there's some hype around this new one now.

[Jean]

This looks like a scheme to get populations with high present preference to save money instead of blowing it and ending on welfare when older.

[vexed87]

@jean, agreed, I was about to say that too.

The fact that you can't select the underlying assets, all you get is some vague classification of low risk, medium risk, and high risk is a huge no no for me. If I'm risking my capital, I want more control. I'm only working with the info you provided here, but it feels to me like you put your money in an index fund, cross your fingers and hope for the best. Of course, if this is your investing style anyway, it won't change much but here as some more questions I would ask myself before taking the plunge, because you are locking your funds up for a long long time.

Who manages the fund?
Who decides on asset allocations, and risk profiles?
You said it's mandated by the government that commercial banks provide these account types. Is the government going to micromanage the asset allocations of the funds?
If not, the fund may only be as as good as its manager, or are they buying into a larger index fund?
What sort of risks will the fund manager take with your pension to meet the return required for your fund's risk preference if there are targets?
How low risk is the 'low risk' profile exactly? What are the guarantees? Is it protected under financial insurance, what happens if your bank collapses?
What penalties are there if you need to drawdown the funds much sooner? Poor health well before retirement age for example. Is it even an option?
You might not care about what happens to your funds when you die now, but will that always be the case in the future? I'd want to know for sure where that money goes in the worst case scenario. Might end up having several dependents who never see a penny of your contributions.
How likely is it that you will want to switch investment strategy?

These are all questions I would want to understand completely before making the decision to tie up my capital.

If the account could be used like the UK ISA, where your brokerage accounts are capital gains and dividends tax free, and you could withdraw as much, little, or as early as you like, and invest it in whatever you want, I would be all over it.

To me, it doesn't sound this way at all. It sounds like an account designed to encourage saving, but not 'smart' investing. It sniffs like buy and hold index investing to me. There's nothing inherently wrong with the strategy, particularly if you have alternative income streams from other investment strategies, but make sure you understand what you are getting into before you lock your funds in.

Even the low risk fund may not work out well in a low growth, high inflation rate scenario. If you can afford to contribute part of your savings into this scheme, it might be beneficial. As an ERE'er, with less to invest than some here, I prefer the flexibility of standard investment accounts, despite the relative tax inefficiency. It depends what your priorities are really.

tl;dr version, I suspect this account is only for you if you're content with long haul index investing and happy to give up the freedom of when and how much you withdraw and can stomach the broker of choice.

[wood]

The fact that you can't select the underlying assets, all you get is some vague classification of low risk, medium risk, and high risk is a huge no no for me. If I'm risking my capital, I want more control. I'm only working with the info you provided here, but it feels to me like you put your money in an index fund, cross your fingers and hope for the best. Of course, if this is your investing style anyway, it won't change much but here as some more questions I would ask myself before taking the plunge, because you are locking your funds up for a long long time.

True and my thinking as well. I want to add that I would never put all my money into this. But with time and maximum accumulation it could potentially make up 1/3 of all my assets, or I could make it be 1/10 of my assets. I just thought the delayed taxation could be a nice benefit, but the way I see it now it's not worth the cons.

Thanks for raising a few questions I hadn't considered.