The EU's Borderless Pensions
Annette Power works in the London office of a large German bank. A 46-year-old trade-finance specialist, she was recently offered a promotion that would require her to move to the bank's head office in Frankfurt. But while the new job would be a big step up, she's not sure she should take it. Why? Blame Europe's patchwork of pensions. Power (not her real name) is required to contribute to Britain's state pension system via payroll deductions. She supplements that with an employer-sponsored pension plan. Her husband, a self-employed computer programmer, sets aside money for his dotage in a private retirement plan.
Yet if the couple moved to Germany, Power would have to freeze contributions to the British state program and start contributing to Germany's more generous -- but more expensive -- one instead. She would still get a British pension on a pro rata basis, but local tax rules would prevent Power from rolling over her British company pension into a new one in Germany. To make things worse, if Power's husband followed her to Germany, he would no longer be able to make tax-deferred contributions to his private pension. And wherever the couple ended up retiring, they would face a bureaucratic nightmare sorting out how much pension they were entitled to and whether they would have to pay tax on it. "Europe's different pension systems can make moving from one country to another incredibly difficult," says Rodney Taylor, a director in the London office of consulting and accounting firm Mazars. "It limits labor mobility."
The pension roadblock undermines one of the main goals of the European Union -- creating an open, flexible labor market. What Europe clearly needs is portable pensions -- retirement packages that its workers can take anywhere. The 15 governments of the EU have dragged their feet for a decade on passing the laws needed to make that happen. But now, EU action and court rulings are beginning to break the logjam.
The first crack came in May. That's when the European Council, made up of the heads of government of all EU members, agreed on a directive requiring member states, plus the 10 new ones that will join next May, to change their laws by 2005. They're required to let pension funds authorized in one country operate on equal terms in all others. "This is a major achievement," says EU Internal Market Commissioner Frits Bolkestein. As a result, pension providers "will now be able to offer safer and more affordable pensions across the EU."
Then, on June 26, the European Court of Justice in Luxembourg took a major step toward dismantling tax barriers that prevent pension plan portability. In a test case brought by Swedish financial firm Skandia on behalf of employee Ola Ramstedt, the court ruled that employers in one country have the right to claim tax deductions for premiums paid into pension plans sold by financial companies based in another EU country. That followed last October's court ruling that Rolf Dieter Danner, who holds dual German and Finnish citizenship and lives in Finland, could get a full tax deduction for contributions he made to two private German pension plans. Finnish authorities had given him only a partial deduction. Meanwhile, the European Commission is taking legal action against most EU states to stop the use of tax systems to discriminate against cross-border pension plans.
The reforms are likely to save peripatetic workers a great deal of hassle. Just as important, though, they will save corporations billions of euros in administrative costs and allow financial-services firms to sell pension products Europe-wide without tailoring them to each nation's laws. Today, European multinationals operate at a major disadvantage to American rivals since U.S. federal pension rules apply to everyone, and these companies can offer a single pension plan to employees no matter which state they work in. One consequence is a more efficient labor market. Employers can send the best candidate for a job to any location. Plus, greater economies of scale keep pension management costs down. Pension experts estimate that the lack of a pan-European system costs the companies up to $5.7 billion a year in administration and money management fees. "These are major steps in the right direction," says Renee McGowan, a pensions specialist in the London office of Mercer Human Resource Consulting. "Barriers are being broken down."
Large, cross-border companies, such as Swedish carmaker Volvo or Anglo-Dutch conglomerate Unilever Group, for example, could each save up to $45 million a year if they could manage their pension funds on a Europe-wide basis, say European Commission experts. The savings would come from lower back-office and paperwork costs, along with volume discounts from money managers. Now, Volvo and Unilever have to operate separate pension plans in each of the EU countries they operate in. And they must think twice before making any transfers. With the changes to come in 2005, much of this confusion and red tape could fall away.
The EU's new rules will also be a boon to financial-services providers, allowing them to operate freely across borders. They stand to save millions of dollars by grouping all their European pension plans together and managing them centrally. Creating a single market for pensions also should spur greater competition between companies eager to sell their pension programs Europe-wide. Management fees should drop, since they tend to be higher than in the U.S. due to the difficulty in generating economies of scale. That, in turn, could encourage more people to take out private pensions that supplement or replace overstretched national plans. Private-pension accounts now total $2.75 trillion EU-wide. But that could double by the end of the decade, say European Commission experts, giving capital markets a much-needed boost.
The reforms and court rulings won't tear down all the barriers to making pensions portable. For the foreseeable future, for instance, it will still be impossible in most cases for workers who are changing companies to roll over the balance of their corporate pension fund into a fund in another country. What's more, no fix has been proposed for the gaps among government-funded pensions. Benefits in Italy, for instance, are far more generous than in Britain. That creates a painful choice for a Milanese worker offered a job in London.
Those and other thorny issues remain to be ironed out. But after a long waiting period, Europe finally has started down the path toward a single, borderless market for most types of pensions. That will benefit hundreds of thousands of people -- people like Annette Power, who may not have to think twice about her next promotion.
By David Fairlamb in Frankfurt