If you work in the Netherlands, you can secure tax advantages when saving for retirement income to top up your state retirement benefits. In this article you will learn about how you can make the most of your retirement savings when you are self-employed or your employer does not offer a pension plan.
While state benefits are widespread, workplace pensions make up for the vast majority of retirement income in the Netherlands. This means that if you do not participate in an employer-sponsored pension plan, you may be at a disadvantage and only have a low pension when you retire.
Especially if you are self-employed, you always need to make your own arrangements for your future financial well-being. The sooner you start planning for your retirement, the better prepared you will be.
When it comes to retirement savings, the Dutch government offers tax benefits for putting away income that you earn today in order to build a pension for the future. More precisely, you can contribute a certain amount of your income to certain pension plans without paying income tax on the contribution today.
The amount that you can put away while enjoying tax benefits in a particular year is not fixed, but can change every year. It depends on your previous year income and is referred to in Dutch as jaarruimte, loosely translated as the annual space for tax-advantaged savings.
If you work full-time for an employer who offers a pension plan to its employees, you often make full use of the tax advantages already and your jaarruimte will be (close to) zero. Conversely, if you do not participate in a workplace pension plan, you will likely have a positive jaarruimte. If this is the case, you can use that amount to save in a tax-advantaged pension plan that is designed to accumulate pension income.
Furthermore, if you have earned income for several years but not contributed or only partially contributed to a tax-advantaged pension plan, then parts of your unused jaarruimte from the last seven years aggregate into a reserveringsruimte. This amount can still be used today to make up for the fact that you didn’t use it in the past.
The Dutch tax authorities offer a calculator on their web site to compute the precise amount that you are allowed to contribute in this way.
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By taking advantage of the jaarruimte you lower your taxable income and at the same time save for retirement. Is this a win-win situation, or are there also drawbacks? Foremost, saving for retirement is always good, especially if you do not participate in a workplace pension plan. The question therefore, is not whether to save but rather how to save for retirement. Evaluating whether or not to make use of the jaarruimte involves taking several factors into account.
First, even if you save tax-advantaged today, you will eventually have to pay income taxes on the pension you draw when you are retired. However, as many pensioners earn less during retirement the marginal tax rate is often lower and it can therefore make sense to ‘postpone’ taxes in this way.
Second, you cannot just put away the money in any type of savings or investment account, you need use a specific pension savings account. Many banks and brokers offer these accounts, but they come with additional restrictions compared to a regular savings or investment account.
You cannot freely withdraw the funds that you save. You are required to keep them in the account until you reach retirement and at that point in time, you have to convert the funds into a steady stream of cash-flows. You can thus not withdraw them as a lump-sum payment. Whether this `forced` conversion is `good` or `bad` depends to a large extent on your preferences for income: Do you prefer a large lump-sum at the time of retirement or a steady monthly pension income?
Furthermore, in addition to your preferences, the conversion is sensitive to interest rates at the time of retirement. If interest rates are low, then your funds will translate into a smaller monthly income compared to if interest rates are high.
It is difficult, if not impossible, to predict future interest rates. This makes it difficult for accurately estimate the amount of retirement income you will earn from participating in a tax-advantaged plan. This problem is not unique to tax-advantaged plans that you initiate yourself, but also apply to many of the modern employer-sponsored pension plans (such as PPI:s, or defined contribution based plans) that have emerged over the last few decades.
In the table below, we contrast some of the major differences between the use of a tax-advantaged and standard investment account as a source of pension income.
|Tax-advantaged pension plan||Standard investment account|
|How much can you save per year?||Up to your jaarruimte||Unlimited|
|Investment choices||Often limited by the plan provider||Unlimited|
|Withdraw funds at any time?||No||Yes|
|Conversion into annuity at retirement?||Mandatory||Optional|
|Lowers your taxable income when you save||Yes||No|
|Taxation||Subject to income tax during retirement||Subject to investment tax (Box 3) each year|
As the table above shows, there is a trade-off between the two sources of pension income. While the tax-advantaged plan offers tax advantages today, it comes with several restrictions on how you can use that money. These restrictions mimic those of many employer-sponsored pension plans. On the flip side, a standard, non-tax-advantaged account may offer more flexibility but it does not aim to mimic a workplace pension plan. Which product, or whether a combination of the two, is better for you is a personal decision.
If you would like to know more about your financial future, we offer a personalized Dutch pension report that presents all relevant information about how much state benefits and workplace pension you are likely to receive. Moreover, the report helps you plan additional savings to be able to maintain your standard of living in retirement.