Romanian pension system - Benefits and Challenges

In the context of the demographic figures, each individual should invest more in the private pension plans as the national system plan may conduct to uncertainties. Are you aware of the benefits and challenges of the Romanian pension system?

The national pension system is causing increasing challenges at the level of Governments, as in most countries a “pay-as-you-go” system is implemented. The payments performed by the active generation cover the pensions of the aged population and further, their own pensions would be covered by the future generations.

At the moment, in Romania, the mandatory pension insurance contribution represents an uncapped 25% of the gross income obtained. To minimize the risk of the traditional “pay-as-you-go” system, the Romanian pension system is structured in a multi-pillar system which is based on redistribution, saving and insurance.

The first pillar

The first pillar is managed by the public institutions and intended to safeguard employees with a basic level of protection at the moment of retirement, as 21.25% from the mandatory contribution is transferred to this pillar. In order to benefit of the pension from the first pillar, a minim subscription period should be fulfilled. Further, if the subscription period is met, the pension is computed, not based on the effective amounts paid, but by multiplying the average annual score realized by the individual in the subscription period with the value of one pension point in the moment of retirement. Under such conditions, the amounts paid are not equivalent to the benefits obtained.

In this context, the trends of the demographic figures (reduction of the birth rate, the decay of the population overall, the dependency ratio between employees and retirees, the life expectancy) put significant pressure on the public/state pension system, as the existing resources might not cover the pensions of the aged individuals. A final pay pension system might be unsustainable.

The second pillar

Comparing with the first pillar, the second pillar is financed with a difference of 3.75%. It is intended to be an additional source of income and financed by means of capital accumulation. The benefits granted by the second pillar depend on the level of the contributions made during the active/working period.

The third pillar

The third pillar is represented by voluntary agreements through which participants can increase their retirement benefits as each individual has a private account and owns personal assets, compared with the first pillar which is own by the state. The fiscal treatment of these amounts, framed as a contribution to a voluntary pension fund is non-taxable at the level of the employee, in the limit of EUR 400 (the equivalent in RON) in a fiscal year. The maximum contribution rate should not exceed 15% of the gross income obtained. 

The second and third pillars are managed by private institutions. Any investment will increase the individual quality of life at the age of retirement as all the amounts acquired in the personal assets portfolio. Thus, the amounts paid for the private pension are similar to a savings account, but with a preferential interest rate compared with the first pillar which functions based on the contributions made during active life and potential benefits at retirement age might arise only under certain conditions.

In the long term, the competition on the private pensions market will significantly increase as the amounts at the state budget do not provide long-term sustainability and long-term financial protection. Basically, a balanced pension system will lead to the elimination of pressure on the public budget system, stimulating economic growth by investing the amounts accumulated in the private pension funds and development of the capital market.