Author Topic: Case Study in the Netherlands: to max or not to max the 401k equivalent  (Read 5817 times)

Rienk

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Hello Mustachians,

I've run into the MMM blog a few months ago and have since been a lot more conscious about my finances, and I'm here to ask some advice on where to actually put my savings. I've always been reasonably financially responsible, but I always reasoned that I put some money towards a pension, have a sizable emergency fund, and any money beyond that is not very useful to save so you may as well spend it. So after being inspired by MMM I'm looking at the best way to grow my 'stash given the tax/regulations situation here in the Netherlands, which Ill try to explain as well and as concise as I can. My case:

Situation:
Age: 27
Income: 35k take-home
Expenses: 23k
Savings: 12k

Assets:
Apartment worth 105k, with 120k left on mortgage
Emergency fund: 17k (in 1.85% savings account)
Pension account: 3.6k (only started this year)
Investments: 10k
Money in my checking account waiting to be moved: 6k (where to put this is the key question)
No other debt

Goal:
To provide options for Future Me. Not necessarily to retire extremely early, but still earlier than normal with possibly a sabbatical year or something, who knows. In short, some degree of financial independence.

Specific question:
I have 8.4k/year to put somewhere, and Im not sure whether I should max the pension account or not. My choice is between a hugely tax-advantageous but equally restrictive pension account, or accepting the taxes and investing post-tax. What should I do?

The Rules and restrictions:
- The pension account is similar to a 401k: I have investment options with low costs etc. and manage the money myself.
  • Contributions are tax deductible, at 42% marginal tax rate. Max contribution for me is 6.8k/year. I calculated I need to contribute 3.6k/year (adjust for inflation) to provide my pension from age 68 or so (projected official retirement age by that time).
  • Withdrawals are taxed at about 38% when withdrawn before official retirement age, and taxed at about 22% after retirement age.
  • Withdrawal must be done by purchasing (1) a life annuity (fixed monthly payment until death) starting any time you like or (2) an annuity with a fixed length for a period of at least 5 years, starting no earlier than age 65. You can do both (1) and (2) and create multiple income streams this way. You cannot withdraw money in any other way, there is no 401k-Roth pipeline or anything like that.
  • Money in the pension account is exempt from capital gains tax.
  • Most employers have a company pension plan here, but mine doesn't. I intend to stay here for a while but probably not until retirement, so I might end up with a mix of bits of pension.
- The total value of my investments and savings above 20k is subject to 1.2% capital gains tax per year independent of actual capital gains. The pension account is exempt from this.
- Social security (currently 14k/year) starts at the official pension age which is expected to slowly increase, probably to 68-70 when I reach that age. Note that this makes it really hard to use the pension account for early retirement, because before the official pension age I will need to withdraw more pension than after, which cannot be realized within the restrictions.
- Accelerated payment of the mortgage is very complex and seems to be about a neutral value proposition for me, let's leave that possibility out of scope here.

Any insight would be most welcome. In particular Id also love to hear from other Dutch people how they approach it and if my summary of the rules is even correct (PS. If theres any Dutch forum on personal finance please let me know, I havent been able to find any yet most people seem to leave this stuff to the financial advisor or just dont bother at all).


bugbaby

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #1 on: December 09, 2013, 08:15:48 PM »
Hi Rienk and welcome.

I think the options depend on a few factors such as: job stability, stability of your govt social security (ie.40 yr from now will it be there, or do you have to have a lot more saved in case not?). Also, what's your mortgage interest - if higher than the expected investment returns you could throw the cash at it for more immediately visible benefits.

With these caveats, my thoughts:
1. Do you mean you have 8.4k after the 3.6 you already contribute? If so, then you can easily add another 3.2 to reach your 6.8 max and still have >5k remaining per year to invest in taxable accts.
2. You have a sizeable savings & emergency fund so it's unlikely you'll need more, esp if your current job is secure and prospects good of getting another one in case of a job loss. With a 42% marginal tax, I can't imagine too much of downside of maxing your pre-tax acct. Even if you have to wait for official retirement age to withdraw.
3. Also, if you plan to have children who could potentially inherit it, use for tuition etc, if for whatever reason you don't get to spend it all down, more reason to save.
4. However, if your mortgage interest rate is high, you could consider throwing a bit at that if you're more on the debt & risk averse side.

just my 2cents, not being too familiar with the netherlands stock /property landscape

Rienk

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #2 on: December 10, 2013, 12:43:39 AM »
Thanks for your response babybug, much appreciated. Government stability is very good, that's probably not a really big issue, but rules can change at any time so that is a risk.

1) Yes, 8.4k left after 3.6k contribution. Indeed I have the money to max it.
2) Well, the downside is that it's so restrictive in that you really have to use that money for old age retirement. Having too much money coming in each month when I'm really old won't be that useful. The question of course is what else I'm going to do with the money, but I certainly give up some flexibility by maxing the pension account.
3) This is a good point, it would increase the value of my inheritance if either I die before the pension age, or I get old enough to again save a large portion of the payouts. Tuition would be hard though, maybe for my grandchildren :) But I'm not allowed to fund my children's tuition with the money unless I've already started the life annuity.
4) I may have to see a financial advisor on this one. Mortgage rate is 5.15% at 42% deductible, but it's a construction where I put the money into a savings account that gets 5.15% and is linked to the mortgage, and then use that to pay back the mortgage in one go, in order to maximize the interest deductions (yes it's ridiculous that the Dutch gov allows this, and in fact this form of mortgage was recently banned). There are other tax implications as well that I'm not fully aware of.

markbrynn

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #3 on: December 10, 2013, 04:30:39 AM »
Funnily enough, I'm headed to a financial planner this very afternoon to discuss these subjects. Hopefully I will get some good advise and be able to pass it on here.

Rienk

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #4 on: December 10, 2013, 08:45:42 AM »
Funnily enough, I'm headed to a financial planner this very afternoon to discuss these subjects. Hopefully I will get some good advise and be able to pass it on here.
Great! That would be really useful.

markbrynn

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #5 on: December 12, 2013, 02:24:22 AM »
I was in the middle of writing a whole story of what the financial advisor told me, but it was really very little (quite disappointing).

Basically, it boils down to this:
Put what you need for post-65 retirement into the tax-free pension account. Nothing more or it will be wasted as you can't touch it without big penalties until then. Of course you can always have extra to give to your children, grandchildren, friends, etc. if that floats your boat.

Put the rest into an investment account. 1.2% yearly wealth tax is a fact of life, get used to it.

You can always buy a house, though I'm not convinced that they're good investments in the Netherlands. Buy low and sell high will always work of course.

Don't bother with any kind of offshore investments. The Dutch government is one of the many governments that is working to reduce the various loopholes. It's possible, but works better with large amounts of money and people who are willing to move to the Bahamas.

You could consider moving somewhere else at some point to have different tax levels, but that's not really what you were asking.


Sorry, no silver bullet came out of this meeting. Would be happy to hear from others who might be able to give better news.

Rienk

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #6 on: December 13, 2013, 02:08:46 AM »
Thanks for sharing your findings. Indeed nothing revolutionary, but that there are no better alternatives is good information in itself. My conclusion then is that I'll invest only what I need for old age retirement in the pension account, and the rest in taxed investments.

gorion83

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #7 on: December 13, 2013, 03:03:58 AM »
What kind of investment options do you have for your pension funds?
One thing that so far prevented me from investing every single penny saved in these deductible vehicles even with a 38% marginal rate deduction (I'm in Italy) is that the quality of the pension funds is usually lower than the ETF i invest into in a taxable account.

You have to consider that the "gain" is the marginal tax rate minus the final tax rate. In your case that would be 42%-22% assuming that you withdraw when retiring.

That 20% benefit can be well consumed by bad performance/higher costs when you have a lot of years before retiring.
If the pension fund has higher fees than the ETF/index fund and the same return of a market portfolio, even a 0,5% gap would be enough to eat the whole fiscal benefit over 40 years, leaving you with more bounds than in a taxable account.

The case is different with late contributions.

I think it is a wise move to contribute the minimum amount needed for the employer contribution to kick-in and wait in the pension fund to lower the final tax rate (at least here in Italy the more you stay in the fund, the lower the final tax rate, up to 15%). In the late years contribute the maximum amount needed. Even with bad funds a 43%-15% gap is hard to dissipate in only 5-10 years.

The sad thing is that these kind of deductions work against young people and favours older people, which I don't think is why they were put in place.

Rienk

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #8 on: December 13, 2013, 08:37:50 AM »
Interesting to hear your perspective, the Italian system seems to be somewhat similar but also sufficiently different that the best decisions may change.

Quality of investment options: currently my pension fund options are quite good, not a full range of ETF options but I can invest in a World equity fund and Euro equity fund at 0.5% expense ratio. My regular bank allows me to invest in ETFs of around 0.3% but the bank charges fees for the account of 0.2% - this would be lower if I had a lot of money.

Late contributions: I didn't really consider this point, it's a good one to bring up but on the other hand, early contributions save me 1.2% per year in tax, which adds up to even more than the 20% tax difference. This 1.2% capital gains tax is extremely important, it's like an extra 1.2% to the fees of the funds I invest in in my taxable investments. Considering this I think that actually the earlier I contribute to the pension fund the better.

Employer contribution: I may not have made this completely clear, but my current employer does not contribute to my pension at all. This is exceptional in the Netherlands, most employers offer a pension to their employees. I'm actually using the rules intended for "supplementary pension" to fund my full pension. There is no lowering of the final tax rate depending on how long you invest funds, the only thing that matters is your age (<65 high rate, >65 low rate, the cutoff of 65 will be higher when I retire).

gorion83

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #9 on: December 15, 2013, 04:08:27 AM »
Interesting to hear your perspective, the Italian system seems to be somewhat similar but also sufficiently different that the best decisions may change.

Quality of investment options: currently my pension fund options are quite good, not a full range of ETF options but I can invest in a World equity fund and Euro equity fund at 0.5% expense ratio. My regular bank allows me to invest in ETFs of around 0.3% but the bank charges fees for the account of 0.2% - this would be lower if I had a lot of money.

I'd make sure to compare also the results between those pension funds and the ETF. Ideally you want funds which stay very close to the index you want to mimic.. Funds with big variations from the benchmark are more risky, you could find yourself with sub-par performance.

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Late contributions: I didn't really consider this point, it's a good one to bring up but on the other hand, early contributions save me 1.2% per year in tax, which adds up to even more than the 20% tax difference. This 1.2% capital gains tax is extremely important, it's like an extra 1.2% to the fees of the funds I invest in in my taxable investments. Considering this I think that actually the earlier I contribute to the pension fund the better.
That 1,2% is a lot, indeed.
Here we have only 0,15% tax (probably rising to 0,165% this year), but in your situation I'd second your conclusion.
If the pension funds are good enough from a performance standpoint it would almost be a no-brainer.

Do you have any chance for early withdrawals?
Here we can withdraw up to 75% to buy/renovate the first home or 30% for no specific purpose.

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Employer contribution: I may not have made this completely clear, but my current employer does not contribute to my pension at all. This is exceptional in the Netherlands, most employers offer a pension to their employees. I'm actually using the rules intended for "supplementary pension" to fund my full pension. There is no lowering of the final tax rate depending on how long you invest funds, the only thing that matters is your age (<65 high rate, >65 low rate, the cutoff of 65 will be higher when I retire).

I think a true mustachian would look for an employer matching contributions, but I can understand that in real life it may be difficult to find a good job with all the bells and whistles in the right place.

Rienk

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #10 on: December 16, 2013, 04:07:35 AM »
I'd make sure to compare also the results between those pension funds and the ETF. Ideally you want funds which stay very close to the index you want to mimic.. Funds with big variations from the benchmark are more risky, you could find yourself with sub-par performance.
I think my current fund choices do track the corresponding index very closely but indeed I'll look into this more closely to see if the fund is really equivalent to an ETF for me in terms of strategy.

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That 1,2% is a lot, indeed.
Here we have only 0,15% tax (probably rising to 0,165% this year), but in your situation I'd second your conclusion.
If the pension funds are good enough from a performance standpoint it would almost be a no-brainer.

Do you have any chance for early withdrawals?
Nope, no withdrawal possibilities whatsoever. Theoretically you can withdraw the money and pay a penalty tax, but that is 50-70% of the total amount so I don't think that's ever a good idea.

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I think a true mustachian would look for an employer matching contributions, but I can understand that in real life it may be difficult to find a good job with all the bells and whistles in the right place.
In the end an employer contribution represents a certain monetary value, so to compare wages between employers you simply have to take all benefits into account. My wage is probably not the very highest I could attain, but also not too bad and I enjoy my job very much. Also it's 5 minutes biking from my home, so my commute is highly Mustachian :)

gorion83

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Re: Case Study in the Netherlands: to max or not to max the 401k equivalent
« Reply #11 on: December 16, 2013, 06:54:25 AM »

Nope, no withdrawal possibilities whatsoever. Theoretically you can withdraw the money and pay a penalty tax, but that is 50-70% of the total amount so I don't think that's ever a good idea.


That's bad.
You must be sure that the money you will invest in these vehicles will never be needed for other purposes.
I'd keep some assets outside the pension funds then, just to make sure I won't be cash-costrained, probably around 5k every 20k invested in the fund.