The reform of the pension system in Latvia began in the early 1990s. The aim of this reform was to restructure the pension system to align with Latvia’s new socioeconomic conditions.
Latvia was one of the first countries in Central and Eastern Europe to introduce a multi-pillar pension system, and the first country in the world to establish a notional (non-funded) intergenerational solidarity pension scheme based on the principles of capital accumulation.
The pension reform was necessary due to several reasons:
- The previous system did not comply with the requirements of a market economy and could no longer operate under the new economic principles.
- People lacked motivation to pay taxes, as pension amounts were not linked to individual contributions. Instead, pension amounts were based on length of service and the national average wage, rather than
factual social insurance contributions. To qualify for a pension, it was sufficient for employers to pay contributions based on the national minimum wage, regardless of the employee’s real income. - Due to a low retirement age and population aging,the system would have faced a future shortfall in funds needed to sustain pension payments.
There is a three-pillar pension system in Latvia:
- 1st pillar the state mandatory non-funded pension scheme;
- 2nd pillar the state mandatory funded pension scheme;
- 3rd pillar the private voluntary pension scheme.
The insurance system combines individual personal interest in income security during old age with intergenerational solidarity. The key principle of the reformed pension system is: the greater the social insurance contributions today, the greater the pension tomorrow. The simultaneous operation of all three pillars ensures the pension system stability by balancing the demographic and financial risks at different levels.
Pension amounts of all three levels depends on contributions. Therefore, individuals who contribute more or retire later receive higher income in after reaching retirement age. A common feature of all three pillars is that contributions are accumulated (conditionally or directly) and form pension capital, earning the interest.
Before the reform, pension capital accumulation mechanisms did not exist, and people had no opportunity to participate in the accumulation of their own pension capital based on the target indices of financial capital and the performance results of specific contribution plans.
By participating in the three-pillar pension system, individuals have more opportunities to secure sufficient income in old age. Since the financial conditions of the first-pillar scheme are mainly affected by demographic and labour market factors, while funded schemes are affected by the financial capital market, the pillars support one another by mutually offsetting risks while pursuing a common objective: the welfare of pension recipients.
The 1st pillar of the state pension system (the state mandatory non-funded pension scheme) is regulated by the Law “On State Pensions”, which came into force on 1 January 1996. This pension scheme is based on social insurance contributions and functions according to the principle of intergenerational solidarity. (State pensions) It means that contributions made by currently insured workers are directed to finance pensions for current beneficiaries. The ideology of the pension system is that the able-bodied population should participate fully in the national social insurance system and remain employed as long as possible by postponing retirement.
The following principles are applied:
- higher contributions result in higher pension income,
- retirement at an older age results in even higher pension income.
The 2nd pillar of the state pension system (the state mandatory funded pension scheme) is regulated by the Law “On State Funded Pension”, which was adopted by the Saeima on 17 February 2000 and \became effective on 1 July 2001. It is administered by the State Social Insurance Agency (SSIA). The aim of the state funded pension scheme is to increase pension income without raising the social insurance contributions rate for old-age pensions (20% of salary) by investing part of those contributions into the financial capital markets, where they generate investment returns.
The second pillar of the pension system is compulsory for individuals who were under 30 years of age on 1 July 2001 (that is, born after 1 July 1971). It is voluntary for individuals who were 30 to 49 years of age on 1 July 2001 (that is, born between 2 July 1951 and 1 July 1971, inclusiv). To join the second pillar pension scheme on a voluntary basis, a person needs to submit an application to the State Social Insurance Agency (SSIA). In the long term, the entire employed population will be included in the second pillar pension scheme.
Social insurance contributions for persons enrolled in the 2nd pillar are invested in the financial markets and accumulated by the participant’s chosen asset manager in an individual pension account.
Upon joining the 2nd pillar pension scheme, no additional social insurance contributions beyond the standard 20% pension contribution rate are required. The total pension contribution rate(20% of income) remains constant, but it is divided between the 1st and the 2nd pillars. In 2012, 2% of income was allocated to the 2nd pillar, followed by 4% in 2013 and 2014, 5% in 2015, 6% from 2016 onward, and 5% again in 2025.
The 3rd pillar of the pension system (the private voluntary pension scheme) has been in operation since 1 July 1998. Its aim is to accumulate and invest additional pension contributions paid voluntarily by individuals through private pension funds, ensuring supplementary pension capital in old age. Pension funds may be closed or open, and may offer one or more pension plans. Pension plan participants may contribute directly, or through their employers. From the age of 55, participants may choose to withdraw their entire accumulated pension capital, or continue participation and receive pension capital in installments. The accumulated pension capital is the personal of the participant, regardless of the entity that made the contributions. It is also subject to inheritance rights. Alleviations of income taxes and social insurance contributions are also determined