Pension investing (annuity) or an ETF investment plan?

When planning a future with financial peace of mind, we can adopt different strategies depending on our investment capacity, needs and objectives.

In the current economic context, characterized by inflation that could erode our future purchasing power (i.e. our ability to purchase goods and services), seeking higher returns in the capital market may make sense.

Retirement investment accounts in their traditional form are one of the favorite options for Dutch investors, especially the more cautious ones, but they may not be enough to counteract the loss of purchasing power caused by general price increases. On the other hand, investing through an (ETF) investment plan offers the opportunity to expose ourselves to the growth of the most competitive companies in the world, so that the potential returns can beat inflation to some extent.

Below we will analyze both options in depth and compare the traditional retirement investment account and the ETF investment plan.

What is a (traditional) pension investment account?

In addition to your state pension (AOW) and perhaps a company pension that you contribute to through your employer, it is possible in the Netherlands to contribute money yourself to a supplementary pension pot, through which you get a tax benefit. You can read exactly how this works later in this article. This type of pension pot, which is tax deductible,is called an ‘annuity’. You can build up an annuity by either saving or investing. If you put the deposit into a blocked savings account, it often means the account has a fixed term and that in most cases you can only withdraw money from the account (penalty-free) before a predetermined date. If you want to deviate from this, fines may apply. The account is therefore purely aimed at building long-term capital, which you can then fall back on later. You can also build up annuity by investing. This can be lucrative, especially if your retirement date is still far away. Just like with bank savings, there are often certain restrictions with a traditional pension investment account. For example, you often cannot withdraw money before your official retirement date.

With a pension investment account, you typically would choose a fixed product in which you would deposit a fixed amount per month over a certain period of time (long term), which suits your wishes for your pension and your risk profile. So we are talking about passive investing, where the provider's asset managers manage the investments for you. When you retire, you benefit from the returns that have been built up over the years.

How is a Dutch pension investment account taxed?

There is a tax advantage when investing in your pension pot, because the contribution for such a supplementary pension is a deductible item in your tax return. In other words: your contribution is deducted from your income in box 1, so you have to pay less tax overall. If you want to take full advantage of this tax benefit, you must ensure that you use your complete annual allowance (‘jaarruimte’). The annual allowance is the amount with which you can supplement your pension annually and on which you are entitled to tax deduction. If there is a pension deficit, you can increase your pension by this amount in a tax-efficient manner. Are you unable to meet the annual allowance with your contribution to the AOW and any company pension? Then you can supplement this and profit from the tax benefit. The condition for having a pension investment account in the Netherlands is that your tax residence is also in the Netherlands. Are you Dutch and do you live abroad? Then unfortunately you are not eligible for this tax benefit.

The myths surrounding pension investing

Many people may be tempted to enter into a retirement plan out of habit, or be encouraged by information such as the fact that this form of investment is 'tax free' or that the capital invested carries 'little to no risk'. Both statements are incorrect.

The reality is that other alternatives to pension plans can be more tax efficient and can also offer other benefits, such as greater transparency (knowing where our contributions go), profitability (what we get back for our contribution) and liquidity (the ease with which we put our money into get cash back).

An ETF investment plan as an alternative

Investment plans for ETFs (exchange-traded funds that track a specific stock index) can be a complement or alternative to increasing our wealth in the long term. They allow us to implement a diversified investment strategy (in other words, to put our 'eggs in different baskets': regions, companies, sectors, etc.) with regular contributions from just €1 per month.

The capital market exposure of ETF investment plans can help us combat the aforementioned effect that inflation can have on our savings.

Another interesting aspect of ETF investment plans is the effect of compound interest: price gains from regular contributions are reinvested in the plan, allowing the capital to grow exponentially. Finally, ETF investment plans are much more flexible than other instruments like the traditional retirement investment account that we analyzed previously, meaning they can be paused or adjusted at any time. Also, unlike with a pension investment, you can withdraw money at any time with impunity.

In terms of tax, the big difference between traditional pension investing and investing in ETFs is that investments in ETFs in the Netherlands fall under box 3 of the tax system. The advantage of this is that you can offset your debts* in order to pay less tax. The tax-free allowance (‘heffingsvrij vermogen’) also applies in box 3, which is the amount that you can build up in capital that is not taxed. If you stay below that number, you don't have to pay wealth tax. If you exceed it, you will be taxed in box 3 on the notional return (‘fictief rendement’).This means that the tax authorities will assume that you have earned a certain return on your savings and/or investments, one that can be expected for that type of asset, on which you are subsequently taxed. More information about the calculation of the notional return can be found on the Tax Authorities website.

Now that we have looked at both 'traditional' pension investing and investing through an ETF investment plan, as an alternative form of investing, it is up to you to decide which form of investing best suits your situation and your investment needs.

*Note: there is a so-called debt threshold, which your debt must exceed in order for the debt to be included in box 3.