Should I start drawing my pension early in Iceland?

I hear this surprisingly often. People are getting close to retirement age and starting to realise that the Icelandic pension system can be fairly complicated. But is it really that complicated? Is the best answer simply to start drawing the pension as soon as it becomes available?

“Well, that’s what people say,” is often the answer when I ask where the claim came from. Sometimes it seems a colleague pulled the trigger early and has become rather energetic in the staff canteen. There may be little reasoning behind the advice, but the confidence is strong.

Others say they were advised to start drawing their pension early because it suited their particular situation. When we look more closely, it sometimes turns out that a salesperson was encouraging them to draw pension payments and place the money directly into a savings product sold by that same person.

It can certainly be difficult to make an informed decision about when to start drawing a pension. But one thing is clear. The worst method is to copy someone else. Whether we like it or not, each of us is responsible for choosing what suits our own situation. To do that, we need to understand our pension.

What type of pension do we have, and what are we allowed to do?

Pension funds differ in when pension payments can begin and what effect early drawing has. Three colleagues sitting at the same table at lunch may all have very different pension rights and different access to them. Before any decision is made, it is important to gather the information needed to understand the amounts involved, when and how pension payments can be drawn, and how the monthly amount changes if the start date is moved forward or back.

There can be a large difference between pension arrangements, even when the names sound similar. For example, the rules may differ between Division A and Division B of LSR (government workers), or Division V of Brú (municipalities). There is also a major difference between those arrangements and funds such as Almenni-Lífsverk, Frjálsi lífeyrissjóðurinn and Íslenski lífeyrissjóðurinn.

So why is “everyone” suddenly talking about drawing pensions early? Somewhere, the rumor began and of course there can be very good reasons why not everyone wants to start drawing pension payments on their 67th birthday.

What happens when you draw the pension early?

Most pension divisions allow old-age pension payments, meaning monthly payments for life, to begin from age 60. In Division B of the public pension funds, however, this is usually not possible until age 65, unless the member can use the 32-year rule or the 95-year rule. Those rules may allow earlier drawing with certain advantages for the member.

In some divisions of Frjálsi lífeyrissjóðurinn and Íslenski lífeyrissjóðurinn, old-age pension payments may become available much later, while restricted private pension savings may be paid out earlier.

If lifetime pension payments begin at age 60, they are paid for seven years longer than originally assumed. The monthly payments are therefore reduced accordingly, often by around one quarter to one third, depending on the arrangement. This can allow someone to stop working earlier, or increase income by drawing pension payments alongside salary income. That may be useful if the goal is to pay down debt, build a necessary emergency fund or simply have more money available.

But the cost of early drawing is often left out of the staff-canteen version of the story. If pension payments are drawn while you are still working, they may be taxed much more heavily than they would be after retirement, when your personal tax allowance can be used against them. In addition, disability pension insurance from the pension fund ends when old-age pension payments begin. As with other forms of insurance, it can be difficult to put a price on disability cover. But if you need it, the difference between receiving disability pension and only receiving a reduced old-age pension can be very large. This is a real risk, and it should not be underestimated. There may be another cost too. If pension rights are being built up under a system of equal accrual, valuable rights may be lost if old-age pension is drawn while contributions continue to be paid into the fund.

None of this is easy. But it should make one thing clear: it can be dangerous to follow the next person’s example or look for shortcuts in pension matters. Early drawing may well suit some people. But the decision needs to be based on correct information about that person’s pension rights, financial position and the advantages and disadvantages involved.

What about other pension savings?

Most of us also build up private pension savings. The two most common types are supplementary pension savings and specified private pension savings, known in Icelandic as tilgreind séreign. Specified private pension savings can generally be drawn in monthly payments from age 62 at the earliest and must be paid out no faster than until age 67. After that, the full amount is usually available.

Supplementary pension savings (additional private pension, viðbótarlífeyrissparnaður) held in Iceland can be withdrawn after age 60, whenever and however suits the saver. Foreign pension insurance, however, may be tied to a different payment structure.

So does it perhaps pay to draw private pension savings early? This is where the discussion often becomes confused. Different pension terms are mixed together, and people may come to believe that they need to rush out and draw some or all of their pension before they stop working. Often, this seems to be based on misunderstandings about payments and reductions from the Icelandic Social Insurance Administration, usually known as TR. If it looks as though someone will receive payments from TR in addition to pension fund payments, it is important to remember one thing: supplementary pension savings are the only common pension payments that do not reduce those TR payments.

Other pension payments, whether they are called old-age pension, spouse’s pension, specified private pension savings, restricted private pension savings or something else, will generally reduce TR payments when they are withdrawn. That means it may be reasonable, if someone expects to receive payments from TR and has private pension savings that would reduce those payments, such as specified private pension savings, to place emphasis on drawing those savings before applying to TR.

Take the decision seriously

Pension that has been paid out does not go back into the system. And you only apply for old-age pension once in your life. The combined value of lifetime pension payments and private pension savings may amount to tens of millions of krónur, or even more than ISK 100 million. We should not take shortcuts when sums like that are at stake.

I therefore encourage everyone to take pension decisions seriously, even though there are certainly more entertaining ways to spend an afternoon. With careful work, we reduce the risk of costly mistakes. And who knows? The time spent understanding your pension may turn out to be the highest hourly wage of your working life.

This article first appeared in the newsletter of the National Association of Firefighters and Paramedics in Iceland, with minor changes made since that publication.