In an effort to encourage defined contribution plans, the government now will create a sliding-scale tax — amounting to a tax reduction — on defined contribution plan participant benefits/redemptions from plans started after Jan. 1.
The government hasn't extended this tax reduction to defined benefit plans because it wants to encourage the growth of defined contribution plans, and thus decrease the funding risks of defined benefit plans.
The income tax that DC plan participants will pay on their benefits and redemptions will be based not on the size of the benefit/redemption but on how long the money has been saved. For example, a savings of up to two years will have a 35% income tax and a more than 10-year savings will have a 10% income tax.
Government officials are hoping that overall savings in Brazil will increase because the exemption on all investment returns from DC plans will allow participant savings to grow faster and the new, sliding-scale income tax will encourage participants to save longer. The increased longer-term savings will provide the cash-strapped government with cheaper financing.
"The government's tax decree — one which will bring Brazil up to speed with the international practice of taxing benefits, not returns — is aimed at encouraging increased pension fund savings, a goal which will allow it to borrow long-term capital more cheaply to finance its own long-term projects, like infrastructure projects, from roads to dams," said Devanir da Silva, the executive secretary of ABRAPP, the national association of pension funds. "The government wants pension fund capital, which now accounts for 15% of the GDP, to eventually account for 40% of the GDP."
DC plans created after Jan. 1 will have to adhere to the new sliding-scale income tax. Participants of existing pension funds — whether defined benefit or defined contribution —will almost certainly be allowed to migrate to the new taxation system, although the government has not yet provided rules for how this will happen, said ABRAPP officials and actuarial consultants.
Jair Ribeiro, the risk manager of Fundao Eletrobras Seguridade Social, the $4.5 billion pension fund of the state energy company Eletrobras, said that officials at Eletros, as the plan is known, plan to create a new defined contribution plan in early 2005 and allow its participants (all of whom now are in defined benefit plans) to migrate into it, once the rules become clear.
"The tax scheme for new DC plans won't create a revolution in our investment structure," said Mr. Ribeiro. "But its being based on longer-term investments will gradually force Eletros to invest in longer-term instruments, given that 40% of our investments are in short-term bonds and only 40% are in longer-term bonds with average 10-year" maturities.