Greta Zarembiene. Investment Account: Higher Earnings for Both Citizens and the State
The investment account planned in the tax proposal package being prepared by the Ministry of Finance, if approved by the Seimas (Parliament), would strongly encourage citizens to take a greater interest in investing and to adopt a long-term strategy. The proposed taxation of profits only at the time of withdrawal would yield a slightly higher real return for investors than paying taxes annually, and the state would also benefit.
While the Ministry has not yet provided all the details about the investment account model being prepared, the main principles are already known. There will be no limit on the size of the investment account for citizens (previously, a limit of just EUR 10,000 was proposed), it will be possible to offset profits and losses from different investment transactions and hold multiple investment accounts.
The most significant change compared to the current situation is that profits received through the investment account will only be taxed when funds are withdrawn. In other words, if interest income is currently taxed annually, under the proposed investment account model, taxes would only need to be paid when the earnings are cashed out. This aspect is worth examining mathematically.
Currently, annual investment returns in Lithuania are taxed at a 15% personal income tax (PIT) rate. All individuals are granted a tax exemption on interest up to EUR 500: if the interest earned from all investment instruments does not exceed this amount in a year, the 15% PIT rate does not apply, and no tax is payable. It is likely that this exemption may be abolished with the introduction of the investment account.
To clarify the effect of the investment account, let's take a simple and fairly common scenario in Lithuania. Imagine investing an initial capital of EUR 30,000, with an 8% average annual return (currently realistic with bonds, stocks, or crowdfunding, but not achievable with deposits). The investment is made for 10 years, during which all returns are reinvested (a common practice among many investors), but no additional capital is contributed (an unusual practice, but used here for simplicity).
Paying taxes annually and reinvesting the real return left after taxes, in the first year, such an investor would earn and reinvest EUR 2,115, in the second year another EUR 2,259, in the third year another EUR 2,412, and after ten years, would have earned a total return of EUR 28,947 in interest and paid EUR 4,226 in taxes. Taking into account the initial capital, the investor's account would have accumulated EUR 58,947. This scenario reflects the currently applicable tax regime, including the EUR 500 interest PIT exemption.
Using an investment account, the investor would be taxed not annually, but only at the end of the investment period. Therefore, under identical circumstances, in the first year, they would earn and reinvest EUR 2,400, in the second year another EUR 2,592, in the third year another EUR 2,799, and after ten years, would have earned a total return of EUR 34,768. Upon withdrawal of this amount, EUR 5,215 in taxes would need to be paid, but the final profit after taxes would be EUR 29,553 – six hundred euros more than without the investment account. Taking into account the initial capital, the investor would have a total of EUR 59,553 in their account. In this scenario, the EUR 500 interest exemption is no longer applied – if it were, the profit would be EUR 75 higher.
It may seem surprising, but the investment account model satisfies both the interests of investors and the state – citizens will be able to earn more, so they will pay more taxes, and the final result for both "sides" will still be positive, i.e., more profitable than now.
In this example, the EUR 600 difference over ten years may not seem astonishing, although to a financially savvy eye, it would appear as "2% additional return over 10 years". It’s unlikely that anyone would refuse such a bonus, especially if they could invest not EUR 30,000, but several or dozens of times more capital. However, the investment account model has an even broader, immeasurable benefit – it will inherently encourage people to adopt a long-term investment perspective and take an interest in finance.
Speaking of a long-term perspective, this is perhaps the most important principle that brings solid results even when investing in more conservative instruments. For some people, neither a 4% nor an 8% return seems significant when assessed nominally and over a short period. In other words, some investors, seeing they could earn "only" EUR 80 from EUR 1,000 in a year, do not consider such a profit significant and either do not invest at all or choose risky instruments promising "get-rich-quick" returns. However, even such a return and initial capital bring relatively increasing earnings each year if the interest is reinvested. This happens due to the so-called compound interest effect – by reinvesting not only the initial capital but also the annual return, the investment portfolio grows faster each year than in previous years, and after several years, the earnings surpass the investor's own funds. The planned investment account model will encourage adherence to this direction, which is recommended by almost all experts.
Another significant value of the investment account for citizens and the entire country is the further growth of financial literacy in society. With the investment account, the state is essentially telling its citizens, "We trust you and encourage you to invest". Unlike in the second pension pillar or investment life insurance (which is likely to lose its PIT benefit), citizens will be indirectly encouraged to be more self-reliant – to take a greater interest in finance, investment instruments, and strategies, and to make investment decisions themselves. Of course, all investments involve risks, and the investment account does not inherently protect against them. However, for some people, it will certainly serve as an additional stimulus to try investing, learn, and gain practical experience. After all, it is the experience that most effectively enhances financial literacy.
So, while the final details of the investment account are still unclear, the publicly announced key principles are commendable. The only thing left is to hope that the Seimas will approve this measure and that citizens will take advantage of its main benefit – a long-term, or even better, a periodic and long-term investment perspective.
Greta Zarembiene. Investment Account: Higher Earnings for Both Citizens and the State
The investment account planned in the tax proposal package being prepared by the Ministry of Finance, if approved by the Seimas (Parliament), would strongly encourage citizens to take a greater interest in investing and to adopt a long-term strategy. The proposed taxation of profits only at the time of withdrawal would yield a slightly higher real return for investors than paying taxes annually, and the state would also benefit.
While the Ministry has not yet provided all the details about the investment account model being prepared, the main principles are already known. There will be no limit on the size of the investment account for citizens (previously, a limit of just EUR 10,000 was proposed), it will be possible to offset profits and losses from different investment transactions and hold multiple investment accounts.
The most significant change compared to the current situation is that profits received through the investment account will only be taxed when funds are withdrawn. In other words, if interest income is currently taxed annually, under the proposed investment account model, taxes would only need to be paid when the earnings are cashed out. This aspect is worth examining mathematically.
Currently, annual investment returns in Lithuania are taxed at a 15% personal income tax (PIT) rate. All individuals are granted a tax exemption on interest up to EUR 500: if the interest earned from all investment instruments does not exceed this amount in a year, the 15% PIT rate does not apply, and no tax is payable. It is likely that this exemption may be abolished with the introduction of the investment account.
To clarify the effect of the investment account, let's take a simple and fairly common scenario in Lithuania. Imagine investing an initial capital of EUR 30,000, with an 8% average annual return (currently realistic with bonds, stocks, or crowdfunding, but not achievable with deposits). The investment is made for 10 years, during which all returns are reinvested (a common practice among many investors), but no additional capital is contributed (an unusual practice, but used here for simplicity).
Paying taxes annually and reinvesting the real return left after taxes, in the first year, such an investor would earn and reinvest EUR 2,115, in the second year another EUR 2,259, in the third year another EUR 2,412, and after ten years, would have earned a total return of EUR 28,947 in interest and paid EUR 4,226 in taxes. Taking into account the initial capital, the investor's account would have accumulated EUR 58,947. This scenario reflects the currently applicable tax regime, including the EUR 500 interest PIT exemption.
Using an investment account, the investor would be taxed not annually, but only at the end of the investment period. Therefore, under identical circumstances, in the first year, they would earn and reinvest EUR 2,400, in the second year another EUR 2,592, in the third year another EUR 2,799, and after ten years, would have earned a total return of EUR 34,768. Upon withdrawal of this amount, EUR 5,215 in taxes would need to be paid, but the final profit after taxes would be EUR 29,553 – six hundred euros more than without the investment account. Taking into account the initial capital, the investor would have a total of EUR 59,553 in their account. In this scenario, the EUR 500 interest exemption is no longer applied – if it were, the profit would be EUR 75 higher.
It may seem surprising, but the investment account model satisfies both the interests of investors and the state – citizens will be able to earn more, so they will pay more taxes, and the final result for both "sides" will still be positive, i.e., more profitable than now.
In this example, the EUR 600 difference over ten years may not seem astonishing, although to a financially savvy eye, it would appear as "2% additional return over 10 years". It’s unlikely that anyone would refuse such a bonus, especially if they could invest not EUR 30,000, but several or dozens of times more capital. However, the investment account model has an even broader, immeasurable benefit – it will inherently encourage people to adopt a long-term investment perspective and take an interest in finance.
Speaking of a long-term perspective, this is perhaps the most important principle that brings solid results even when investing in more conservative instruments. For some people, neither a 4% nor an 8% return seems significant when assessed nominally and over a short period. In other words, some investors, seeing they could earn "only" EUR 80 from EUR 1,000 in a year, do not consider such a profit significant and either do not invest at all or choose risky instruments promising "get-rich-quick" returns. However, even such a return and initial capital bring relatively increasing earnings each year if the interest is reinvested. This happens due to the so-called compound interest effect – by reinvesting not only the initial capital but also the annual return, the investment portfolio grows faster each year than in previous years, and after several years, the earnings surpass the investor's own funds. The planned investment account model will encourage adherence to this direction, which is recommended by almost all experts.
Another significant value of the investment account for citizens and the entire country is the further growth of financial literacy in society. With the investment account, the state is essentially telling its citizens, "We trust you and encourage you to invest". Unlike in the second pension pillar or investment life insurance (which is likely to lose its PIT benefit), citizens will be indirectly encouraged to be more self-reliant – to take a greater interest in finance, investment instruments, and strategies, and to make investment decisions themselves. Of course, all investments involve risks, and the investment account does not inherently protect against them. However, for some people, it will certainly serve as an additional stimulus to try investing, learn, and gain practical experience. After all, it is the experience that most effectively enhances financial literacy.
So, while the final details of the investment account are still unclear, the publicly announced key principles are commendable. The only thing left is to hope that the Seimas will approve this measure and that citizens will take advantage of its main benefit – a long-term, or even better, a periodic and long-term investment perspective.
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