Why actual income is a poor basis for YEL pension coverage
An expert at Suomen Yrittäjät, the Finnish SME association, says that using actual income as the basis for entrepreneurs’ pension coverage (YEL) would lead to unequal treatment of business owners between different business formats.
Janne Makkula, a Vice President at Suomen Yrittäjät, gives his views in his recent blog post about the use of an entrepreneur’s actual income as the basis for YEL coverage as opposed to the current YEL income.
“The view is presented from time to time that an entrepreneur’s actual income should be the basis for their YEL pension coverage. The thinking is probably that pension coverage would then work in a similar way to employees’ pensions,” Makkula writes.
Makkula writes about what the use of actual income as the basis for entrepreneur’s pension coverage would mean in different business formats.
“In practice, for a sole trader the model would barely differ from the current situation, because under the present regulations, YEL income is determined on the basis of the salary level of somebody doing similar work, and the nature and extent of business activities,” Makkula writes.
However, the situation could become problematic if other people than the sole trader themselves have, through their labour, contributed to the business’s profits.
“A sole trader may have several employees and subcontractors, and in such a case the yield generated by those employees’ and subcontractors’ labour is included the business’s profit and through that the business owner’s earnings. In practice, this would mean that YEL policy would not cover the work done by the business owner and the ‘real earnings’ from it, but also the work done by other people and businesses, as well as other operations which increase the business’s turnover and profits,” Makkula writes.
Limited company owners would try to evade YEL
With limited liability companies, the situation would be different because in such companies the entrepreneur can decide independently how much salary to draw.
“If a business owner does not draw any salary at all, but only pays themselves (interim) dividends from the company, then they would not have any income at all which could be the basis for YEL coverage,” Makkula writes.
He believes that basing YEL pension coverage on actual incomes would, particularly among limited companies, lead to “YEL planning” as well as tax planning.
“This is because in addition to income tax, the owner of a limited company would also have to pay around 24% in YEL contributions from the salary they pay themselves. This could lead to owners only drawing enough salary to avoid compulsory YEL coverage (at present around €8,600 annually). That would happen if they wanted to shirk their obligation to take out YEL coverage. Naturally, this would lead to the owner accruing no occupational pension whatsoever or any income-linked social security during their career.”