Pension System
Pension System Design
Germany's pension system is grounded in a strong public pension pillar. In the past individuals relied predominantly on pension benefits provided by the statutory pension insurance.
With the German demographic changing towards an aging population and the intergenerational contract (in G.: Generationenvertrag, where the young Generation provides for the old Generation) therefore only working objectionably – Pensioners approach their retirement planning more diversely and where possible build upon all three pillars at once.
Statutory Pensions (First Pillar)
The German first pillar pension is an obligatory pay-as-you-earn system financed by employees, employers and governmental subsidies. The contribution rate is equally shared between the employee and the employer with a current annual contribution assessment ceiling of 74,400€ (West Germany) and 64.800€ (East Germany).
The legal retirement age is 65 for both men and women but is scheduled to rise to 67 years over a transition period from 2012 to 2029.
Persons who have paid into the Statutory Pension Insurance for 35 may retire at Age 63 but will be deducted the months of work they would have still needed to work until the age of 65 (or 67 if you were born after 1963) – in a worst case scenario (retiring 48 months before the retiring age), this would mean a deduction of 14.4% to the pension entitlement.
An exemption is applicable since the 1st of July 2014: persons with a contribution record of at least 45 years may retire at age 63 without a deduction to their pension entitlement
The pension entitlement is based on the number of contribution years, the average level of income and the retirement age.
Occupational Pensions (Second Pillar)
In 2013 20.086.000 people were active members in a form of occupational pension; with 59.5% of employees being active members in an Occupational Pension.
The German occupational pension market, employers can choose between two different funding methods. These two methods and their vehicles are listed below.
Pension Promise
1. Direct pension promise
Direct pension promises are usually funded via book-reserve accruals. The employer gives a promise to the employee to pay him an agreed amount once he retires.
The 4% tax-deductible contribution limit which applies to the external pension vehicles ('Pensionskasse', pension fund, direct insurance) does not apply to book-reserve accruals. The employer can deduct the complete annual pension scheme contributions to book reserves from taxable income. The contributions are not considered taxable income to the employee.
Benefits are taxed as (deferred) salary when received.
In recent years, larger German companies set up contractual trust agreements (CTAs) to fund their pension liabilities off the balance sheet. CTAs are legally separated from the sponsoring undertaking. They have been gaining popularity since they do not have restrictions regarding their asset allocation.
External Pension Providers
2. Direct insurance
Under a direct insurance scheme, the employer takes out a life insurance policy on behalf of the employee and pays contributions to the contract. The employee has a direct entitlement to the benefits accrued under the contract against the insurance company.
Combined employer and employee contributions of up to 4% 2.976€ (W. Germany), 2.592€ (E. Germany) of the contribution assessment limit plus the fixed contribution limit of 1.800€ are tax exempt. This also applies to the 'Pensionskasse' and direct insurance funding vehicles.
Insurance companies are subject to supervision by the Federal Financial Supervisory Authority (Bafin). Strict quantitative investment regulations apply to direct insurance, e.g. the share invested in equity may not account for more than 35%. This also applies to the 'Pensionskasse' and direct insurance funding vehicles.
3. "Pensionskasse"
The 'Pensionskasse' is the main pension vehicle for private employer-sponsored pension provision after the direct pension promise. The 'Pensionskassen' are special insurance companies that serve one or several employers.
The "Pensionskasse" must be financed according to actuarial principles, ensuring that the necessary means to fulfil pension liabilities are available at any time.
4. Pension fund
Pension funds are separate legal entities, which could either be formed as a joint-stock company or a mutual pension fund association. Insurance law regulates them. Pension funds can be set up by a single company, a financial services provider or by an industry-wide pension scheme sponsored by the employers' association and the unions.
According to a new insurance regulation, pension funds do not need to be 100% funded at all times. Pension funds will be allowed to have an under funding of up to 10%. In that case a recovery plan for a 10-year period is required. The same tax treatment applies as in the case of the 'Pensionskasse'.
5. Support fund ('Unterstützungskasse')
Support funds are separate legal entities set up as an association, less frequently as a limited liability company, or as a foundation. The employee has no legal claim against the support fund but directly against the sponsoring employer. Support funds can either be sponsored by one single company or can be founded as a group support fund used by several companies.
Contributions to support funds are tax-deductible without limit for both employer and employee contributions. Pension benefits are taxed as ordinary income.
There are no restrictions regarding asset investments. The entire fund may even be lent back to the company at a market-related interest rate, which used to be common practice.
Private Pensions (Third Pillar)
In Germany whilst relying on Statutory and Occupational Pensions, persons may also choose to improve their pension benefit by investing into a private pension.
There are multiple vehicles in place to invest into a private pension, some of which are listed below.
1. Riester Pension Plan
The Riester Pension Plan is a life annuity plan and government subsidized up to an amount of 2.100€ annually.
At least 4% of the person's income is put towards the pension plan, with the government subsidizing 154€ and an additional 185€ per 1 child (300€ if born after 2008), this pension vehicle is therefore suited towards low-income earners, who plan to benefit over a long period of time.
The Riester Pension Plan comes in five investing varieties: classical, unit-linked, bank savings plan, and two kinds of building loan contracts (Wohn-Riester), the resulting Pension Benefit is 100% taxable.
2. Rürup Pension Plan
The Rürup pension plan is a life annuity plan and a more flexible Pension plan compared to the Riester pension plan, it is therefore ideally more suited towards self-employed persons and freelancers.
The Rürup Pension plan comes in three investing varieties: classic, unit-linked and immediate annuity. During the contribution period, the contribution towards this form of Pension Plan is tax deductible. The annual contribution assessment ceiling is set to 22.766€ for individuals and 45.532€ for couples. Currently 82% of this Contribution assessment ceiling can be (it is scheduled to rise in 2% steps until 2025) transferred as special expenses.
When the person retires, a certain percentage of the Pension Entitlement is taxable. In 2016 this was 74%, but is scheduled to rise to in 2% steps until 2040. The taxable percentage is defined by the first year the person retires.
14.10.2016
