A practical guide to the pension system in Germany

Are you living and/or working in Germany? It is important that you know how the pension system is structured in Germany and start planning your future as soon as possible. This guide will cover everything you need to know about the retirement system in Germany.

The structure of the German pension system

The German pension system is highly ranked worldwide and is based on three pillars. These are the mandatory state pension, occupational and private pension schemes.

The First Pillar: Public Pension

The mandatory state pension is also known as Deutsche Gesetzliche Rentenversicherung (DRV) or German public retirement insurance. This public pension insurance is government subsidised and is mandatory for all employees who as well financially support it through their German social security contributions (which are automatically deducted from the salary each month). These subsidies and financial contributions are later redistributed among the existing pensioners rather than saved or reinvested. In other words, the current working population is paying for the today’s old age people following the generation principle that the younger population supports the older. As a matter of fact, everyone who has contributed to the German pension system for 5 years or more becomes eligible to receive a lifelong pension from the German government after reaching the retirement age (67 years according to the German legislation). In addition, according to the European law your working years in other EU-member states can be added to the calculation and increase future pension payout. 

The Second Pillar: Company pensions

The occupational pension scheme is called betriebliche Altersvorsorge (bAV) and offered by companies to their employees on voluntary basis. This company pension scheme was designed to function as an add-on to the potentially unstable state pension and help employees improve their retirement planning situations. Such employer’s pension insurance type can be an attractive option thanks to the tax benefits and subsidies offered by the government. For example, pension contribution amount is usually calculated from the gross income and is mostly exempt from income tax and social security payments. when you retire, your pension would be paid out to you worldwide (which is where you will reside after retirement) and, however, your pension will be fully taxed according to the current tax rate.

The Third Pillar: Private pensions

Private pensions or private Altersvorsorge include a varying range of individual retirement investments offered by banks and insurance companies. These private pension plans are also supported by the government through tax advantages as an incentive for German residents to save for the old age. Private pensions can significantly increase your pension payout if built correctly. There are two plans within the private pension scheme (Riester and Rürup Rente) each has its advantages and different tax benefits.

The idea when the younger provides for the older has proven to be not a reliable foundation for a public pension system despite its heavy government subsidies and tax advantages. Like many economically advanced countries, for decades Germany has been facing the problem of “population aging.” As a consequence, the number of pensioners is increasing and putting more financial pressure on the government, while there are less and less younger people willing to contribute to the public pension budget. The emerging “pension gap” called for changes.

Riester pension (or Riester Rente)

Riester Rente appeared as a fiscal reform to sustain financial pressure built up by the aged population crisis. In short, state-sponsored riester rente is a private pension plan designed to support the German public pension. Since its introduction, however, the plan has come under serious scrutiny mainly due to the lack of transparency, high and uncertain costs and poor product choice. Riester pension turned out to benefit only the low income employees and civil servants and particularly low income families with children thanks to additional allowances.

How does Riester Rente work?

Because the structure of the plan is so complex and opaque, attempts to give an easy explanation of it often makes many people even more confused. Yet, below we will briefly describe who is eligible for this type of private pension plan and how it works.

Importantly, everyone who monthly pays to the German public pension insurance can sign up for Riester Rente, including employees and civil servants, self-employed people who contribute to the public insurance, unemployed who receive government benefits, etc. It is particularly recommended to the low income families with children thanks to special benefits. As a bonus, the saver receives basic allowance of 175 euros per year while for each newborn child after 2008 the German government would pay 300 euros as an annual child allowance. To receive these Riester Rente benefits contributors should pay at least 4 percent of their yearly income with a maximum annual contribution of 2,100 euros. These annual pension contributions can be claimed as a special expense in the income tax return. 

The capital saved through the Rieste Rente plan is protected and guaranteed to be paid upon retirement. Savers can begin receiving payouts from the Riester Rente plan at the age of 60 which will be subjected to the income tax. Moreover, the amount can be received as a lump sum payment.

Rürup pension (or Rürup Rente)

The Rürup Rente plan was developed for everyone who is not eligible for the Riester Rente plan, in other words, who is not contributing to the German public pension, generally, self-employed and freelancers. Also known as Basis Rente, this private pension plan is subsidised through its own tax advantages which primarily benefit self-employed, business owners, freelancers or anyone with high income.

How does Rürup Rente work?

With Basis pension plan savers decide on the amount they are willing to contribute monthly. However, unlike with Riester Rente, the Rürup Rente savers do not receive bonus allowance. Instead, they have certain tax advantages that allow to subtract considerable part of pension contributions from their taxes as special expenses. 

Pension payout through the Rürup pension plan is only possible as a monthly pension and cannot be taken out as an a lump sum payment. Neither it can be inherited or transferred, but the saver’s dependants can be covered under certain circumstances 

Have you ever considered that…

setting up a pension plan at age 25 means you only have to put 20 percent of the amount aside every month  compared to a person who starts a plan at age 45. This is due to the compound interest. Do not procrastinate. Time is money.

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