Ultimate Guide to the German Pension System

Introduction: Is the German state pension enough for a comfortable retirement?

The German state pension is designed to provide a basic level of income for your retirement. 

However, it may not be enough to ensure a comfortable retirement, especially for those who have high living expenses or who have not saved enough money for retirement. 

How is the state pension in Germany calculated?

The state pension is based on a formula that takes into account the number of years of contributions to the pension system, the average income earned during those years, and other factors such as the age at which the pension is claimed.

This ultimate guide to the pension system in Germany will cover everything you need to know about the pension system, from how much state pension you should expect to receive, the pension pillars in Germany to the pension plans available.

What state pension should I expect to receive?

According to the German Pension Insurance, the average state pension in 2021 was €1,052 per month.

This amount may be supplemented by additional benefits, such as the “Grundsicherung im Alter” (basic security in old age), which provides a minimum guaranteed pension for people without any assets.

However, it is important to note that this is only for employees. Freelancers, on the other hand, don’t receive any state pension by default – unless they voluntarily sign up to contribute to the state pension themselves.

What is the pension gap?

The difference between your salary and your pension when you retire is known as the pension gap, reflecting the drop in salary you will experience when you retire. If you don’t supplement your state pension in Germany with an additional private pension plan, your pension gap is, unfortunately, likely to be quite big.

On average, the income you receive from your state pension in Germany is 46% of the income you receive when you work.

However, there are ways to close this gap and increase this percentage. You can download the Horizon65 app to visualise your current pension income when you retire, and simulate how any potential private investment to help you close your pension gap.

What exactly will my pension gap be?

Find out how your current pension drop off with the Horizon65 app.

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How can I make sure I retire comfortably?

To avoid a high pension gap, you should consider supplementing your state pension. You can do so by investing in a private pension plan or investment types.

The amount needed for a comfortable retirement will vary depending on factors such as your lifestyle, living expenses, and healthcare needs. It is important to plan for your retirement and to consult with a financial advisor to determine the best options for your specific situation.

Moreover, you can make use of tax benefits already by investing in a private pension.

What tax benefits are there with a private pension?

Private pension plans in Germany offer several tax benefits to encourage individuals to save for their retirement. Here are some of the key tax benefits:

Tax deductions

Contributions made to private pension plans are tax-deductible, up to a certain limit, from your taxable income.

Tax deferral

Investment gains earned in private pension plans are tax-deferred, meaning you do not have to pay taxes on them until you withdraw the funds in retirement.

Reduced tax rate in retirement

When you retire and begin to withdraw funds from your private pension plan, you may be subject to a reduced tax rate compared to your income tax rate during your working years.

Income replacement

Private pension plans can help to supplement your income during retirement, which can help to reduce your overall tax liability.

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What subsidies are there if you invest in a private pension?

Alongside certain tax benefits (depending on the type of private pension plan you invest in), you can also benefit from certain subsidies, depending on your situation. 

These are:

Basic allowance

Depending on your income and family situation, you may be eligible for a basic allowance of up to €175 per year.

Children’s allowance

If you have children, you may be eligible for a children’s allowance of up to €300 per year per child.

Start-up bonus

If you open a new Riester pension plan before your 25th birthday, you may be eligible for a one-time start-up bonus of €200.

Retirement bonus

If you have been paying into a Riester pension plan for at least 10 years and meet other eligibility criteria, you may be eligible for a retirement bonus of up to €175 per year for life.

Occupational pension subsidies

If your employer offers an occupational pension plan, you may be eligible for subsidies or matching contributions from your employer.

What should I keep in mind with a private pension plan?

It’s important to keep in mind that there are different private pension plan types in Germany with different rules and limitations. Therefore, it is recommended to speak with a financial advisor to determine with private pension plan is right for you.

You can find out everything you need to know about private pensions in our ultimate guide.

At what age can I expect to retire in Germany?

The official retirement age

The retirement age in Germany depends on your year of birth. Currently, the standard retirement age is gradually increasing from 65 to 67 years for those born in 1964 or later.

Is it possible to retire earlier?

However, early retirement is possible from age 63, but this may result in a reduction in above mentioned benefits. Additionally, there are special rules for certain professions and for individuals with disabilities.

What is the minimum pension in Germany?

The minimum pension in Germany depends on various factors such as the number of years you’ve contributed to the pension system, the type of pension plan you’ve taken out and your income during your working years.

However, as of July 2021, the minimum pension for individuals who have contributed to the pension system for at least 35 years and are eligible for the standard pension is €853.02 per month in the western states of Germany and €814.14 per month in the eastern states of Germany. It’s important to note that this minimum pension amount may change over time and is subject to adjustments based on inflation and other factors.

Pension pillars in Germany

The three-pillar pension system is the idea that retirement income can be supported by the following:

• The state
• The company or industry you work for
• Your private savings

However, while this is generally true in most European countries, in Germany, the system is often viewed as:

• Rights-based and salary-dependent
• Wealth-based and subsidised
• Wealth-based and without incentive

A private pension contract is often regarded as the first pillar option. This means that you benefit from income tax deferral and bankruptcy protection (once earned, the pension cannot be taken away from you – even if you experience bankruptcy).

For the purpose of this article, however, we will follow the international classification.

What are the three pillars of the German retirement system?

Pillar 1: Statutory Pension Insurance

This is the foundation of the German retirement system. It provides a basic level of retirement income to all employees, including self-employed individuals and civil servants. Contributions are mandatory for all employees and employers, with the amount of the contribution based on the employee’s income. 

The statutory pension insurance is managed by the German government and pays out a monthly pension to retirees based on their years of contributions.

This system was created as far back as 1899, originally to provide support to workers who were injured or disabled on the job. It has evolved over time to include retirement benefits, becoming the foundation of the German retirement system.

Pillar 2: Company Pension Plans

The pillar consists of occupational pension schemes provided by employers to their employees. These plans are designed to supplement the statutory pension and provide an additional source of retirement income. 

Participation in company pension plans is voluntary, but once an employee joins, they are required to make contributions, and their employer may also contribute. These plans are managed by companies and can take various forms, such as defined benefits or defined contribution plans.

Despite dating as far back as the 19th century, it wasn’t until the 1950s that the government began to promote company pension plans as a way to supplement the statutory pension insurance.

Pillar 3: Private Pension Plans

This allows individuals to save for their retirement by investing in a private pension plan. The individual decides what the private pension plan invests in. In practice, however, they are advised by the financial advisor on what to invest in.

Contributions to these plans are tax-deductible, and the investment gains are tax-deferred. Private retirement savings are managed by private companies, banks, or insurance companies.

They became a more significant part of the German retirement system in the 1990s with the government’s introduction of the Riester pension (we will explore this pension among others further on in the ultimate guide). 

This pillar also gained significance in response to demographic challenges in Germany. This is due to Germany’s ageing population, an issue that will continue to burden the state.

What is the importance of the three pillars of the German retirement system for your retirement planning?

The three pillars of the German retirement system are important because they provide a diversified approach to retirement income. Relying on just one source of income during retirement can be risky, but having multiple sources of income can provide greater financial stability and security.

Importance of statutory pension insurance

The statutory pension insurance, as the first pillar, provides a foundation of retirement income to all employees, ensuring that everyone has some level of retirement income, even if they are not able to save enough through the other two pillars. This makes it an essential component of retirement planning.

Importance of company pension plans

The company pension plans, as the second pillar, allow employees to supplement their retirement income by contributing to occupational pension schemes provided by their employers.

These plans are often more generous than statutory pension insurance and can provide a higher level of retirement income. Participating in these plans can be particularly important for employees who work for large companies or have a long-term career with one employer.

Importance of private pension plans

Private pension plans, as the third pillar, allow individuals to save for their retirement using private pension plans or investment products. This pillar is particularly important for those who want to have more control over their retirement savings and invest in a way that aligns with their risk tolerance and financial goals. 

Private retirement savings can also provide tax benefits and greater flexibility in terms of withdrawal options.

Overall, the combination of these three pillars provides a comprehensive approach to retirement planning in Germany and can help individuals achieve greater financial stability and security during retirement.

What types of private pension plans are available to you?

There are four main private, supplementary pension plans in Germany. They are:

The basic pension plan

The basic pension plan, known as the “Basisrente” in German, also known as the “Rürup-Rente,” is a type of private pension plan that is designed to provide a guaranteed income for retirement. It was introduced in 2005 and is named after Bert Rürup, the economist who helped design the plan.

The Basisrente is a type of annuity, which means that it provides a guaranteed income for life once the annuity payments begin. It is intended to be a long-term retirement savings product, and contributions are tax-deductible up to a certain limit. 

This tax advantage is intended to incentivise individuals to save more for retirement and reduce their reliance on the statutory pension insurance.

One of the unique features of the Basisrente is that the annuity payments are subject to taxation as ordinary income, which means that individuals who have a lower tax rate in retirement may pay less tax on their annuity payments than those who have a higher tax rate. 

This is intended to provide an incentive for higher-income earners to contribute to the Basisrente and reduce their tax burden in retirement.

The flexible pension plan

The flexible pension plan is a pension plan that doesn’t benefit from any government subsidies or income tax reductions. However, this means that it can be used anywhere in the world.

What is the main feature of the flexible pension plan?

The main feature of the flexible pension plan is that you can dictate in what exactly the plan invests in and when you can withdraw the money.

What are the main benefits of the flexible pension plan?

The first main benefit is that your investments can grow without having to pay dividend income taxes or capital gains taxes as your pension grows.

The second main benefit is that you can benefit from a tax relief when you take the money out, and that it can be converted into a lifelong income.

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The “Bring your own” Company Pension (bAV)

The company pension is known as the “betriebliche Altersvorsorge” (bAV) in German. It is a type of retirement savings plan that is offered by some employers to their employees, with the goal of providing additional retirement income and financial security for employees after they retire.

However, employers often do not have bAV schemes in place in which case you are legally entitled to bring your own.

One of the main advantages of the bAV is that it is a tax-efficient way for employees to save for retirement. Contributions to the bAV are made on a pre-tax basis, which means that employees do not pay taxes on the contributions until they receive the benefits during retirement. This can provide a significant tax advantage and help employees maximize their retirement savings.

The other main benefit of doing so is that your employer will pay directly into the contract, handle the tax reporting for you and is also required to contribute 15% on top which represents his social security savings (up to a certain threshold).

The bAV is an important component of the German retirement system and there are many ways employers can structure a company pension.

The Riester pension

The Riester Rente, also known as the “Riester pension,” is a type of private pension plan in Germany that was introduced in 2002. It is named after Walter Riester, the former German Minister of Labor and Social Affairs, who was instrumental in designing the plan.

The Riester Rente is intended to supplement the statutory pension insurance and provide individuals with additional retirement income. It is a flexible savings product that allows individuals to choose how they want to save and invest their money. There are different types of products available, including annuities, life insurance policies, and investment funds.

One of the key features of the Riester Rente is that contributions are eligible for tax benefits. The government provides incentives to encourage individuals to contribute to their private pension accounts, including annual subsidies and tax breaks. The amount of subsidies and tax breaks depends on the individual’s income, family status, and the number of children they have.

State subsidies are 175€ for an adult and 300€ for every child born after 2008.

Did you know you can invest in ETFs through a private pension plan?

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German statutory pension system

The German statutory pension system, also known as the “Deutsche Rentenversicherung,” is a pay-as-you-go pension system that provides retirement benefits to eligible individuals. The system is financed by contributions from employees, employers, and the government.

To be eligible for pension benefits, individuals must have paid into the system for a certain number of years, typically at least five years. The amount of the pension benefit is based on the individual’s average earnings over their working life, the number of years of contributions, and other factors such as disability status and age.

The statutory pension system also provides benefits for surviving dependents of deceased contributors, as well as disability benefits for those who are unable to work due to illness or injury.

How are German statutory pension benefits calculated?

These benefits are calculated based on a complex formula that takes into three key factors.

Factor 1: Your earnings over your working life

This is calculated based on your earnings and the number of years over which you paid contributions into the pension system. To arrive at the average earnings, the system first adjusts the earnings for inflation and then divides the total adjusted earnings by the number of years in which contributions were made.

Factor 2: “Pension factor”

This is determined based on your year of birth and the age at which you start receiving pension benefits. The pension factor is applied to your average earnings to determine your monthly pension benefit.

Factor 3: Circumstantial situations

Finally, there are a number of additional factors that can affect the amount of the pension benefit, such as whether you have worked part-time or have taken time off work to care for a child or other dependent. In some cases, you may be eligible for additional benefits such as disability pensions or survivor benefits.

How can I make contributions to enhance the state pension benefits?

There are several ways to enhance state pension benefits in Germany through contributions. These are:

Paying into the state pension system for a longer period

Working longer means you pay into the system for a longer period and the higher your pension benefits will be. To receive the maximum pension benefit, you need to have paid contributions into the system for at least 45 years.

Paying higher contributions

You can choose to pay higher contributions into the state pension system, which will increase the amount of your pension benefits. This can be done voluntarily.

Combining periods of contribution from different countries

If you have worked in other EU countries, you can combine the periods of contribution to the state pension system in those countries with your contributions in Germany to increase your pension benefits.

Taking advantage of private pension plans

As discussed above, private pension plans have tax incentives and subsidies to encourage you to save for your retirement and supplement your statutory pension.

What are the benefits of relying on the statutory pension?

The benefits are:

Guaranteed income

The statutory pension provides a guaranteed income for life, which can provide a sense of security and stability in retirement.

Inflation protection

The statutory pension benefits are adjusted each year to account for inflation, which helps to maintain the value of the pension over time.

Spousal benefits

The statutory pension system provides benefits for surviving spouses or partners, which can help to provide financial support after the death of a spouse.

No investment risk

Since the statutory pension is a defined benefit plan, there is no investment risk for you as the benefits are guaranteed by the government.

What are the drawbacks of relying on the statutory pension?

The drawbacks are:

Basic level of income

The statutory pension provides only a basic level of retirement income, which may not be sufficient to maintain a comfortable standard of living in retirement.

Uncertainty over future benefits

The statutory pension system has faced some challenges in recent years, including demographic changes and financial sustainability. This has raised concerns over the long-term viability of the system and the future level of benefits.

Lower benefits for some

The statutory pension benefits are calculated based on a complex formula that takes into account various factors, including average earnings over the individual’s working life. This means that some individuals may receive lower benefits than others, depending on their work history and contributions record.

Limited flexibility

The statutory pension system provides little flexibility in terms of when and how benefits are received, which may not be ideal for individuals with unique retirement goals or circumstances.

Purchasing power concerns

The statutory pension is not automatically adjusted to inflation. This means that as life gets more expensive during your retirement, your purchasing power does not remain the same. There is an adjustment that is made but it has historically trailed inflation and corrections have happened by parliamentary decree.

Summary: Pros and cons on relying on the statutory pension for your retirement

Pros

• Guaranteed income
• Inflation protection
• Spousal benefits
• No investment risk

Cons

• Basic level of income
• Uncertainty over future benefits
• Lower benefits for some
• Limited flexibility
• Purchasing power concerns

Careers with special pension status

In Germany, there are certain professions that offer a special pension status, also known as a “Berufsständische Versorgung.” These special pension plans provide additional benefits and may have different eligibility requirements than the standard state pension plan. Some of the professions that offer a special pension status in Germany include:

Military personnel

In Germany, soldiers are eligible for a special pension plan known as the “Soldatenversorgungsgesetz” or SV. This plan is designed to provide retirement benefits to military personnel and their families.

The SV plan provides a range of benefits, including a basic pension, a widow’s and orphan’s pension, and disability benefits. The amount of the pension is based on the length of service, rank, and salary of the soldier. The minimum period of service required to be eligible for the SV plan is four years.

In addition to the SV plan, soldiers may also be eligible for a supplemental pension plan through their employer, the German Armed Forces. This plan is designed to provide additional retirement benefits beyond the basic pension provided by the SV plan.

Civil servants and judges

In Germany, civil servants are eligible for a special pension plan known as the “Versorgungsausgleich” or VA. This plan is designed to provide retirement benefits to civil servants and their families.

The VA plan provides a range of benefits, including a basic pension, a widow’s and orphan’s pension, and disability benefits. The amount of the pension is based on the length of service, rank, and salary of the civil servant. The minimum period of service required to be eligible for the VA plan is five years.

In addition to the VA plan, civil servants may also be eligible for a supplemental pension plan through their employer, the German government. This plan is designed to provide additional retirement benefits beyond the basic pension provided by the VA plan.

An overview of Company Pensions (BAV)

As we’ve mentioned throughout the article, the importance of company pensions in Germany cannot be overstated. Company pensions in Germany are known as the “betriebliche Altersvorsorge”. The BAV system in Germany is a way for employers to offer their employees a form of retirement savings that is in addition to the state pension system.

The bAV can take different forms, such as defined benefit plans or defined contribution plans. Employers are required by law to offer a bAV plan to their employees, and can choose the type of plan that best fits their needs and the needs of their employees.

One key feature of the bAV system in Germany is that it offers tax advantages to both employers and employees. Employers can deduct their contributions to the plan as a business expense, while employees can defer taxes on their contributions until retirement when their tax rate is likely to be lower.

What tax benefits does the company pension bring?

The bAV (betriebliche Altersvorsorge) system in Germany offers tax benefits to both employers and employees. Tax benefits include:

Tax-deductible contributions

Employers can deduct their contributions to the BAV plan as a business expense, which can help reduce their tax liability.

Tax-deferred contributions

Employees can make contributions to the BAV plan on a tax-deferred basis, which means they won’t have to pay taxes on those contributions until they withdraw the money in retirement.

Tax-free capital gains

The money in the BAV plan grows tax-free, which can help employees accumulate more savings over time.

Lower tax rate in retirement

When employees withdraw money from their BAV plan in retirement, they may be in a lower tax bracket, which can help reduce their tax liability.

Private pension plans in Germany

There are several types of private pensions available in Germany. Here’s a brief overview:

Riester pension

This is a state-subsidised private pension plan that is available to everyone who is eligible for the German state pension. It offers tax benefits and government subsidies to encourage individuals to save for retirement.

Basic pension (Rürup-Rente)

This is a form of private pension plan that is also subsidised by the state, but is designed for self-employed individuals and high-income earners. It offers tax benefits and government subsidies to encourage retirement savings.

Flexible pension

This private pension plan is relatively new, being introduced in 2017. Under the Flexirente scheme, individuals can choose to receive their pension payments starting from age 63, or they can continue to work and defer their pension payments until a later age. This can be particularly beneficial for individuals who want to continue working part-time or in a reduced capacity during their retirement years.

The Flexible pension scheme also offers a range of other options for individuals to customise their pension benefits. For example, individuals can choose to receive a lump-sum payment instead of regular pension payments, or they can opt for a higher pension payment in the first few years of retirement followed by a lower payment in later years.

What tax benefits do the individual private pension plans bring?

As discussed throughout the article, private pension plans offer tax incentives. They are:

Tax incentives: The Riester pension plan

The Riester pension offers tax deductions for contributions made to the plan, tax-free growth of savings, and tax-deferred payments. Additionally, individuals may be eligible for government subsidies that further increase their savings. 

Tax incentives: Basic pension (Rürup-Rente)

The tax benefits of the basic private pension plan, also known as the Rürup pension, in Germany involve:

Tax deductions for contributions

Contributions made to the Rürup pension plan are tax-deductible up to a certain limit. The maximum tax-deductible amount varies based on the individual’s age, and the amount of their income, and the maximum limit for tax-deductible contributions is reviewed annually.

Tax-free savings growth

The money invested in a Rürup pension plan grows tax-free. This means that the interest, dividends, and capital gains earned within the plan are not subject to tax.

Deferred taxation on pension payments.

When you start receiving pension payments, only a portion of the payments is taxable. The remaining amount is tax-free, and the taxable portion is subject to your personal income tax rate.

Did you know you can invest in ETFs through a private pension plan?

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Pensions in Germany and the self-employed

The pension situation for the self-employed in Germany can be challenging as they are not covered by the statutory pension system by default. However, self-employed individuals have various options to save for retirement through private pension plans.

What options do the self-employed in Germany have to receive a pension?

Luckily, the self-employed have options available to receive a pension. These are:

Basic private pension (the Rürup-Rente)

This private pension plan provides tax benefits and can be a suitable option for self-employed individuals with higher incomes.

Flexible private pension plan

Self-employed individuals can also opt for a “Fondsgebundene Rentenversicherung” or a “Fondssparplan,” which are flexible private pension plans that offer tax benefits and investment options.

Company pension plans

If a self-employed individual has a company, they can offer a “Direktversicherung” or a “Pensionskasse” as a company pension plan for themselves and their employees.

Voluntary contributions to the statutory pension system

Self-employed individuals can also choose to make voluntary contributions to the statutory pension system in Germany. These contributions can be used to increase the level of their pension benefits, but the contribution rate is relatively high compared to that of employees.

Private savings

Self-employed individuals can also save for retirement through private savings, such as investment accounts, real estate, or other assets that can provide income during retirement.

Disability pensions

In Germany, there are several disability pension options available for individuals who are no longer able to work due to a disability. These are:

Erwerbsminderungsrente (Disability Pension)

This pension is for individuals who are no longer able to work due to a disability, but have worked for a minimum number of years (depending on their age). The amount of the pension is calculated based on the individual’s average income over the last five years before becoming disabled.

Grundsicherung bei Erwerbsminderung (Basic Security for the Disabled)

This is a means-tested benefit for individuals who are unable to work due to a disability and have little or no income or assets. It provides a minimum income to cover basic needs such as food, housing, and health care.

Schwerbehindertenrente (Severely Disabled Persons Pension)

This is a pension for individuals who have been severely disabled since childhood or who have become severely disabled before reaching retirement age. The amount of the pension is calculated based on the individual’s degree of disability and their years of contribution to the pension system.

Unfallrente (Accident Pension)

This is a pension for individuals who have been disabled due to a work-related accident or illness. The amount of the pension is calculated based on the individual’s degree of disability and their years of contribution to the pension system.

Hinterbliebenenrente (Survivor’s Pension)

This is a pension for the surviving spouse or children of a deceased individual who was receiving a disability pension or was eligible for a disability pension at the time of their death.

The amount of the pension is calculated based on the deceased individual’s years of contribution to the pension system and their average income over the last five years before their death.

Conclusion

In conclusion, personalised retirement planning is crucial for ensuring a secure and comfortable retirement. Everyone’s financial situation, goals, and needs are unique, and therefore require an individualised approach to retirement planning.

By taking the time to create a personalised retirement plan, you can identify your retirement goals, assess your financial resources, and develop strategies to achieve your desired outcomes. 

This proactive approach to retirement planning can help individuals avoid financial uncertainty, achieve financial security in retirement, and enjoy a fulfilling post-work life. 

Ultimately, investing in personalised retirement planning can provide you with peace of mind and the ability to confidently face the future.

Luckily, finding your tailored retirement investment plan is easier than ever before. 

The retirement advisor app at Horizon65 is designed to easily find you your ideal retirement plan, based on your situation, income levels and goals. 

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