Basics of pension insurance

It would be ill-advised to put too much trust in the state pension. Many old people are already pushed into poverty and have to live on a level, that is nowhere near their old quality of live. In the future, the number of these pensioners will increase significantly, since on the one hand the state […]

Seamus Wolf
From Seamus Wolf

11. Nov 2022

Reading time: About. 6 minutes

It would be ill-advised to put too much trust in the state pension. Many old people are already pushed into poverty and have to live on a level, that is nowhere near their old quality of live. In the future, the number of these pensioners will increase significantly, since on the one hand the state coffers are largely empty, and on the other hand an ever-greater imbalance in the age distribution in Germany has been developing for years. The main reason for this is the low birth rate, combined with the ever-increasing life expectancy of people in the modern world.

The result of these circumstances is that more and more pensioners are facing a smaller number of workers. This cannot work in the long term. It can therefore be expected in the near future that the state pension system will collapse completely, and that pensions will be cut further and further, so that hardly anyone will be able to support themselves in old age.

A private-pension plan and pension insurance as solution

Since almost 20 years, the government is encouraging people to make private provision for their own retirement in addition to the statutory pension scheme. A mixture of statutory pension and private provision for retirement should be the goal for everyone who wants to live a nice retirement.

The main point of a private-pension plan, and biggest difference to a state sponsored plan, is the use of already taxed income. Unlike a voluntary payment into the state system, a Rürup- or a Riester-Rente, a true private pension insurance will not be able to benefit from a tax break. You will have to finance it out of your own pocket. On the other hand, you will have to pay far less to the taxman after you entered your retirement. A factor, that you have to take into account.

There are a few examples of how every German citizen can make additional provisions for their old age. There are various other models, which we would like to discuss in more detail below.

A life insurance pension plan

For many decades, the words private pension insurance and life insurance were used interchangeable: What makes this form of insurance so popular in Germany? The main reason is that by taking out an endowment insurance, the insured person not only secures their own future, but also the financial future of their family if they should decease. As the name suggests, this insurance basically consists of two different forms of insurance – a conventional life insurance policy and a special endowment insurance policy.

The main advantage of endowment insurance is that it can be used to provide for one’s own retirement, as well as to provide optimum protection for one’s own family. But that is not all. Such endowment life insurance can also be used to finance real estate or to secure loans or credits.

The basis of every endowment insurance policy is the so-called combined endowment and whole life insurance model. This means that if the insured person dies during the insurance period, his or her surviving dependents (e.g., spouse and/or children) receive the benefits specified in the insurance contract. However, if the insured person lives to see the allocation date of the insurance, which is also the end point of the insurance term, he or she will receive the benefits from the insurance. With many insurance companies, the insured person can choose whether the insurance benefits are to be paid out in the form of a lump sum or as monthly annuities.

However, it should be noted that if the insured person lives to see the allocation date, i.e., draws benefits from the insurance himself, the previously granted death benefit will cease with most insurers. In this case, the insured himself receives money from the insurance, but if he dies, the surviving dependents cannot expect any benefits from the insurance. Anyone wishing to claim these benefits should take out additional term life insurance.

In recent time, these conditions are relaxing somewhat, so that some insurance companies already offer endowment life insurance policies that include lifelong death protection. In this case, there is no need to take out additional insurance, as surviving dependents can draw benefits even if the allocation date has already been reached and the insured person himself draws benefits from the insurance.

In addition, it is also possible for married couples to take out endowment insurance together, from which the other partner benefits in each case in the event of an emergency. However, the exact conditions for such a special form of endowment insurance vary greatly from company to company, so in this case you should definitely seek advice from an independent insurance expert beforehand.

The decline of the life insurance pension plan

Yet, in recent years, this private-pension plan has lost a big part of its appeal and the life insurance pension plan is no longer the dominating institution that it once was. The reason for this is that this form of insurance is no longer tax-free.

Before the pension reforms of 2005, the payout of the life insurance pension plan was completely tax-free. Just like the state pension of that time. And contracts made before this date are indeed still under this very beneficial regulation. But new ones have no possibility to enjoy this benefit. They still have a lower tax burden than most other options, but they no longer are completely exempt.

The other reason for its decline are the interest rates of the last years. As a pension insurance, it was always very dependent on an expectable income through interest rates and investments with fixed rates. Investing in the stock market was unusual or even completely impossible. As a result, the low interstates made the life insurance pension plan a rather uninteresting investment.

While it still has it use, most people today tend to choose other kinds of pension insurance. Like the state sponsored alternatives, Rürup, Riester and BAV. Or even the younger brother of the endowment insurance, the capital-based pension insurance.

The capital based private-pension plan

The capital-based pension plan is an evolution of the life insurance. An origin that can be seen in the fact that the responsible departments in the insurance companies are still named after the life insurance, and they share the legal regulations with their predecessor.

The basics of pension insurance

The basic principle is the same. One pays into the contract, once or regularly, and receives the return at the end of the term. Either as a single sum or as an annuity. However, this type of pension insurance usually does not include a special death benefit for the surviving dependents, but instead concentrates exclusively on providing retirement security.

The decisive factor, however, is that the contributions can be used freely according to the wishes of the investor. It is thus possible to invest the money on the stock market and acquire shares or ETF. It is a form of investment that involves more risk than fixed-interest life insurance, but is less dependent on interest rates and offers basic protection against inflation.

Tax benefits

It also benefits from a lower tax burden in old age. This is due in part to the 12/62 rule. This means that after the 62nd birthday and a 12-year contract term, one also receives an advantage in the case of a lump-sum payment. Only half of this has to be taxed at the personal tax rate, which is an enormous advantage. But a recurring annuity also benefits from such rules. In general, the tax burden for this form of pension insurance is about half as high as the one for a stand-alone investment and far below that for a state-subsidized pension.

International private pension plan

A private pension is also of particular interest to those who would like to spend their retirement in another country. Since the private pension is built up from already taxed money, there are practically no problems when withdrawing abroad. Especially for an unattached and mobile lifestyle, this should be the first choice for a private-pension plan.

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