Retirement is often referred to as “World’s longest coffee break”. It is just a never-ending vacation. But all that sounds good, only for those who have planned well in advance for their financial independence post retirement. And pension is one such instrument that can help to achieve financial security.
Statutory Pension
Ever since Germany established its first Social Security System in 1889, the public retirement insurance has been “pay-as-you-go”. This public pension is an“Inter-generational contract”. which means, the current pensions of the retired is paid from the current premiums of the not yet retired (working population). This insurance (Statutory Pension Insurance) is mandatory for all the employees, in some cases for the self-employed as well. Currently around 85% of the workforce is enrolled under it.
A simple illustration of its working
Assume a person “X” Gross salary is around 65,000 €, whereas average German Salary is 45,000 €. So, this 45,000 € equals to 1 Pension Point. In our case, Mr. X will earn 1.5 pension points. One gets points, based on his salary for his entire working period. Once retired, all these points are deployed to make up for the Public pension. Assume value of 1 point in Germany– 34 €. Now if X works for 35 years and earns 1.5 times the average German salary which is super unlikely, he will have 52.5 points by the time he retires.
Now 52.5(points) times 34 € = 1768 €(Gross) which will be the monthly pension of X for the rest of his life.
Drawbacks of Statutory Insurance
Now taxes are to be paid from this Gross 1768 monthly income; not to mention changing social fabric, lifestyle inflation and of course increased life expectancy (beyond 81 years).
That means, 65,000€ before retirement results in a little over 21,000€/year(1768€*12) post retirement which looks very scary. Is it all enough to lead a peaceful life after working lifelong?
OECD observations
OECD (Organization for Economic Cooperation and Development)in its report has also slammed the German Pension System.
Key highlights of their report:
- Even those working full- time throughout their lives receive significantly lower pension benefits than the OECD average.
- German women suffer one of the worst gender pension gaps (46%) amongst the other OECD countries. So future pension entitlements of women are likely to remain low compared to their male counterparts.
- Rapid ageing population to put an immense pressure on the financial sustainability of the public pension scheme. The German working-age population will reduce by 21% by 2050.
- In future, pensioners may also be exposed to the risk of old-age poverty, especially single parents, part time working women and certain self-employed category.
Now to fill this lacuna, the German Government in 2001 through legislative reforms brought in certain Private pension schemes to supplement the already existing ones. One such is Riester- Rente plan, conceived by Walter Riester, the former General Secretary of Labor.
What is Riester-Rente ?
A supplementary private pension plan endowed with Government benefits – tax benefits, government subsidies and social security benefits. It is a state-sponsored pension scheme to bridge the gap in Statutory pension insurance. Because of its advantages, you can close your personal pension gap. Currently around 16.5 million people have a Riester pension in Germany and this number is increasing rapidly.
How does the Riester-rente work?
Firstly, one must make contributions into the statutory pension scheme to be eligible for Riester-Rente.
During your active working life, you pay contributions to a Riester pensioni.e., minimum of 4% of your Gross earnings must be paid /capped at a maximum of 2,100 €/year to receive 100% subsidies from the Government. For low and middle wage earners, families with children, the government allowances are attractive, and for high-income earners, the tax advantage is usually very interesting.
Allowances and tax- breaks
How much Allowances do you get?
The following allowances are available every year:
- Basic allowance: 175€
- Child allowance for children born before Jan 1st 2008: 185€
- Child allowance for children born on/after Jan 1st2008: 300€
- One-time career starter bonus for young adults:200€(to encourage younger people)
The full allowances are only available if the corresponding contribution (either 4% of gross salary or 2100€) is made. So ideally a family of 4(husband and wife with two kids) are entitled to 950€/year as subsidies. This way, the Government incentivizes through subsidies, thus reducing the premium pay-in.
2100 – 950 = 1150€ (is the actual premium paid out of pocket), where the full premium paid(including the subsidy) can be offset against the tax.
What about tax breaks?
The contributions to the Riester pension can also be claimed via the tax return , that can go upto a maximum of 2,100€/year. All the contributions (including the bonuses) qualify as a special expense for tax purposes and are tax deductible. If the resulting tax advantage exceeds the amount of allowance, the tax office will recognize the difference as tax refund. The single and high-income earners get the most out of it.
Basic contribution
If you have a very low income, it is possible that your contribution to be paid (minus the allowances) would be 0 € or negligible. Nevertheless, at least 60 € per year must always be paid.
Who are eligible?
- Employees (also the trainees), students with mini jobs, federal volunteers
- Self-employed with compulsory insurance
- Civil servants, officials, judges, soldiers
- Recipient of unemployment benefits or sickness benefit
- Differently challenged people
- Spouses of people who are eligible for funding (working couples can separately enroll for this plan. However, child allowance will be most likely credited to mother’s account).
Is the Riester pension worthy?
The Riester pension is absolutely a sensible addition to your retirement provision. It generates an annual guaranteed return through bonuses and later pays a lifelong annuity. Hence it is worthwhile for a vast majority of the people provided they have taken a good Riester pension.
Advantages
- The monthly pension received is subjected to pensioner’s personal tax rate. The big advantage is that your tax rate as a pensioner will be very lower than the tax rate during your working period.
- Also, it does not require any additional social security contributions unlike some other old-age provisions.
- 30% of the capital can be received at one go at the start of retirement. The rest of the capital is then paid out as lifelong annuity.
- The Riester-Rente plans are strictly regulated by the German Government. Information about costs,benefits,agent commissions, fees and other details are transparent and fully available to the customers.
- Benefit payouts can begin at age 60 and are subject to only German income tax, excludes any kind of flat tax or capital gains tax.
- The entire money put into the plan is guaranteed to you at the end of the contract and is not subject to any legal claims or attachments.
- Most of these products are fund-based. The products offer a wide range of funds to choose from( Mutual funds, equity) including managed portfolios.
- Capital can be withdrawn at any time to finance a house for self-use only.
- It is possible to cancel/change your Riester pension at any time with an optimal cost. The entire process is hassle-free.
Disadvantages
- It is a complex insurance product. A bad Riester contract may end up in high costs, eventually lowering the rate of return.
- The Riester-Rente will be beneficial for those planning to retire in the EU. If one cancels on moving out then the person doesn’t receive the subsidies .
- Capital cannot be borrowed against a Riester-Rente.
- Cannot be used as a collateral for any other real estate investment except for house that too for self-use only.
- Pay income tax during pay-out period.
When it comes to pension, planning for long term is extremely important. A lot can happen in one’s lifetime – financial crisis, economic recession, bankruptcy of companies etc. Hence, it’s very important to get your Riester pension from one large, financially strong insurer who has been present for considerable period. Ensuring the financial strength of the insurer is one way to achieve the highest possible level of security for you in the long term.
Therefore, it is advisable to look for an insurance broker when choosing the right kind of product. There is no One-size fits all pension scheme, that can work well for all. One should consider his/her current financial status, life planning, future goals and expectations, decisions regarding migration, weigh down the pros and cons before arriving at a best suitable pension scheme. So, help from professional expertise is a must. The onus lies on the individual because financial success can only be achieved through financial education.
Last but not the least, Personal provisioning is the most important – If you want to be cared for, you have to take care of yourself.