Find out why your German public pension will not be enough to provide you with a comfortable life in your old age and what other options there are for retirement provision in Germany.
- The three pillars of pension provision in Germany
- The essence of Germany's public pension (GRV)
- Riester pension: State-subsidized but beneficial in one form only
- Rürup pension: A poor choice despite tax advantages
- Company pension plans: Why they often don't pay off
- Private pension plans or PPP have the best potential
- A PPP invested in stock ETFs: The most promising addition to your retirement plan
The three pillars of pension provision in Germany
Pension provision in Germany can be divided into three pillars:
Pillar one of Germany's retirement system is, for most people, the basic public pension (‘Gesetzliche Rentenversicherung’ or ‘GRV’). The second pillar consists of company pension schemes. And the third pillar includes various forms of private pension insurance. Some of these are partially subsidized by the state.
So what do these three pillars mean for you? And how can you use them to enjoy a relaxed, financially secure retirement? Let's take a closer look at the individual pillars:
The essence of Germany's public pension (GRV)
The public pension that you may get in Germany is higher than in many other countries, but you shouldn't rely on it exclusively. For one thing, the amount paid out in retirement depends heavily on how much and how long you have paid in during your working life. But if you have not paid into the system for several decades or were only employed part-time, the statutory pension will not be enough to live on and certainly not to maintain your lifestyle. For example, the current average pension for men in western Germany is €1210, and for women it is only €730.
Around half of the pensions paid are thus less than €1000 per month. Almost every fifth pensioner even receives less than €500 per month from the GRV!
Even if you paid in all your life it is often not enough. The big benefit of the GRV pensions, though, is that it keeps up with inflation, and it pays no matter how long you live. Thus in planning your pension it is essential to understand how big that base pension is that you can always count on, and what happens if you move abroad.
Do I have to pay contributions to the public pension?
If you are employed you basically have little choice.
Virtually all employed people in Germany have to pay into the official pension system of the Gesetzliche Rentenversicherung. Those who are not subject to compulsory contribution can voluntarily insure themselves with the GRV. This applies, in particular, to the self-employed, freelancers or non-working adults, such as stay-at-home moms or dads. This voluntary contribution can be done through contributions of between €83.70 and €1,311.30 per month.
We have calculated that it mostly makes sense to contribute voluntarily if you are older (around 50-55). This particularly applies if you are female or well educated, as you are expected to live longer and hence benefit more years from the GRV. Also if you are risk averse or don't have many other savings, then it makes sense to contribute more to the GRV if you can, starting around middle age.
When will my GRV be paid out?
The standard retirement pension age is currently 65 plus ten to eleven months and it will gradually increase to 67 by 2029. So when you’re born after 1964, you will have to work until the age of 67 to get the full pension.
With longevity increasing gradually, we expect that the normal retirement age will increase by about 1 year per decade. So if you are 30 now, you can expect the GRV to be available at about the age of 70.
Can I retire early?
Yes, but you will receive less pension unless you are at least 63 years old and have 45 years of minimum insurance (the so-called waiting period). All others who are 63 or older and have completed at least 35 years of waiting time can retire early but with deductions.
Every month that you want to retire earlier costs a deduction of 0,3 percent on your monthly pension. To avoid this, you can make special payments before the official start of your pension from the age of 50. This is a relatively attractive option, and should definitely be considered if you want to retire early. If you do so, it makes sense to spread the special payments over several years to avoid exceeding your tax deduction limits.
How high will my GRV pension be?
Your pension is determined foremost by the number of pension points (so-called 'Entgeltpunkte', often also called ‘Rentenpunkte’) you have collected. For every year of average income contribution, you earn one point. The average income is recalculated every year; currently, you receive one pension point for 38.901 € of income. If you earn less, you will receive proportionally fewer points, and if you earn more you will get proportionally more pension points.
Accruing pension points does have a maximum limit, which in 2022 is 2,17 points for all incomes 84.600 € and above.
To calculate your pension, you need to multiply these pension points with the pension value or 'aktueller Rentenwert', currently 34,19 € in western Germany.
Note: On this pension, you still have to pay taxes, so it will be reduced even further!
To assess the net value of your personal pension it is critical to be able to forecast the value of the pension points, how many point you will still accumulate, and understand the taxes. As this is complex we suggest you use our Hypofriend pension gap calculator to estimate your pension based on your wage outlook and our scenarios for the value of these pension points.
Our forecast takes into account population dynamics, and expected wage growth. You can also use the calculator to analyze the impact of various options to supplement your pension, and choose the one with the highest net impact.
You can compare this to the forecast of the official forecast the ‘Deutsche Rentenversicherung’ DRV (the official insurance institution of the state pension) provides you every year (if you are older than 27 years and have already paid at least 5 years of contributions). But mind you this is a static forecast, that does not model how the value of the GRV points or your income evolves over time. We think the DRV should use our model ;).
Do I keep my public pension when I move abroad? The simple answer is yes. You are entitled to the pension no matter where you live. Do be careful with double taxation. Fortunately over 90 countries have a tax treaty with Germany, from Australia to Russia, that will prevent the pension to be taxed twice. Typically the pension, as it was built up in Germany and is paid for by German contributions, will be taxed in Germany and at German tax rates. But it does vary by treaty, so you have to check it. Asking for a refund makes rarely sense unless you have not reached the minimum 5 year threshold for a pension. We do have a special article on this topic.
Riester pension: State-subsidized but beneficial in one form only
There is an expectation that the GRV will not keep up with living standards as it is paid by current workers, and fewer and fewer of those will have to support more and more pensioners. In response to this problem, the government introduced in 2002 the Riester pension (‘Riester-Rente’) to encourage private retirement insurance as a supplement, with support of subsidies and tax benefits.
Unfortunately, the Riester pension also has some crucial flaws, that we discuss later, that reduces the net return on your investment to about zero in the savings phase. If you consider inflation and taxes on your pension, you can even get a negative result.
In individual cases, it can still be worthwhile to take state subsidies, and we will show you when and how after discussing who and how much subsidy you can get..
Who can get a Riester contract?
All those who contribute to the GRV scheme can benefit from these subsidies. So this applies to all employees, but also recipients of unemployment benefits, parents on parental leave, caregivers, early retirees, artists. Self-employed or persons without their own income can also be indirectly eligible as the spouse of an employee with a Riester contract.
Subsidies for Riester contracts
There are two types of subsidies: direct subsidies through an old-age provision allowance (‘Altersvorsorgezulage’) and indirect subsidies through tax benefits.
The direct basic allowance amounts to 175 € per year for each person and 300 € for all children born after 01.01.2008. For older children, the allowance is 185 €. These allowances are linked to conditions: to receive the full allowance, you must pay at least 4% of your annual gross salary, including the subsidy.
You can also benefit from tax advantages, as you can deduct your contributions up to 2.100 € per year from your taxes.
But it is only the highest of the two ways of calculating the entitlement that counts. So if your tax deduction could save you 800 € and the subsidy is 775 € you are entitled to a maximum of 800 €.
Disadvantages of the Riester pension
Despite the sometimes high subsidies, we cannot advise you to take out a Riester contract in many cases.
The Riester pension is mostly tied to the current low interest rate, as providers have to guarantee that you get at least your main sum back.
This is why insurance companies in essence don't want to offer these contracts anymore and rarely do they offer them with adequate upside. Even whne interest increase, the money earned will first go to offset the relatively high cost.
And to top things off, the pension you receive in the payout phase is taxable and subject to a so-called pension factor (“Rentenfaktor”). We will spare you the details here, but it means that insurance companies pay only about 65% of what you have paid in when you have an average current life expectancy! This is a dismal outcome as you don't get back your nominal savings, let alone be protected by inflation. Hence only if the subsidies are really big (e.g. you have 3 children) is it worth it. Below we show how homeowners can get around this and avoid this huge Rentenfaktor "tax" in retirement.
TIP : Don't use Riester if you plan to move to a country outside the EU or the European Economic Area (EEA) during your retirement, as you will also have to pay back all allowances and tax benefits that you received if you do so even for part of your retirement. In addition to the EU states, the EEA also includes Iceland, Liechtenstein and Norway.
The best way to make your Riester-Rente profitable
Your best (and usually only) option for using Riester sensibly is the so-called “Wohn-Riester”. The Wohn-Riester is a specific use of the Riester pension. It just means you use the proceeds for paying your mortgage or investing in a home, more precisely in the purchase, construction or age-appropriate renovation of a property. Some providers offer special Riester home savings contracts (“Riester-Bausparvertrag”) that you can only use for this purchase, but we would not normally recommend this.
We do recommend using your Wohn-Riester at the latest right before retirement to pay off (part of) your mortgage. This way you save on interest payments, and avoid the huge "Rentenfaktor" tax (see above) implied by having the Riester paid out gradually and partially in retirement. With interest rates higher you can also use any Riester savings to immediately lower your mortgage, or when your interest rate reset is coming up--ie at the end of your fixed interest period.
The further good news is that:
You can use it for any own home in the EU.
You can sell your home and transfer your investment to a new home.
You can avoid any normal tax by owning your home till the age of 85. If you sell your home before that, without buying a new one, you will just have to pay the normal tax, and don't need to repay your subsidy.
We also recommend investing your Riester assets in stock ETFs until you pay off (part of) your mortgage. That way you benefit from high expected returns.
Note that when you pay off your mortgage earlier then in retirement, you will implicitly pay 2% interest on the Wohn-Riester amount you put in your home. In other words, your Riester balance that you would have to pay tax on in retirement will grow by 2%. If the return on your Riester plus 2% is less than your mortgage rate, it makes sense to immediately use Riester assets to pay off your mortgage. If you plan to own your home until at least the age of 85 you don’t pay any tax anyhow, and then it pays already if the return on your Riester is less then your mortgage rate (which it virtually always is).
Note that you can use your Riester also as a downpayment for your home purchase. We can calculate if that makes sense for you.
Rürup pension: A poor choice despite tax advantages
Rürup-Rente (or officially: “Basisrente”) is a pension designed for those that are not or not sufficiently covered by the GRV. Mainly it should ensure a basic provision for the self-employed in old age. It is therefore often referred to as a basic pension. But like the Riester pension, this originally good approach is now a losing proposition due to high costs both in the savings and in the payout phase and low returns. We, therefore, suggest using alternatives.
Who can get a Rürup contract?
The basic pension, better known as the Rürup pension, was introduced to provide a basic pension similar to the GRV for self-employed and freelancers in particular. But Rürup pension is not restricted to these occupational groups, in principle, they are open to all taxpayers in Germany. For example, as a GRV paying employed person you can use the Rürup up to the maximum of your GRV contribution.
Types of Rürup pension
As with all insurance companies based pension plans in Germany, there are three different types to choose from in the pay-in phase:
The classic pension insurance gives you a 100 percent payout guarantee. Unfortunately, because this type is linked to the extremely low guaranteed interest rate, you are also assured of a minimal return. Note that for Rürup, in contrast to Riester, the guarantee is after cost. This means that if your return is just the 0,25% guaranteed interest, and the cost is 2%, you are not even getting your nominal contributions back.
The same applies to the second type of pension insurance: the new-classical options, that have guarantees on part of the investments. These may seem attractive but de facto have very low returns, as the negative/low net return on the guaranteed part drags down the overall return, and should be avoided as well.
The only option we can recommend to even consider are the plans where you directly and fully invest into low-cost stock ETFs.
Tax advantages with Rürup pension
The state subsidy of the Rürup pension takes place via tax benefits. The contributions you pay in during the savings phase are mostly tax-deductible. Currently, 94 % of the contributions are tax-deductible, but the percentage increases annually so that it will be 100 % from 2025. The tax benefits are capped at 25.639 € for single persons and 51.278 € for married persons per year.
Unfortunately, the disadvantages outweigh these tax advantages.
Drawbacks of Rürup pension
There are a few key reasons why the Rürup pension is not worthwhile for many people. First are the high administrative costs. In the savings phase, you have a cost of 2,85% on average (we compared the costs of all 44 providers), which more than halves the end result even if you invest in high-return stock ETFs.
Second, is the very poor return in the pay-out phase, which you cannot avoid. As the return on your savings in the retirement phase has to be guaranteed, they are very conservatively invested, with no positive return after cost. You are also bound to the conservative life expectancy assumptions of life insurance companies. This combined amounts to "Rentenfaktor" tax, and hence you will not even get the nominal amount of the savings accumulated at 67 back, but only 65% if you have the current average life expectancy. Only those who are lucky enough to live a very long life benefit from more generous payouts, since they profit from the surpluses of the deceased persons in their cohort.
This "Rentenfaktor tax" is a drawback that affects both the Riester pension and Rürup. For Riester we can then offer the Wohn-Riester solution for Rürup there is at present no solution. Your only hope is that the reforms, which the government has already announced, will change the system for the better.
Company pension plans: Why they often don't pay off
The company pension plan (“betriebliche Altersvorsorge” or bAV) is a collective term for various forms of pension provision by the employer. Originally, these were separate pension funds, well managed and properly invested by professional fund managers. These funds would also spread the risk of longevity across all participants. Hence they have two major benefits and are typically quite beneficial for you. Unfortunately, these plans are becoming rarer and rarer as companies worry about the liabilities of these funds. The most typical form these days is therefore direct insurance (“Direktversicherung”).
These direct insurance suffers from the same weaknesses as the other voluntary pension options: high costs and low returns. In addition you pay in less to your GRV, while that has a positive net return that is higher than the bAV with current low interest rates. On top of that, if you change employer, you loose your subsidies, unless the new employer so happens to have the same insurance contract. Your large upfront cost are then basically lost.
We have a special article on this topic and a calculator to help you review your bAV situation. Do review this as it typically is about the worst pension decision you can make, and instead you should consider alternatives like a Private Pension Plan as a long-term tax efficient ETF savings plan, or saving up for your own home or an investment property.
How does a direct company pension work?
With a bAV direct insurance, you pay a monthly contribution to this contract out of your wage. In Germany, this is referred to as deferred compensation ('Entgeldumwandlung'). Deferred compensation implies that contributions of up to 284 € a month are free of social security contributions and you don't have to pay taxes on up to 568 € per month during the savings phase. These two maximum limits are valid for the year 2022 and are adjusted annually.
Since your employer also saves their social contributions, they are obliged to top up the deposit with usually 15 % of your contribution. And if you are lucky, your employer participates to a greater extent.
At the end of the savings phase, usually upon retirement, and with the beginning of the payout phase, you will receive your monthly pension, which you then have to pay tax on, and social security contributions, including what is normally the employers' part. Alternatively, you can sometimes also take a complete or partial lump sum, but then you will fall into a high tax bracket.
Disadvantages of the bAV
The disadvantages are such that it makes the direct bAV one of the least attractive pension products:
Upfront costs make imply that a negative return is almost guaranteed if you change jobs and terminate your plan--the subsidies fall away in most cases unless by happen stance your new employer offers the same program.
Your savings are not well invested as there are legal requirements that force employers to limit the investment options to products that are deemed save. After cost this implies returns in the current environment are about zero. In any case returns are far less than direct investment in stocks/ETFs (Exchange Traded Funds).
The tax subsidies you get are not real subsidies – they are de facto loans and you have to pay them back through taxes and social security levies in retirement. The subsidies at most double your return but doubling a low or even negative return does not make the option much better.
As you don't pay social security premia on your bAV contribution, you also pay in less to the GRV and your entitlement drops. When we run the numbers we find that these losses are surprisingly high as the GRV has no cost and an expected return on the order of the inflation rate.
We would advise you to check carefully whether it is really worthwhile for you to join the company pension plan. Tip: Most people we talk to think their employer pays the subsidies as some extra, but that is rarely the case. These are usually just deferments of taxation and social security obligations, that come out of your own pocket.
Private pension plans or PPP have the best potential
Ok, so we have shown you why the GRV will not be enough to maintain your standard of living in retirement. At the same time, we have also told you that the state-subsidized forms of saving for old age do not make much sense in most cases. So what are you going to do about it? How should you close your pension gap now?
In our opinion, a wisely chosen Private Pension Plan ("Private Rentenversicherung") is the best answer to this question as it allows you to combine tax advantages with a reasonable return.
A PPP invested in stock ETFs: The most promising addition to your retirement plan
The traditional classic and the revamped new classic versions of the private pension plans suffer from the same weaknesses already described for Riester and Rürup: low returns as the full or partial premium guarantees force investment in low interest rate investments like government bonds. Costs will then eat a considerable part of the return, sometimes even leading to negative returns
Instead, for a sound financial future, you need to use your PPP to invest in widespread stock indices. Over the long run, they return on the order of 6-7 %, historically even higher. The beauty of wide stock ETFs is that over the long run they become relatively more stable. The simple reason is that stocks grow with the economy as companies grow with the economy. In the short term, they suffer from volatility as there is uncertainty in the outlook and this translates in valuation questions and price volatility. But over time that becomes less and less important as the underlying value keeps growing. This is nicely illustrated in the following figure.
What this means is that for your pension you need to invest in stock index ETFs. Such stock indices are the best for the long run – a minimum of about 10-15 years, and the longer the better. The good news is that:
These investments in ETFs of broad stock indices are very very cheap. With 0,1-0,2 % the costs are much lower than mutual funds or other solutions used in the past.
That the Private Pension Plan provides a very attractive solution from a tax perspective. If you hold ETFs directly you, in principle, will have to pay capital gains tax every time you sell and make a profit. With a PPP you pay only once. If you hold the PPP for over 12 years and take the assets out in one go after the age of 62, you also benefit from half the capital gains tax rate at about 13,19%.
The following graph demonstrates the benefit of using a PPP over investing directly into ETFs, taking into account the provided costs.
So for us, the most attractive form of additional pension is an ETF based private pension insurance. You won’t get any guarantees with that type of PPP, but if you choose for a wide index and hold the course you are likely to have a very significant return over the long run.
We, therefore, recommend that you consider for a long-term savings plan the option of an ETF PPP, as this allows you to benefit from a high return over the long term.
In addition, it is key to choose a low-cost provider. A fee of 1,7 % on a return of 6-7 % sounds modest. But over 30 years you could have double the amount if you choose a provider with just 0,7 % cost.
To help this process we have reviewed all providers for their cost and selected one with about the lowest costs that still is available to provide a good menu of ETFs, good tracking of your assets, and necessary features like automatic rebalancing. You also have as an alternative a fund linked PPP (Fundsgebundene). Instead of owning an ETF outright, you get paid based on an index. We have seen examples of poorly constructed and expensive indices. We also consider that owning an ETF outright gives you a better protection: You can seek to have your ETFs transferred to another company.
You might be wondering why you should take out an ETF PPP when you can just invest in ETFs on your own? You benefit above all from the tax wrapper, so you're saving taxes in the savings phase. You can at all time cancel. We have an option where you do NOT pay up front fees. In addition, you have the flexibility to choose whether you prefer to receive a monthly annuity or take the lump sum and then reinvest, and when you take the lump sum.
Tax benefits with Private Pension Plan
With an ETF based PPP you can benefit from the so-called "tax wrapper" function, which helps to shield your investment earnings from tax.
You only pay capital gains tax at the very end. If you pay capital gains tax every year when you rebalance your portfolio, this can cut substantially into your net return.
If you hold the PPP for over 12 years and take the assets out in one go after the age of 62, you also benefit from half the capital gains tax rate at about 13,19%. If you have your PPP paid out as a monthly annuity, you must pay tax on it at your individual tax rate. But you can also have the entire value of your PPP paid out to you at the beginning of your pension. In this case, you benefit from a rule that you only have to pay half of the normal capital gains tax. Combined with the solidarity surcharge, you then end up paying about 13,19 % tax – and only on your investment gains, not on your contributions!
You can also late in life choose to have your PPP paid out as an annuity, a constant monthly payment. If you do this at a late age it has even further tax benefits: the effective tax rate drops with age to below even the lump sum tax rate of 13,1875% and you accumulate even longer tax free.