Find out why the German state 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 the German state 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 insurances: Wisely chosen the best option
- ETF PRV: 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 retirement provision in Germany is the basic public provision which happens for most people through the statutory pension insurance (‘Gesetzliche Rentenversicherung’ or ‘GRV’). The second pillar consist 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 the German state pension (GRV)
The state pension 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 and with breaks, the statutory pension will hardly be enough to live on. 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. Thus in planning your pension it helps to understand how big that base pension is that you can always count on, and how it is effected if you retire outside Germany.
Do I have to pay contributions to the state 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 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 not such a good investor 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 value of your net personal pension it is critical to be able to forecast the value of the pension points, how much you will contribute, and understand the taxes. As this is complex we suggest you use our Hypofriend calculator to estimate your pension based on your wage outlook and our scenarios for the value of these pension points.
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 you will get this so-called “Renteninformation” annually by mail). Our forecast takes into account population dynamics, and is not static.
Riester pension: State-subsidized but beneficial in one form only
There is an expectation that the GRV will decline in a relative sense as it is paid by current workers, and fewer and fewer of those will have to support more and more pensioners. WE expect though that the GRV will at least keep upm with inflation. The government to counteract a possible decline introduced in 2002 the Riester pension (‘Riester-Rente’) to encourage private retirement insurance as a supplement through state allowances and tax benefits.
Unfortunately, the Riester pension also has a crucial flaw: being tied to the guaranteed interest rate means there is hardly any return when interest rates are as low as they are now. If you include 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.
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.
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 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 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 right before or in retirement to pay off (part of) your mortgage. This way you avoid the huge "Rentenfaktor" tax (see above) implied by having the Riester paid out gradually and partially in retirement.
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 this entire Rentenfaktor tax and any normal tax by owning your home till the age of 85. If you sell your home before, 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 you can also pay off your mortgage earlier, but then 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 you plan to own your home until at least the age of 85 you don’t pay any tax anyhow.
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 the costs eat up, for example, 40% of your contribution, you only get the 0.25% guaranteed interest on the remaining 60%, so you are most likely not even getting your nominal contributions back.
The same applies to the second type of pension insurance: the new-classical options. These may seem attractive but de facto have very low returns, 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 highly 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 Euro for single persons and €51,278 for married persons per year.
Nonetheless, as we have calculated, the disadvantages clearly outweigh the tax advantages. Despite lower tax benefits we, therefore, have to recommend the PRV solution.
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 an effective cost of 2.85% on average (we compared the costs of 44 tariffs and providers), which more than halves the compounded 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. The savings are not invested in stock ETFs in retirement, but nearly all in bonds. As a result, you are bound to the high cost and conservative assumption of life insurance companies. You are also subject to the "Rentenfaktor" tax, and hence will not even get the nominal amount of the savings accumulated at 67 back, but perhaps only 65%! 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 Wohnriester 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”).
Typically Direct insurance suffers from the same weaknesses as the Rürup pension: high costs and low returns.
Whether the option provided by your employer can still make sense depends on the conditions: How high is the subsidy element? How high are the ongoing administrative costs? How high is the upfront cost? And in particular what is the solution in the pay-out phase. Is it like Rürup which forces you into bond investment and the huge Rentenfaktor tax in retirement or is it more like the PRV (see below) and you can take lump sum payments, that you can reinvest? Depending on the answers to these questions the bAV can end up being a very unattractive option.
In addition, you should always be aware that you can formally take your current occupational pension contract with you if you change jobs. But in practice, this can turn out to be difficult or have cost implications.
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 direct company pension plan is often rightly criticized. We would advise you to check carefully whether it is really worthwhile for you to join the company pension plan. Can you take a lump sum payment in or before retirement? Are the costs reasonable (under 1-1,5%)? You will need a large subsidy for each question answered by no. And with large we think in the order of 50-100%!
Private pension insurances: Wisely chosen the best option
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 Rentenversicherung" (PRV, meaning “private pension insurance”) is the best answer to this question as it allows you to combine tax advantages with a reasonable return.
ETF PRV: The most promising addition to your retirement plan
The classic and new classic models of private pension insurance suffer from the weaknesses already described for Riester and Rürup: low returns as the full or partial premium guarantees force investment in low or even negative interest rate bonds.
Instead, for a sound financial future, you need 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 specific outlook. 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 you need to invest in stock ETFs for the long run – a minimum of 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 PRV 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 PRV you pay only once. If you hold the PRV 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 PRV over investing directly into ETFs, taking into account the provided costs.
So for us, the most attractive form of additional pension is a fund-linked private pension insurance (‘Fondsgebundene private Rentenversicherung’). You won’t get any guarantees with that type of PRV, 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 the option of an ETF PRV, as this allows you to benefit from a stable 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 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 basic menu of ETFs, good tracking of your assets, and necessary features like automatic rebalancing.
You might be wondering why you should take out an ETF PRV 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. In addition, you have the flexibility to choose whether you prefer to receive a monthly annuity or take the lump sum. And finally, your ETF PRV is seizure-proof, so you can't be forced to sell it if you should ever receive state welfare benefits.
Tax benefits with PRV
With an ETF based PRV you can benefit from the so-called "tax wrapper", which helps to shield your investment earnings from tax:
If you have your PRV 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 PRV 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!