Chapter 26 Retirement and Occupational Pensions

Abstract

In Germany, just as in most other European countries, the overall concept for retirement is based on the so-called “Three Pillar Model”. This model suggests that for each individual the combined income during retirement should be derived from three types of sources:

• The first pillar is the statutory German Pension Insurance (Deutsche Rentenversicherung) which is compulsory for all employees with very few exceptions (e.g. board members). For the average pension household this pension accounts for more than 70% of the overall retirement income. Its level depends on the number of years insured and the income level during this time. It is funded through equal contributions from the employer and from the employee, the latter deducted directly from the monthly payroll.

• The second pillar represents the occupational pensions, which in Germany comprise five different types of funding vehicles. All of these funding vehicles allow for any type of sole or joint funding by employer and employee. This variety of instruments has developed historically and each of them appreciates a different treatment with regard to accounting, tax and social security. Moreover, employees have the right to demand that a portion of their salary be converted into a deferred compensation plan (Entgeltumwandlung).

• The third pillar comprises any type of private retirement saving. It is entirely voluntary. Some specific types of pension savings products appreciate direct statutory subsidies predominantly aiming at lower incomes and families with children (Riester-Rente).

Providing a company pension plan can have significant advantages for employers as well if they are designed to reduce staff turnover costs and to encourage staff loyalty, which is particularly important with regard to highly qualified employees. Long vesting periods combined with a pension plan providing for progressively increasing pensions in line with the length of service can be used as a very powerful retention programme.