Fundamentals of the retirement system in Germany

Part of the Contributions to Economics book series (CE)


As documented in the SOR model,79 individual behavior is influenced by macro-level elements (e.g., economic, technological, political and cultural) and by micro-level factors such as an individual’s socio-demographic and socio-economic attributes but also his personality and psychology. The focus of this study is the micro level. However, in order to assess the different micro-level financial planning perspectives and actions of an individual, an understanding of an individual’s macro environment is required. This chapter aims to shed light on the key characteristics of the German retirement system that influence the retirement-specific financial planning behavior of German affluents, the target group of this research.


Pension System Pension Scheme State Pension Retirement Income Occupational Pension 


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  1. 79.
    See Kotler/Bliemel 1995, p. 279ff, Kotler 1999, p. 161ff or Meffert 2000, p. 98ff and for individual aspects of involvement and activation Trommsdorff 1998, p. 47ff, or Kroeber-Riel/Weinberg 1996, p. 53ff and the introduction of the model in sub-chapter 2.3.Google Scholar
  2. 80.
    Definitions for different generation types according to Frick 2005, p. 15f.Google Scholar
  3. 82.
    See WEF 2004, p. iii.Google Scholar
  4. 83.
    See UNPD 2005, p. Germany country profile.Google Scholar
  5. 84.
    Between the DAV (Deutsche Aktuars Vereinigung — Germany actuary association) tables published in 1994 and 2004, the life-expectancy of a man born in 1940 increased from 86 to 89 years. For a girl born in 2005, the estimates range from 95 years (in the 1994 DAV table) to 102 years (in the 2004 DAV table). See GDV 2004, p. 2.Google Scholar
  6. 85.
    See WEF 2004, p. iv for the indications for Germany and UNPD 2005, p. xvii for the world observation.Google Scholar
  7. 86.
    See for example indications from the German Statistical Federal Office, with its 10. coordinated population projection (STBA 2003a), the BMAS 2006b, p. 13, or the medium variant from the UNPD 2005.Google Scholar
  8. 87.
    The German Statistical Federal Office bases its calculations on a net balance of foreign immigrants of about 200,000 yearly and assumes that the net immigration of Germans is reduced from a level of 80,000 in 2002 to zero in 2040. 10. coordinated population projection (STBA 2003a), see BMAS 2006b, p. 13 or Pötzsch/Sommer 2003, p. 22.Google Scholar
  9. 88.
    OECD 2001, p. 141. Although there is only vague understanding of the details of the existing pensions systems, for many individuals the basic attitudes are realistic. This can be seen in the fact that individuals like existing arrangements, because they have worked in the past. Furthermore, there is empirical evidence that they lack confidence in the sustainability of the systems (due to the demographic pressure), and that they are suspicious of a later retirement age (because up to the 1990s, jobs for old workers were difficult to find). “This suggests that if the debate is sensibly framed and if good empirical evidence is available, discussions about pension reform need not be as polarized as is often feared.” OECD 2001, p. 141f.Google Scholar
  10. 89.
    See Borgmann 2005, p. 45.Google Scholar
  11. 90.
    See Börsch-Supan et al. 2005, p. 19.Google Scholar
  12. 92.
    The World Economic Forum has estimated a ratio of 16.9% for 2050. See WEF 2004, p. vi. However, the new reforms are supposed to lead to a reduction in this number.Google Scholar
  13. 93.
    See OECD 2001, p. 106ff.Google Scholar
  14. 94.
    See DIA 2006f, p. 1f.Google Scholar
  15. 95.
    The function of the pension system was originally a consumption allocation mechanism where a portion of the output (goods and services) produced by the worker is distributed to the elderly who have already accomplished their working careers. This should ensure that productivity improvements would be shared with the elderly and that the standard of living could be maintained. See WEF 2004, p. v. This aspect underlines the two-generation aspect of a pension scheme. Furthermore, since the pension system also takes into consideration the socially beneficial effect of raising children (e.g., through accumulating pension entitlements), it can be considered even as a three generation contract where the working population supports both the old and the young.Google Scholar
  16. 96.
    If both the funded and the PAYG system base the benefits on earnings levels during worker’s careers, they are more expensive if the underlying wage rate is growing faster compared to a lower salary growth scenario. However, while the PAYG systems are not sensitive to interest rates, the costs of the funded system are influenced by the interest/return rates. Therefore, the costs of a funded system are driven by both salary growth and interest/return rates. See WEF 2004, p. x.Google Scholar
  17. 97.
    See Börsch-Supan/Wilke 2004, p. 3ff.Google Scholar
  18. 98.
    See Stiefermann 2005, p. 8, Peape 2004, p. 24ff or DIA 2006a, p. 1. Since the German state pension is digressive, the relationships are somewhat different for high-income earners. They have to cope with a very low replacement level and thus have more incentives to have additional private pension. Consequently, a higher share of their income stems from private and occupational voluntary pensions. The digressive character of the state pension system is shown in Fig. 3.5.Google Scholar
  19. 99.
    See Peape 2004, p. 11ff.Google Scholar
  20. 100.
    See Kortmann et al. 2005, p. 29.Google Scholar
  21. 102.
    Individuals born before 1948 can apply for this form of retirement pension if they have turned 63 and meet the criterion of 35 “waiting years” (Wartejahre). Individuals born after November 1948 can also apply for this sort of pension if they have accomplished their 62 anniversary and meet the criterion of 35 “waiting years” (Wartejahre). Apart from this early retirement form the German system also featured the old-age pension for women or the old-age pension due to unemployment or “Altersteilzeit”. These pension types have been abolished and are not available anymore for individuals born after 31.12.1951. For all the early retirement options the cRVt (the value of the pension entitlement) of the year in which an individual retires is relevant. However, the early retirement will be linked to a reduction in retirement income of 0.3% per month relative to the regular retirement age. See DIA 2006c, p. 1f.Google Scholar
  22. 103.
    Numbers relate to the total number of new retirees in the Old Bundesländer in 2004. The shares of early retirement for women or individuals receiving contributions for unemployment are still high as these forms of benefits are still available for older generations. See VDR 2005, p. 46f.Google Scholar
  23. 104.
    This “Geringfügigkeitsgrenze” represents about 15% of the average gross wage and is relevant for only about 5.6% of all workers. See Börsch-Supan/Wilke 2004, p. 11.Google Scholar
  24. 105.
    Many of these funds are still in the process of maturing. Therefore, the payouts have not reached the desired full level yet. However, already now, members of these schemes may opt for an exemption from compulsory membership in the SSP. See Kortmann et al. 2005, p. 22.Google Scholar
  25. 106.
    According to the German Statistical Federal Office, 6.3% of the entire working population are operating as civil servants. See STBA 2005b, p. 1. The Civil Servant’s Pension Scheme is designed to guarantee a gross pension of 75% of the last “pensionable” earnings after 35 years of “pensionable” service. See Kortmann et al. 2005, p. 14.Google Scholar
  26. 107.
    See Peape 2004, p. 24 and Börsch-Supan/Wilke 2004, p. 10.Google Scholar
  27. 108.
    Gross earnings are before deduction of the individual contribution to health insurance, any other contributions to social security as well as taxes. In the year 2003, the gross average salary amounted to €28,978, equivalent to a monthly net income of €1,536. The net pension income was then €1,077, corresponding to a replacement level of 70%. See VDR 2005, p. 29.Google Scholar
  28. 109.
    See for example the “Rentenschätzer” (online application to estimate one’s pension income) from the DIA. See DIA 2006b, p. 1.Google Scholar
  29. 110.
    According to Börsch-Supan/Wilke 2004 about half of all entrants to the system have 45 earnings points or more. See Börsch-Supan/Wilke 2004, p. 15.Google Scholar
  30. 111.
    See VDR 2005, p. 63.Google Scholar
  31. 112.
    See Peape 2004, p. 6.Google Scholar
  32. 113.
    See Kortmann et al. 2005, p. 13 for indications up to 2030 and DIA 2005a, p. 1 for estimates for 2050.Google Scholar
  33. 114.
    Taxes as an element of financing were originally thought to be dedicated only for these parts of the SSP for which there is no income source (e.g., contribution free but eligible years — such as raising children or educational times — as well as burdens stemming from war times). However, an ever increasing share of regular pension expenses is financed through taxes as the dependency ratio increases. See Ottnad/Wahl 2005, p. 3.Google Scholar
  34. 115.
    The contribution rate varied from 14% in 1960 to 20.3% in 1998 and stands at 19.5% in 2005. See DIA 2006g, p. 2. Going forward, the reforms set the limit for contributions at 19.9% for 2009. See BMAS 2006b, p. 31.Google Scholar
  35. 116.
    In case self-employed individuals choose to contribute to state pension as well, they pay the entire contribution rate (19.5%) and are charged the so-called norm contribution (Regelbeitrag of €477.75 in 2006) which is calculated on the basis of the average gross income. See DRV 2006d, p. 9.Google Scholar
  36. 117.
    See BMAS 2006b, p. 27. Other authors mention a rate of 30%. See Börschsupan 2004, p. 11.Google Scholar
  37. 118.
    See Börsch-Supan/Wilke 2004, p. 53.Google Scholar
  38. 119.
    Specifically for low income workers, the German system provides two specific solutions: Either the non-contributory pension that is a means-tested safety net option for pensioners or the possibility to adjust the low-income worker’s pension entitlements upwards by up to 1.5 times to a maximum of 75% of the average earnings of contributors. This would then correspond to 0.75 EP points as discussed in section 3.2.3 if they have contributed for 35 years. See WEF 2004, p. 3 on Germany. With only about 1% of the population relying on the safety net option — called social assistance — that entitles to about 13% of average earnings for a single person, Germany can be considered as very effective. In the UK and Italy 40% and in France 7% of the population are receiving non-contributory means-tested pensions. See Peape 2004, p. 6ff and pages on Germany.Google Scholar
  39. 120.
    See Ottnad/Wahl 2005, p. 4.Google Scholar
  40. 121.
    See Kortmann et al. 2005, p. 66, Peape 2004, p. 12 and Stiefermann 2005, p. 8.Google Scholar
  41. 122.
    The book reserves are an internally organized scheme, under which the employer takes upon himself to provide for the employees later on. He has the right to accumulate reserves for this purpose and encounters liquidity advantages as the taxes for the gain caught in the reserves only accrue when the pensions are paid out. The support fund is the most traditional form of corporate pension provision. It describes an independent institution that provides pension income for one or several employers. For both these vehicles there is no supervision by the state which implies free asset allocation choices. In case of insolvency of the employer the pension is secured by the mutual insurance association (Pensions Sicherungs-Verein). The direct insurance is a kind of life-insurance that the employer arranges for his employees. Retirement funds are institutions similar to life-insurances and can be borne by one or more companies. Both these vehicles are subject to the insurance supervision and thus have restricted asset allocation possibilities. The last and youngest vehicle, the pension funds are independent institutions that provide corporate pension services against payment and are subject to the insurance supervision. Contrary to the direct insurance and the retirement funds, the investments can be invested relatively freely on the capital markets (up to 100% in equity). See Stiefermann 2005, p. 19ff.Google Scholar
  42. 123.
    Kortmann et al. 2005, p. 14.Google Scholar
  43. 124.
    See Kortmann et al. 2005, p. 22ff.Google Scholar
  44. 125.
    Peape 2004, p. 7.Google Scholar
  45. 126.
    Borgmann 2005 defines sustainability as a state in which the current laws can be maintained ad infinitum without further increasing the contribution rate. Borgmann 2005, p. 133. A sustainability factor with this aim has been introduced into the benefit calculation based on the “Gesetz zur Sicherung der nachhaltigen Finanzierungsgrundlagen der gesetzlichen Rentenversicherung” (RV-Nachhaltigkeits-Gesetz).Google Scholar
  46. 128.
    See Börsch-Supan/Wilke 2004, p. 29.Google Scholar
  47. 130.
    Ehrentraut et al. 2005, p. 5.Google Scholar
  48. 131.
    A couple can take double the amount as “Riester Rente”. See DIA 2006b, p. 3.Google Scholar
  49. 133.
    See Peape 2004, p. 25. A comprehensive review of the criteria for individual pension plans eligible for subsidies or tax relief can be found at Börschsupan/Wilke 2004, p. 34ff.Google Scholar
  50. 134.
    While the “salary sacrifice” products already allow a deduction of 4% of salary from taxable income or an equivalent direct subsidy in 2005, the personal pension product allows only a 1% deduction at the beginning, increasing to 4% only by 2008. See Peape 2004, p. 24ff.Google Scholar
  51. 135.
    See Bofinger et al. 2005, p. 238 for a detailed explanation of the role the sustainability factor plays in the derivation of the pension value (cRVt). The mechanics for the calculation of the pension income based on this cRVt can be found in section 3.2.3 or DRV 2006d, p. 4.Google Scholar
  52. 138.
    See BMAS 2006b, p. 109, Rasonyi 2006, p. 23 and Rasonyi 2007, p. 23.Google Scholar
  53. 140.
    See DIA 2006h, p. 1.Google Scholar
  54. 142.
    See Börsch-Supan/Wilke 2004, p. 38ff.Google Scholar
  55. 143.
    See DIA 2006d, p. 1.Google Scholar
  56. 144.
    See BMAS 2007c. This growth can be compared to an initial growth rate from 2001 to 2002 of 141% that decreased thereafter to 16% (in 2003) and even further to 7% in 2004. Only in 2005, the growth started to pick up again substantially with 34% growth in total private Riester contracts. Author’s calculations based on BMAS 2007b.Google Scholar
  57. 145.
    See BMAS 2007c.Google Scholar
  58. 146.
    Borgmann 2005, p. 132.Google Scholar
  59. 147.
    For a detailed explanation of the formula for the cRVt and the mechanics associated with the sustainability factor refer to Bofinger et al. 2005, p. 238.Google Scholar
  60. 148.
    See DRV 2006d, p. 23. For a detailed overview of the historical adjustments of the cRVt refer to DIA 2006b, p. 1. The legal background can be found in § 68 together with § 255 e SGB VI (Sozialgesetzbuch).Google Scholar
  61. 149.
    Borgmann/ Heidler 2006, p. 16.Google Scholar
  62. 150.
    See DIA 2006e, p. 1.Google Scholar
  63. 151.
    Number related to the pension income of an individual in the Old Bundesländer. Assuming 45 contributory years with average gross earnings, start of retirement at the age of 65, real increase of salary of 0.65% p.a. (until 2025, afterwards: 0.5% p.a.) and an inflation rate of 1.5%. See Börsch-Supan et al. 2004, DIA 2005a, p. 1.Google Scholar
  64. 152.
    See DRV 2006a, p. 4, 8.Google Scholar
  65. 153.
    Adjustments for early or late retirement need to be applied with utmost care in order to ensure an actuarial neutrality of the system. The level of pension reduction used in the US (0.56% reduction per month of anticipated retirement) is said to lead to actuarial neutrality. Compared to this, the adjustment for early retirement in Germany seems too low and therefore leads to an effective tax rate on labor income near the end of working life that is artificially increased. See also OECD 2001, p. 87ff or Borgmann 2005, p. 111. An indicator for the too low adjustment factor in Germany could be the historically comparatively higher proportion of individuals applying for early retirement. See WEF 2004, p. 5 on Germany.Google Scholar
  66. 154.
    Borgmann 2005, p. 111.Google Scholar
  67. 155.
    See DRV 2006d, p. 5ff.Google Scholar
  68. 157.
    See DRV 2006c, p. 10ff.Google Scholar
  69. 158.
    While the retiree’s share of the charge for the health insurance amounts to approximately 7.3%, the contribution for the care insurance for the long-term frail elderly amounts to 1.7%. See DRV 2006b.Google Scholar

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