401k In Germany: The Company Pension Or bAV

Key Takeaways

The benefit of a company pension is that you can actively reduce your taxable income. In addition, the investments grow tax-free.
The maximum amount for social security benefits is 292€/month, while you can save up to 584€/month to benefit from tax savings.
The minimum employer contribution is 15%. However, the employer can also offer a subsidy of 50% or even 100% if they wish.
Generally, the investment options are ETFs or mutual funds. However, only partly, because a bAV usually includes a high guarantee.

Introduction: Do 401k pensions exist in Germany?

A 401k is a highly popular retirement plan in the United States, known for its appealing benefits such as employer matching and tax advantages. Surprisingly, Germany also offers its own version of the 401k, known as the company pension or bAV (Betriebliche Altersvorsorge). In this blog post, we will explore whether obtaining a German 401k is a wise decision by considering the five crucial factors that significantly impact your retirement savings.

Understanding the origins of the term ‘401k’ is essential. The name is derived from the corresponding section in the IRS code that empowers US employers to establish a pension scheme with remarkable tax benefits. Similarly, in Germany, we refer to it as the company pension or bAV.

What are the benefits of a German 401k (company pension)?

When it comes to responsibly saving for retirement, the German government offers attractive incentives to ensure our financial well-being. As individuals, you can benefit from significant tax advantages through the Betriebliche Altersvorsorge (bAV), the company pension scheme. Let’s explore how these tax advantages can positively impact your finances, keeping in mind factors like current income, retirement income, and retirement location.

Currently earning 60.000€ annually, you’re subject to income tax, and church tax on this amount. Moreover, social security, health insurance, care insurance, unemployment insurance, and public pension contributions are additional financial obligations you face. However, there’s good news: by contributing 5.000€ to your company pension, your taxable income will decrease by the same amount, resulting in savings on taxes and social security payments related to this contribution.

Another advantage of the bAV is that your investments grow tax-free while they remain invested, further enhancing your retirement savings. However, it’s important to assess which pension type is best suited for your individual circumstances. Factors to consider include your current income, expected income during retirement, your intention to retire in Germany, and various other personal considerations.

What are the maximum benefits of a German 401k (company pension)?

Let’s dive into the contribution limits to ensure you make the most out of your money. In 2023, you have the opportunity to save up to 292€ per month with social security benefits. However, the real savings potential lies in the tax savings, where you can contribute up to 584€ per month, twice the amount allocated for Social Security. What does this mean for you exactly? Let’s examine a simulated payslip based on a 5.000€ monthly salary, keeping in mind that the numbers may vary by 10-20€ for every 1.000€ difference in salary.

For salaries up to 8.000€-9.000€, the results are remarkably similar. Without a company pension, you would pay 880€ in income tax and 987€ in Social Security contributions. However, by contributing the maximum amount for Social Security (€292 per month), your tax and Social Security payments decrease. This is because your Company pension contributions are tax-deductible, as we discussed earlier. While €292 goes into your account, your net contribution amounts to only €130, saving you approximately €75 in taxes and €50 in Social Security contributions.

Now, let’s take it a step further. If you contribute the maximum amount for tax and Social Security (€584 per month), your net contribution decreases to approximately €320. This is due to the substantial benefits you receive, including nearly €150 in tax benefits and approximately €40 in Social Security benefits. It’s a remarkable bonus of 55.4% on the left and 45.3% on the right (see payslip below). Considering these numbers, it becomes clear that German pensions are far from inadequate.

What is the employer match of a German 401k (company pension)?

You may have noticed that the numbers aren’t adding up just yet. Don’t worry, there is another crucial factor to consider: Factor 3, your employer match. When you save for social security with your company pension, your employer also enjoys savings since social security payments are split equally between you. However, your employer cannot save money with your company pension alone. Hence, a mandatory employer match of at least 15% comes into play.

In the example on the left, you pay 253€, but with the employer match, the total contribution increases to 292€, thanks to the additional 38€ contributed by your employer. The same principle applies on the right but with double the numbers. It’s important to note that 15% represents the minimum match your employer can provide, but they have the flexibility to offer a 50% or even a 100% match if they choose. Remember, your company sets the rules for their company pension, including the contribution percentage and the vesting period.

It’s essential to have a conversation with your employer to understand their specific contribution percentage and the terms of the vesting period. By being proactive and engaging with your employer, you can gain valuable insights into how your employer match works and ensure you’re making the most of your company pension contributions. Don’t hesitate to reach out and discover more about the contribution dynamics within your unique employment situation.

What are the investment options in a German 401k (company pension)?

Now that you have a solid understanding of what a company pension entails, it’s time to explore how you can invest your hard-earned money. As you may have already guessed, your employer holds the reins when it comes to your company pension, including the investment options available to you. Surprisingly, we’ve observed that nine out of ten company pensions lack any investment component. It seems that employers often overlook the potential of these pensions as a valuable employee benefit.

But that’s not all. Most, if not all, company pensions come with a high guarantee percentage. At first glance, it may seem appealing to have 80% or 90% of your contributions guaranteed at retirement age. However, this guarantee comes at a cost—a significantly low rate of return on your investments. In fact, only 10% or 20% of your contributions are typically invested in ETFs (Exchange-Traded Funds) and mutual funds, while the majority remains locked in the low-return guarantee portion.

Considering that many of you reading this are likely to retire in 20, 30, or even 40 years, it’s disheartening to see such a small portion of your money actually invested in the dynamic stock market. It’s a missed opportunity to capitalize on the growth potential that long-term investing can provide.

What are the downsides of a German 401k (company pension)?

Now, let’s shed light on the disadvantages of German company pensions that you truly deserve to know. Before diving in, we’ve discussed the vesting period, which can span several years, meaning you should only opt for a company pension if you’re absolutely certain about staying with your current employer for at least five years, preferably ten. Why? Because the transferability of your company pension to a new employer is uncertain. You won’t know if your new employer will accept your old company pension until you understand their specific pension scheme. Imagine large companies hiring hundreds of new employees monthly—accepting all old company pensions would quickly create chaos within their system. As a result, individuals often end up with four or five different company pensions throughout their careers, with each paying only a meager amount in retirement.

Moreover, the payout options for company pensions are subject to the rules set by your employer. Will you have the choice between a lump sum payment or a monthly pension? Can you decide or will the company make the decision for you? These questions highlight how the devil lies in the details when it comes to company pensions in Germany. This is precisely why private pensions often prove to be more advantageous than pensions tied to the government or your employer.

We support you in making the right decision that suits your needs. Contact us for advice on the path to a fulfilling retirement. Remember that the decisions you make today will determine your future. We wish everyone a happy retirement and prosperity.

401k in Germany: Company pension or bAV