German Pensions Level 3
German pensions level 3 are as flexible as it gets and that's why they might be the perfect pension level for expats. You will be surprised by how cool pensions can be.
Pensions Inside Level 3 Of The German Pension System
German private pensions level 3 are by far the most flexible way to save money for your retirement. You can choose to get a life-long monthly pension in retirement (in Germany or outside of Germany), a lump sum payment, or use your pension level 3 as collateral when purchasing real estate (as a home or as an investment property).
German pensions level 3 might very well surprise you with how cool pensions can really be given all their advantages. Given that nothing in this world is perfect, there are also no universally best pensions for everyone. That is why private pensions level 3 also have some disadvantages. If you do not like the disadvantages, other German pensions in level 1 (e.g. public pension as well as base pension) or German pensions in level 2 (e.g. Riester pension or company pension) may be better for your personal financial situation.
We know that the German pension market can seem quite overwhelming and confusing at first given pensions are also quite complex financial products. If our pension articles and our pension videos on our YouTube channel are not enough to help you choose the right pension for your personal financial situation, feel free to book a free meeting with us or to test us on WhatsApp if we can help any further.
Which pensions are inside the third and last German pension level 3? Basically all kinds of pensions that do not fit into level 1 or level 2 of the German pension system.
While the prior 2 levels can be defined with specific pensions (e.g. Riester pension), this is not the case in this German pension level. That is why all pensions in German pension level 3 are simply called “private pensions.”
After working on a European pension for many years, European governments planned to introduce a different type of pension into level 3 in March of 2022: the Pan European Personal Pension Product, or short PEPP.
As of writing this article, we have still no further information on PEPP and when the pension will officially be introduced to the public.
Advantages Of German Pensions Level 3
Private pensions level 3 allow you to invest your money in ETFs & mutual funds (at least good pension level 3 schemes). That is probably also the reason why many people compare a pension level 3 with a regular investment account. That comparison is a classical apple vs oranges comparison as there are major differences between the two financial products:
- When buying, selling, or switching an ETF or mutual fund you have to pay fees in an investment account (free in pensions).
- Selling an ETF or mutual fund with a profit is subject to capital gains tax in an investment account. Pensions shield you from taxes.
- Since 2019 ETFs & mutual funds in investment accounts are taxed every year with the so-called “Vorabpauschale” (not in pensions).
With the new investment reform of the European Union, a preliminary tax (“Vorabpauschale”) was introduced for investment funds in European investment accounts. As governments inside the EU were tired of waiting for their tax money until you might eventually sell your investment funds in 20 or 40 years. Given this new investment tax reform, the only way as of today to invest in ETFs and mutual funds with tax-deferred growth in Germany is to save inside pensions. All other forms of investing will enforce the preliminary investment tax.
As interest rates around the world are currently low and inflation is eating away at your hard-earned savings, it is generally speaking a good idea to invest your money. If you would like to invest a little saver, you can choose a pension plan with a guaranteed payout. Whichever pension company you are choosing, they will invest your contributions very safely so they can guarantee you a minimum payout in form of a life-long monthly pension or a lump-sum payment. Even if your investments are down. As the guaranteed pension interest is currently set to 0,9%/year by the German Ministry of Finance, you might want to keep your guarantee percentage as low as possible.
While German pensions level 1 and pensions level 2 offer tax-deductible contributions (at least up to a certain amount every year), private pensions level 3 reward you with tax benefits in the payout phase. This happens if you are older than 62 years of age (the earliest possible retirement age allowed by the German government) and paid into your private pension level 3 for at least 12 years. The exact tax benefits depend on the payout age and the payout model and look like this:
- Lump-sum payout: Given the two requirements mentioned above, only half of your profits from your private pension level 3 will be taxed. If you saved 60.000€ in your pension and managed to gain 40.000€ in capital gains (100.000€ total pension value), only half of your capital gains (=20.000€) will be taxed with your personal tax rate.
- Monthly pension: The longer you wait to retire, the lower your tax rate will be as the tax percentage when receiving a monthly pension is depending on your age (e.g. 21% with age 62, 18% with age 65, 15% with age 69). When receiving your monthly pension at age 67, only 17% of your monthly pension payment will be subject to taxation (e.g. 17€ of 100€ pension will be taxed with your personal tax rate of up to 45%, 83€ will be paid out to you completely tax-free).
If you decide to receive a monthly payout from your private pension level 3, you are also protecting yourself against the risk of longevity. As of today, life expectancy in Germany is 81 years of age, meaning you would live statistically 14 years in retirement from age 67 to age 81. When you are 81 years of age, life expectancy might be 85 or 90. Nobody knows how long you are going to live and while investments can run out of money, pensions cannot. If you live longer than expected, the pension company will still have to pay you a life-long pension every single month.
You can also choose freely to receive a lump sum instead of a monthly pension. That is only possible in private pensions level 3 and not in any other German pension level. Pensions level 1 offers no lump sum option and has to be returned in form of a life-long monthly pension. Riester pensions level 2 offers at least a 30% lump sum option while requiring that the remaining 70% have to be returned in form of a monthly pension payment.
This basically sums up the entire advantages of private pensions level 3 in Germany: they are as flexible as it gets and that is also why they are suiting the flexible expat lifestyle probably the best. As no German pension is perfect, there are also some disadvantages as well…
“Depending on the age that you like to retire, private pensions level 3 can save you tens of thousands of Euros in taxes compared to regular investment accounts thanks to tax-deferred growth.”
Disadvantages Of German Pensions Level 3
The flexibility, which is the major unique selling point for private pensions level 3, decreases other benefits when comparing private pensions level 3 with German pensions in level 1 or level 2. Even though private pensions level 3 offer various tax benefits during the payout phase including tax-free growth of your investments, private pensions level 3 offers no tax benefits while contributing. At least in this regard pensions level 3 can be compared to regular investment accounts as you have to save from your net income.
In some pension plans level 3, the pension company that you are choosing will select the investments for you. In this case, you have absolutely no saying in how your money will be invested as the pension company will choose completely on its own. Historically speaking, very few pension companies have been successful investors so you are probably better off selecting your investments yourself according to your personal risk tolerance.
When choosing the right private pension level 3 plan for yourself make sure to pay attention to your pension factor (“Rentenfaktor” in German). As some pension companies only offer a low pension factor, your possible payout (either as a monthly pension or lump sum) in retirement will also be quite low. And if you selected a pension plan that includes a certain guarantee on your contributions, make sure to also check that your guaranteed pension factor is high.
As the advantages of private pension level 3 in Germany can be summarized with flexibility, the disadvantages can be summarized as bad pension companies or bad pension plans. If you are not sure which pension company or pension plan to choose and would like some help from an independent expert to scan what is available on the German market, we are happy to help you in a meeting or on WhatsApp.
Like the advantages can be summarized with flexibility, the disadvantages can be summarized as bad pension companies offering bad private pension level 3 schemes. So please seek help from an independent expert who knows the German pension market. This will help you to leverage the advantages and decrease the disadvantages. If you want us to help, feel free to reach out.
Conclusion: Who Should Get German Pensions Level 3?
After discussing the advantages and disadvantages of private pensions level 3 it is obvious that this is probably the correct pension level for some people, and other people are better off with different financial products. To give you some inspiration, here are 3 typical expat scenarios in which a private pension level 3 can make the most sense:
- If you like to keep your finances as flexible as your life, a pension level 3 might just be for you. While other pensions in level 1 or level 2 require a considerable amount of commitment, pensions in level 3 can be terminated if you would like to leave Germany again. And as soon as the PEPP pension is introduced you can also transfer that pension across the European Union when moving around.
- Most expats come to Germany to study or for work reasons. Most expats also do not know quite yet how long they would like to stay in Germany. If you know that you would like to stay until retirement and then move back to spend your well-deserved retirement back in your home country, a private pension level 3 might be the perfect savings tool, especially from a tax perspective (also depending on if your home country has a double taxation agreement with Germany).
- If you would like to buy a property in the future in Germany, your private pension level 3 will work very well as collateral for real estate. While the Riester pension level 2 works only as collateral for your home, pension level 3 work just as well for investment properties. As most banks accept pensions level 3 as collateral, it is a lot more efficient to save & invest your money inside a pension instead of giving it to the bank.
In case none of these scenarios is describing your life, you can still secure a private pension level 3 for yourself if you are looking to save for your very own retirement (wherever it may be) as flexibly as possible. Just remember that there is no perfect pension anyway when searching for the right pension level, pension company, or pension scheme for you. And if private pensions level 3 are not right for you, maybe pensions from German pension level 1 or German pension level 2 are better for you.
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