Pension System in Germany Explained
Germany's pension system is considered to be very complex. We will help you understand pensions in Germany by dividing the German pension system in 3 levels.
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Many expats living in Germany find the German pension system really complex. It is easy to figure out that employees in Germany pay 18,6% of their gross salary into the German public pension (Deutsche Rentenversicherung). But what are you getting for that money? And are there other pensions in Germany?
The German public pension is just one of many pensions in Germany. The German pension system is basically built-in three different levels and every level works differently when it comes to tax benefits, government bonuses, and possibilities in the payout phase (e.g. mandatory monthly pension or freedom to have a lumpsum payment).
Find out everything about the German pension system in this article.
Pension Level 1: German Public Pension
The German public pension (Deutsche Rentenversicherung) is part of the German social security system. Meaning, all employees in Germany have to pay into public pension straight from their payslip (in 2022 exactly 18,6% of up to 85.200€ gross salary). That is mandatory for all employees with no way to change that. Your contributions are split 50/50 with your employer.
What are you getting for your contributions? Public pension points. That is how the government calculates your future pension payment. As the German public pension is a generational contract (the current workforce pays for the pension of the previous generation), whatever you contribute is immediately paid out to the current retirees and not invested.
The average German salary (40.551€ gross in 2021) will reward you with 1 public pension point. 1,5x the average salary will reward you with 1,5 public pension points & 81.102€ gross salary will earn you 2 public pension points. 2 public pension points is the maximum anyone can earn every year, even employees with a very high salary.
At retirement age, the German public pension will sum up all your points and pay you roughly 36€/month in gross pension for every public pension point that you accumulated over your career of working in Germany. Gross pension because you have to pay income tax, health insurance (public or private) as well as long-term care insurance.
Doing the math, 40.551€ gross salary will earn you 12.240€ in public pension after working in Germany for 30 years. That makes the German public pension one of the worst pension schemes among OECD countries. And that is also why the German public pension recommends in the letter they send you every year that you should get additional pensions.
Pension Level 1: Base Pension (Rürup)
Similarities between public pension & base pension:
- The payout from both pensions has to be a monthly pension from the moment you retire until you pass away. One-time withdrawals are not possible.
- Contributions are tax-deductible and will decrease your taxable income. Maximum contributions in 2023 are 28.528€/year for singles & 57.056€/year for married couples.
Differences between public pension & base pension:
- You can choose your monthly contribution to the base pension. You can also change that amount basically anytime and also stop contributing completely.
- Your contributions to your base pension can be invested in ETFs and mutual funds (depending on the pension company you choose and the exact base pension).
Pension Level 2: Riester Pension & Company Pension
The German pension system level 2 has probably the most prominent pensions known among the expat community living in Germany: The Riester pension & the company pension. Both pensions in level 2 are taxed like pensions in level 1. As contributions are tax-deductible, all payouts are generally subject to taxation.
The difference is that pensions level 2 will reward you with benefits. You will receive them either from your employer or the government directly:
- The company pension will earn you a mandatory bonus of at least 15% because your employer saves social security contributions when you save money from your payslip into your company pension.
- The Riester pension will earn you a yearly bonus of 175€ for every adult that is enrolled in a Riester pension contract. Every child will earn the pension owner an additional 300€ yearly bonus.
Depending on the pension provider and the exact pension scheme you should be able to invest your contributions in ETFs and mutual funds. One-time payouts might also be possible when you are retired. Most Riester pensions allow taking out 30% of all savings as a one-time payout while the other 70% are paid out as a monthly pension until you pass away.
Pension Level 3: Private Pensions
Pensions in level 3 are all types of private pensions that do not fit into the prior two levels of the German pension system. The main difference between pensions in level 1 + level 2 vs pensions in level 3 is taxation. Level 1 + level 2 offer tax benefits in the contribution phase. Pension level 3 offers tax benefits in the payout phase in retirement.
Pension level 3 offers no tax benefits while you contribute. Therefore, you have maximum freedom over how your invested money is returned to you. You can choose freely if you would like to have a monthly pension in retirement (annuity) or a one-time payout of your total savings (the best is after age 62 for maximum tax benefits).
Because of that one-time payout option pensions level 3 work very well in combination with real estate (both for rental properties as an investment and for homes as self-use). German banks love equity in general – and especially when that equity is invested in pensions level 3 that are meant to be for the long-term. That is why banks will reward you with a better interest as soon as you finance your property with them. (What is better, renting or buying a home in Germany? Find out here.)
Pension Level 3: Pan-European Personal Pension Product (PEPP)
Starting in March 2022 the European Union wants to introduce a new pension to the German pension level 3: The Pan-European personal pension product (in short: PEPP). PEPP is supposed to help more than 240 million people living in the EU to save for their retirement. Therefore, PEPP is a European pension and not just a German pension.
Although there are no details released on PEPP yet, the new European pension will offer various incentives:
- Fully digital application process combined with mandatory professional financial advice
- Flexibility when changing your country of residence within the European Union
- Flexibility to change from one PEPP provider to another PEPP provider at any time
- Transparent fees and costs that are capped at 1% of the invested amount per year
- 6 different investment options + Basic PEPP that will return at least your invested capital
The new European pension PEPP has a lot of potential to support Europeans to save efficiently for their retirement. Especially for the expat community that wants to change residency within the EU. We will see when we get to know more details on PEPP and how soon the pension will be available to get.
Which German Pension Is Best For You?
Hopefully, this article is helpful to you when trying to understand the German pension system and its three different pension levels.
If you are not sure which pension is best for you and what combination is most efficient for your individual financial situation and the goals you have, feel free to book a free meeting with us right here and we will help you to secure your very own retirement.