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:

1. When buying, selling, or switching an ETF or mutual fund you have to pay fees in an investment account (free in pensions).
2. Selling an ETF or mutual fund with a profit is subject to capital gains tax in an investment account. Pensions shield you from taxes.
3. 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…