What is German private pension insurance and should you have it?
While virtually all employees in Germany are obliged to contribute to a state pension, many people also choose to build up their own private retirement pot. The experts at digital insurance company Feather explain what private pension insurance is, why you might choose to have it, and what you should be looking for in a private pension fund.
What is private pension insurance, and is it the right choice for you? Let's dive into the details of private pension insurance in Germany, looking at its structure, tax benefits, investment approach, and why it might be a good addition to your retirement strategy.
Understanding private pension insurance in Germany
There are several different types of pension plans in Germany, but the main two are:
Statutory pension insurance, which is compulsory and taken directly from your salary
Private pension plans, which are voluntary but highly recommended
While you are required to contribute to the public pension scheme, its retirement benefits can be limited, and so relying solely on it will not secure a comfortable retirement. The government itself recommends complementing the state scheme with a private pension to enhance financial security during your golden years.
The structure of a private pension insurance plan
Private pension insurance in Germany is a retirement plan that offers tax advantages and flexibility in retirement. The way they work is fairly simple: you pay in a portion of your income every month to receive an additional pension when you retire. This payout can be received either as a one-off lump sum, a monthly pension for the rest of your life, or a crossover of the two.
While you’re saving, your contributions are invested in an insurance product. This is one of the key differences with a private pension plan: with a wide variety of private pension insurance products on offer, you get a lot of choices as to how your funds are invested, as well as optional add-ons like disability insurance, a survivor’s pension, or additional accident insurance.
The “classic model” of private pension insurance was to invest your contributions in bonds with steady but low yields. The major drawback with this model is that often the cost of maintaining the fund would outpace the return. Nowadays, more and more private pension insurance funds are based in ETFs (Exchange-Traded Funds, a type of pooled investment security that can contain all types of investments like stocks, commodities and bonds). ETFs provide a diversified and risk-return-balanced investment strategy, at a lower cost.
The role of ETFs in a private pension
If you are opting for an insurance product based on ETFs, there are two factors you want your insurer to consider:
The choice of ETFs
The weight of investment distribution within them
The aim is to invest the money into ETFs that strike a good balance between risk, return, and fees, then proportionally distribute the investment between these ETFs based on how much time is left before you retire. You’ll probably have a slightly higher appetite for risk in the beginning, as any losses will be recouped over time, then switch to a more conservative balance when you hit retirement.
ETFs are renowned for their low fees, making them a good choice for anyone who wants to optimise their long-term investments, but you should still pay attention to the specific fees of the ETFs in your pension plan portfolio. Ideally, you should be below 0,5% of ETF fees.
Two good ETFs that strike the right balance are MSCI World and government bonds ETFs.
When it comes to the split of investment within the ETFs, a good balance would be 75% in MSCI World and 25% in government bonds. As retirement approaches, the ETFs should be rebalanced to a 50 / 50 distribution, reducing volatility.
The fee structure of a private pension plan
As mentioned above, some pension plans have fees that outstrip their returns, making them an ineffective instrument for retirement savings. When choosing a private pension plan, make sure you carefully consider their fees, as this could have a big impact on your future retirement pot.
Broadly speaking, the fee structure for a private pension plan includes three components:
- Fees for insurance
- Fees for ETFs
- A fixed monthly fee
In Germany, the average rate for these three components is 2,7%, and you can often reckon with paying upfront fees as well. Our recommendation is to find a plan that offers cumulative fees for insurance and ETFs below 1% and a fixed monthly fee of less than 2 euros.
Upfront fees are an almost certain guarantee for poor returns. Make sure that the plan you choose does not charge upfront fees.
Tax benefits for private pension insurance
Unlike your contributions to statutory pension insurance, your private pension insurance contributions are not tax-deductible. This means you cannot deduct them on your tax return to make tax savings each year.
However, that doesn’t mean there aren’t tax savings to be made with a private pension plan. Indeed, the German government wants to incentivise long-term saving, and so you benefit from a sliding scale of tax savings, the longer you wait to cash out your private pension pot.
Unlike the state pension plan, in which tax-subsidised contributions are taxed in full during the payout phase, private pensions are only taxed on the so-called “income share” (Ertragsanteil), which is determined by the age at which you start to draw your private pension. The later you retire, the lower the taxable share.
Someone who retires at 50, for instance, is taxed on 30 percent of their private pension, whereas someone who retires at 60 is taxed on 22 percent, and someone who retires at 65 is taxed on just 18 percent.
Keep in mind that withdrawing your funds before you reach retirement age will mean you forfeit these advantages.
Therefore, having fees well below 1% is roughly the point at which the tax savings and the fees would cancel out - meaning it is a good investment for any funds you plan on keeping locked up for later - at least until retirement.
Flexibility and accessibility
And as one final point: it’s worth looking for a private pension plan that offers a good amount of flexibility. Since it’s hard to predict the future, you want to be able to take your plan anywhere in the world, and be able to cancel it without incurring extra fees.
On top of this, you might want the option to adjust your monthly payments, temporarily pause them, and make one-off payments. Rather than keeping that money locked up until you retire, you might want some additional flexibility on withdrawals, so you can withdraw a lump sum of money at any time, without having to pay extra charges.
Feather has built a private pension plan that is designed to maximise your return, with low fees and a balanced profile of ETFs. You can take your plan with you anywhere in the world and pause or cancel your plan at any time with no extra fees. Signing up with Feather takes just five minutes online. Alternatively, you can schedule a call with one of their pension experts to gain personalised insights into your retirement strategy at no cost and no commitment.