While almost all employees in Germany are obliged to contribute to a state pension, many people also choose to build their own retirement fund. The experts at digital insurance company Feather explain what private pension insurance is, why you might choose to take it out, and what you should look for in a private pension fund.
What is private retirement 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 advantages, 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 retirement plans in Germany, but the two main types are:
- Statutory retirement insurance, which is mandatory and is taken directly from your salary
- Private retirement plans, which are voluntary but highly recommended
While you should contribute to the public pension system, its retirement benefits can be limited, so relying solely on it will not guarantee a comfortable retirement. The government itself recommends supplementing the state scheme with a private pension to enhance financial security during your golden years.
Structure of a private retirement insurance plan
Private pension insurance in Germany is a retirement plan that provides tax advantages and flexibility in retirement. The way they work is fairly simple: you pay a portion of your income each month to get 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 cross between the two.
While you save, your contributions are invested in an insurance product. This is one of the key differences with a private pension plan: with the wide range of private pension insurance products on offer, you get a lot of choice in terms of how your money is invested, as well as optional extras such as disability insurance, survivor’s pension, or additional insurance Against accidents.
The “classic model” of private retirement security was to invest your contributions in bonds with fixed but low returns. The main drawback of this model is that the cost of maintaining the fund often exceeds the return. Nowadays, more and more private pension insurance funds are in ETFs (exchange-traded funds, which are a type of pooled investment securities that can contain all types of investments such as stocks, commodities and bonds). ETFs provide a diversified investment strategy with balanced risk and return, at a lower cost.
The role of ETFs in private pensions
If you are choosing an insurance product based on ETFs, there are two factors that the insurance company should take into account:
- Choosing ETFs
- The weight of investment distribution within it
The goal is to invest money in ETFs that achieve a good balance of risk, return, and fees, and then distribute the investment proportionately among those ETFs based on the amount of time remaining before retirement. You’ll likely have a slightly higher risk appetite at first, as any losses will be recouped over time, and then switch to a more conservative balance when you reach retirement.
ETFs are known for their low fees, making them a good option for anyone who wants to optimize their long-term investments, but you should still pay attention to the specific fees of the ETFs in your retirement plan portfolio. Ideally, it should be less than 0.5% of ETF fees.
Two good ETFs that strike the right balance are Government Bond ETFs and MSCI World.
When it comes to dividing the investment within ETFs, a good balance would be 75% in MSCI World and 25% in government bonds. As retirement approaches, ETFs should be rebalanced to a 50/50 distribution, which reduces volatility.
Private Retirement Plan Fee Structure
As mentioned above, some retirement plans have fees that exceed their returns, making them an ineffective retirement savings tool. When choosing a private pension plan, make sure you carefully consider its fees, as this could have a significant impact on your future retirement pot.
In general, the fee structure of a private retirement plan includes three components:
- Insurance fees
- ETF fees
- Fixed monthly fees
In Germany, the average rate for these three components is 2.7%, and you can often factor in paying the fee up front as well. Our recommendation is to find a plan that offers cumulative insurance and ETF fees of less than 1% and a fixed monthly fee of less than €2.
Upfront fees are an almost certain guarantee of poor returns. Make sure the plan you choose doesn’t charge an upfront fee.
Tax advantages of private retirement insurance
Unlike your contributions to statutory superannuation insurance, your contributions to private superannuation insurance are not tax deductible. This means you can’t deduct it from your tax return for tax savings every year.
However, this does not mean that there are no tax savings to be achieved through a private retirement plan. In fact, the German government wants to incentivize long-term saving, so you benefit from a sliding scale of tax saving, the longer you wait to cash out your pension.
Unlike a state pension plan, where tax-supported contributions are fully taxed during the payout phase, private pensions are taxed only on what is called the “income share” (ARTRAGSANTIL), which is determined by the age at which you start withdrawing your private pension. The later you retire, the lower your taxable share.
For example, a person who retires at age 50 is taxed at 30 percent of his or her private pension, while a person who retires at age 60 is taxed at 22 percent, and a person who retires at 65 is taxed at 18 percent. Just.
Keep in mind that withdrawing your money before you reach retirement age means you will lose these benefits.
So, having fees well below 1% is roughly the point at which the tax and fee savings will be negated – meaning it’s a good investment for any funds you plan to keep locked up for later – at least until retirement.
Flexibility and accessibility
As a final point: It’s a good idea to look for a private pension plan that offers a fair amount of flexibility. Since the future is difficult to predict, you want to be able to take your plan anywhere in the world, and be able to cancel it without incurring additional fees.
Furthermore, you may want the option to adjust your monthly payments, pause them, and make one-time payments. Instead of keeping this money locked up until you retire, you may need some extra flexibility around withdrawals, so you can withdraw a lump sum of money at any time, without having to pay additional fees.
Feather has built a proprietary pension plan designed to maximize your returns, with low fees and a balanced ETF profile. You can take your plan with you anywhere in the world and pause or cancel your plan at any time without any additional fees. It only takes five minutes to register with Feather online. Alternatively, you can schedule a call with a pension expert to get personalized insights into your retirement strategy at no cost or obligation.