If an employee decides to build up a pension benefit within the third-pillar Riester funds, he or she has to sign an ‘Altersvorsorgevertrag’ (personal old age contract), which has to satisfy a set of detailed criteria to qualify for tax relief on the contributions paid.
Every entitled employee (those with mandatory pensions cover under state social security) who joins the new system gets an extra tax allowance. To qualify for the extra tax allowances, the employees have to allocate a fixed amount of their yearly gross incomes up to the contribution ceiling to social security to fund the additional pension benefit. From this year, employees can allocate an extra 1%, rising in steps to 4% in 2008. By 2008, the tax reduction will represent around e4,000 per couple with a contributions cap of approximately e52,800.
The system of direct payments for low- to medium-income savers that will compensate for the drop in state cover means that workers will be able to claim up to e154 by 2008 (e308 for couples) with an additional e185 per child for families.
Conscious of shifting the onus on to individuals – rarely a popular move by governments – the government prepared a safety net in the form of conditions to be fulfilled before savings products could qualify under the Riester pension legislation.
The first of these disappointed many who hoped for the introduction of pure DC products. Providers would have to include a capital guarantee of a client’s contributions in their fund offering, with a commitment to pay back contributions at age 60 or on retirement.
A further security measure demands that funds pay out the majority of the accumulated capital as an annuity or, in the case of mutual funds and bank products, provide the beneficiaries with a capital withdrawal plan.
Withdrawal of private pensions is possible at 60 and a 20% lump sum can be taken as long as a profit has been recorded over and above the contributions by at least 20%.
When the pensioner is 85 the plan reverts to a life annuity. There are caveats as to how policyholders can withdraw cash from the funds. Should policyholders wish to use their pot to buy a house, they can ‘borrow’ up to e50,000 of their pension contract and invest it in owner-occupied property. This sum taken out has to be repaid every month in equal instalments into the pension contract until the age of 65.
The net effect of the regulation is that for providers of the new third-pillar Riester funds (banks, insurance companies and independent distributors), the market has presented something of a quandary. It is commercially imperative to stay in, but difficult to make the Riester funds pay.
The new regulations have imposed significant procedural obligations on providers, such as involvement in the applications for the state pensions subsidies.
Another key requirement for the Riester products is that fees – both distribution and implementation costs – are to be distributed over at least 10 years.
Furthermore, providers are obliged to inform customers in writing before the contract is concluded about all costs associated with conclusion and execution of the contract.
Throw in the competitive fact that during the course of their contributions savers may switch between pension plans at three months notice and being a Riester provider is no easy ride.
For the saver, the government claims it has provided more freedom of choice. Providers argue, however, that the excessive distribution and administration costs could seriously affect possible fund returns.
For providers the challenge ahead is how to manage the necessary capital requirements and ensure long-term profitability.
Low annual charges set against the cost of administering low contribution, flexible schemes with a principal guarantee will not help in this respect.
Regulations could also lead providers to invest in low-risk assets. A number have called for the introduction of pure DC schemes whose performance is not adversely affected by guarantees.
Nonetheless, some feel that the third pillar got the jump on the second pillar when the legislation was signed at the start of the year. Complications with second pillar regulations meant that third pillar providers could effectively begin marketing products before any attractive occupational product had hit the market.
However, the reverse appears to have been the case. Take up of third-pillar Riester funds has been poor and if anything has stagnated in recent months. Since January this year only 2.2m Riester contracts have been signed out of a potential 30m eligible employees. More worryingly still, some 400,000 of these 2.2m contracts have already been cancelled.
Observers blame the muted market take-up on a mixture of the complicated regulatory framework with overly high expectations. One complication has been confusion surrounding minimum and maximum contribution rates and exit penalties.
Consumer groups have also warned employees that the new funds come with limited tax incentives and are inflexible.
Figures cited by the German mutual fund association, BVI, show that between October 2001 and March 2002, 71% of German employees said they had no intention of taking out a private Riester pension. The number intending to do so rose slightly from 21% to 23%, whilst figures for those having already signed up for Riester funds actually fell from 8% to 6%.
Employees appear to have surmised that the new sector-wide or company occupational schemes could offer a better deal and are waiting to see how they develop – bearing in mind that they have until the end of the year before they lose their right to special tax breaks.
Nevertheless, prospects for the third-pillar market as a whole look healthy. A recent ‘back of the envelope’ estimate by Goldman Sachs Global Equity Research team predicted that some e250bn could be held within private pensions by 2010 – equivalent to around 9% of GDP.

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