Aba: DC and auto-enrolment, German style
Verena Menne and Klaus Stiefermann outline concerns about planned reforms to introduce defined contribution pensions to Germany
Occupational pensions are an important if still insufficient part of the retirement provision of German employees – and their importance is growing.
At the end of 2015, 18m employees were active members of an occupational pension scheme, almost 60% of those employed and subject to social insurance contributions. While this figure has risen 30% since 2001, the increase in coverage has stagnated in recent years. The government therefore considers it necessary to try and increase coverage to ensure that more employees benefit from higher pensions when they retire.
The minister for social affairs, Andrea Nahles, a Social Democrat, sees a particular need for action for those employed in small and medium-sized enterprises, and for those on low incomes. In many sectors, only 28% of those working in companies with fewer than 10 employees are members of an occupational pension scheme.
About half of those earning less than €1,500 per month neither have an active occupational pension membership nor a Riester pension – a personal pension benefiting from tax incentives and supplemented by the government.
And even in bigger companies there is room for improvement – both an increase in coverage and in employer and employee contributions by those already covered would be desirable.
Employers shy away from occupational pensions because of the administrative burden and related costs, and, importantly, the risk that comes with the liability to make sure that the pension promise is met. This is where the current reform comes in: from 2018 onwards, it should be possible to offer defined contribution (DC) pensions in Germany.
New incentives coupled with the option to use auto-enrolment in pay agreements are intended to increase coverage for those on low incomes. Overall, the government envisages that the social partners will play an important role in strengthening occupational pension provision.
The reform: structural innovation
As it stands, it is not possible to make a DC promise under occupational pensions law in Germany. To benefit from the tax framework for occupational pensions, a guarantee has to be included and labour law stipulates that the employer has to make up any gap in case of a shortfall. In terms of the type of pension promise, the new law will be revolutionary as it will make it possible to give a DC promise.
However, to be able to choose this option, the social partners have to be involved. This means that while it will be ‘pay and forget’ for the employer, a framework will have to be built around it to protect members and beneficiaries.
The draft of the law prevents guarantees for this type of DC pension – if this option is chosen, it will not be permitted for the employer, provider, institution or anyone else to give the members a guarantee. The obvious advantage of guarantees is security for the beneficiaries, but this comes at a price, particularly while interest rates remain low.
Since the new DC framework will be introduced on top of existing options, the social partners can decide what they consider best – a lower but secure occupational pension backed by the employer, or a potentially higher but more volatile occupational pension without any guarantees.
However, this ban on guarantees is still being discussed. While the government seems set on the issue, the upper house of parliament (Bundesrat) has called for a softening of the ban, which would mostly benefit insurers providing Direktversicherungen, an existing occupational pensions vehicle. It remains to be seen what the law will eventually stipulate in this regard.
It is important to bear in mind that if the ban on guarantees is retained, it will still be possible to use existing pension vehicles and types of promises to offer an occupational pension including a guarantee if those in charge wish to do so.
The second important innovation of the proposed law is auto-enrolment. The new law will make it legally watertight for employers and social partners to automatically enrol employees in a pension plan with the ability to opt out of the system within a certain period of time.
The law will set standards for those wishing to use auto-enrolment in terms of the period required between the offer of the employer and the first contribution (at least three months) and the information the offer has to include.
Since both of these structural innovations are additional ways of providing an occupational pension rather than mandatory measures, their success in increasing coverage will depend on whether they are used by the social partners.
The new law seeks to extend the existing EET system (§3 Nr. 63 EStG), under which contributions and investment returns are exempt and benefits are taxed (exempt-exempt-taxed).
The maximum tax-free contributions are increased slightly to 8% of the income ceiling of the statutory pension (the assessment ceiling – Beitragsbemessungsgrenze – for 2017 this is €76,200 annually). The current limit is 4% with an additional €1,800 tax free but on which social insurance contribution have to be paid. This means that the current maximum annual tax-free amount of €4,848 would be increased to €5,343.
Under the previous system, only 4% remains free from social insurance contributions. In the pay-out phase of the occupational pension, statutory health and long-term care insurance contributions are levied.
As a secondary measure, the EET system becomes flexible. Tax relief in the accumulation phase is currently granted annually and lost at the end of the year if not used. However, the draft includes a provision allowing a partial or full top-up in case the employment relationship is suspended, as is the case when someone is posted abroad or takes parental leave.
A more generous tax framework generally benefits those on higher incomes. Since one group with low occupational pension coverage is those on low incomes, the law will include support and incentives for this group.
Employers of those with a gross income of up to €2,000 a month (regardless of whether this is earned through full-time or part-time work) will be offered a tax incentive of 30% of employer contributions (to a maximum of €144) to contribute to their employees’ occupational pensions. This support in the accumulation phase is complemented by the abolition of disincentives in the decumulation phase – the new law will introduce an allowance so that low-income pensioners can receive their occupational pension without having it deducted from the minimum income provided by the state.
An ambitious target
Despite more than two years of preparation by the relevant ministries, the period of time envisaged for the legislative process is ambitious.
At the end of March, the committee hearings in the Bundestag will begin, after which the Bundestag and Bundesrat will have to adopt the text. The intention is to complete this process before summer recess, ahead of the general election in September.
If all goes to plan, 2018 could already see employees being enrolled in pension schemes using the new rules.
Verena Menne is a policy adviser at the German Occupational Pensions Association, and Klaus Stiefermann is the organisations’ chief executive