German pension reform: Otto-in-limbo
Two significant developments have taken place in Germany as far as the legislative process is concerned this year.
The amendments reducing the state pension benefits have been enacted and Anglo-Saxon look-alike company pension funds (to be called Pensionsfonds) are to be allowed to absorb voluntary employee contributions to the new Personal Pension Arrangements (PEPAS for short) that are to be encouraged in order for German citizens to save for retirement in their own responsibility thereby reducing their reliance on the state benefit.
The game thus far: Having issued several drafts of the Social Security Code after a flurry of activity in the winter months, the ruling coalition presented its provisionally final draft at the end of January of this year, and then split the whole law into two parts: One requiring the consent of the upper house of parliament (the Bundesrat, currently dominated by the opposition parties and thus able to block legislation passed by the lower chamber of parliament, the Bundestag) and another not requiring consent. The reason why the first part requires the Bundesrat’s consent is that it impacts negatively on the federation’s finances, namely by reducing revenues (in the form of tax breaks and subsidies to be granted for the PEPAS and company retirement arrangements) and increasing benefit expenditure (a means-tested subsistence benefit is being proposed). The second part of the law does not require the upper chamber’s consent because its measures reduce benefit expenditure of the federation in the form of lower state pensions in future.
On March 21, the second part of the legislation was enacted.
This strategy is clearly intended to put the opposition under pressure to approve the counterbalancing tax cuts and social security benefits, since otherwise - the decrease in state pension now being in the statute books - the opposition will be seen to prevent the proposed “goodies” from coming to the benefit of the citizens. A situation no opposition particularly relishes. In addition, the strategy of the opposition has lost direction in particular because the new structure bears some similarities with that of the current opposition’s state pension reform enacted in the Kohl era.
The following four central aspects are now law. On paper, Otto’s (or ‘the man in the street’) net replacement ratio, which is net state pension to net active earnings prior to retirement, will reduce from currently about 70% to no less than 67% over the next 30 years and total employer and employee contributions are to remain below 22% of covered pay. If either of these limits is broken, remedial measures are required by the legislator.
Disability benefits will in future be harder to qualify for. Also, when granted, the amount is significantly less than hitherto. The normal spouse’s benefits will be reduced slightly in the long term. More importantly however, albeit only in the long term, the state spouse’s benefit will be subject to offsetting to the extent that own income, including any own company retirement income earnings of the surviving spouse is payable.
State pensions will no longer be indexed in future in line with modified average net actives’ earnings but rather in line with modified average gross actives’ earnings.
As a consequence first and foremost, the policy makers are expecting Otto to contribute voluntarily to the new PEPAS, thereby possibly partly substituting some of his current savings’ arrangements. If Otto is well advised, he will take advantage of the new PEPAS since the rosy calculations made of his state pension reducing from 70 to 67 % (in theory, 63 % in practice) will in actual fact result in benefits that are significantly lower.
The investment and insurance industry is working feverishly in the background to absorb Otto’s funds.
Otto will have to rethink his personal arrangements concerning disability benefits and, if young, his arrangements concerning his spouse’s benefits; hopefully his employer will help him with this project.
But part of the pension reform is still “in limbo”. This is the portion that has been deferred to a parliamentary mediation committee to sort out details and haggle over them. The main aspects – that are not expected to change significantly in the final version of the law now expected to pass the Bundesrat in early May – are:
p The social security authorities are to issue annual benefit statements; this is expected to kindle Otto’s interest in retirement matters materially. The means-tested subsistence state benefits is hailed by most observers as a necessary move, a safety net for Otto.
p Pensionsfonds are introduced as an additional fifth financing vehicle for company sponsored arrangements; book reserve and support fund arrangements will be tax-neutrally transferable to these new entities, contributions (up to fairly restrictive limits) to Pensionsfonds will be deductible expenses for the employer and not regarded as a benefit in kind to the employee, benefits must be delivered in the form of pensions, but these need not be indexed at all, the employer must provide a money-back-guarantee for PEPAS and employer contributions can be made flexibly (eg on a profit-related basis).
PEPAS can be made to Pensionsfonds or, alternatively, to life insurance contracts, investment funds or even for mortgage payments for home-ownership.
Even after the law has been enacted, the situation for Pensionsfonds remains largely unclear, since significant details governing them are to be defined by the Insurance Supervisory Authority and the Ministry of Finance.
For benefits from employer contributions, the vesting period is reduced from 10 to five years with the minimum age requirement decreasing from 35 to 30. Book reserve allocations and support fund contributions can be made as from age 28/29 in stead of from age 30/31.
Benefits arising from employee contributions become legally vested immediately rather than after the new 5-and-30-year rule; also, book reserve allocations can be made without regard to age and equal in amount to the full present value (no longer only the Teilwert).
Clearly, there are a whole range of questions surrounding the part of the law still not enacted. These issues are being discussed by interested observers. We shall not go into these here on the grounds that the law will certainly address some, but certainly not all of them.
Norbert Rössler and Alf Gohdes are with Buck Heissmann in Wiesbaden