Salary conversion under threat
To continue to safeguard German pension provision in the future, the general aim is to strengthen funded private and company pension schemes. In the field of company pensions, which in the past has been used fairly cautiously in Germany, the legislator has risen to the challenge by implementing significant changes in the Private Pension Plans Act. These alterations to the statutory company pension rules were mainly designed to improve access to company pension schemes. The most important measure was to grant individual employees the right to demand that their employers convert a portion of their gross salary into contributions to a company pension scheme. Employees are given the opportunity of enforcing the establishment a company pension scheme.
Most company pensions in Germany still are company-based schemes (Direktzusage), since the reserves that have to be set aside to service future pension claims do not represent wages or salaries that are subject to taxes or social security contributions. As a result, the commitment on the part of employers to provide a company pension is in part financed by savings with regard to tax and social security contributions. Deferred taxation of the pension payments in the disbursement phase can also result in tax advantages for employees.
However, under the other types of company pension - namely staff pension insurance, pension funds and direct insurance - the contributions paid by the employer legally represent salaries or wages on which tax and social security contributions are payable. To enhance the attractiveness of these pension forms, the Private Pension Plans Act to some extent exempted contributions to such schemes from taxes and social security insofar as the committed pension benefits are disbursed as a life-long annuity or under a payout plan combined with a life-long annuity. If these requirements are met, contributions exempted from social security contributions and wage tax up to a limit of 4% of the threshold for assessing contributions to the statutory pension system. For pension commitments granted from January 2005, an additional fixed amount of €1,800 is also tax-free. This means that in 2006 a single employee may invest contributions of up to €2,520 into a company pension scheme free of social security contributions and taxes (plus, if applicable, €1,800 tax-free). The benefits paid in the future from this funded company pension scheme are then fully taxable if the benefits are based on tax-free contributions. However, in the case of pensions based on salary conversion, the exemption from social security contributions has initially been limited to 31 December 2008.
Thanks to these measures, company pension schemes - those based on salary conversion - are becoming much more popular.
In recent months, a debate has developed on the intention to end the social security exemption for pension contributions under salary conversion schemes under the Private Pension Plans Act of 2001. According to recent press reports, the German employment minister Müntefering is sticking to plans to end this social security relief for salary conversion schemes in 2008. As a result of this exemption, the social insurance system lost some €0.8bn of contributions in 2004 alone. As the number of employees entitled to company pensions has now grown to nearly 20m, it is argued that no further support is required. A ministry spokesman has said that the question as to whether the relief will be terminated remains “open”. But, employer and insurance industry representatives are demanding an extension to the exemption for salary-conversion company pension contributions. Bert Rürup, the chairman of the German Council of Economic Experts, is of the same opinion. Critics fear the ending of the exemption for salary-conversion-financed contributions could represent a “serious setback” for company pensions.
Ultimately, the debate on limiting the period for exemption from social security contributions has to be seen in the context of changes in the financing of the statutory health insurance system. When the concession for salary conversion was introduced, company pension payments – like state pensions – were only subject to one-half of the health insurance contributions. This was changed two years later by the so-called Health Modernisation Act (Gesundheitsmodernisierungsgesetz) which provides that the full health insurance contribution is to be levied on company pension payments. Thus, if the exemption from social security ceases, employees will initially pay one-half of the health insurance contributions from the company pension contributions (the other half being paid by the employer). However, when they later receive their company pension, they will again pay the full health insurance contribution on the pension payment. In effect, such persons will pay twice into the health insurance system. At the same time, they are at a disadvantage compared to those who draw state pensions, since the latter only have to pay one-half of the health insurance contribution on their statutory pensions. For those on smaller incomes in particular, this is likely to result in considerable losses and make company pension schemes based on salary conversion for such employees much less attractive. However, it is precisely this group that will tend to be most affected by the expected cuts in the state pension.
By abolishing the social security contribution exemption for contributions to a company pension scheme financed by salary conversion, the German legislator is acting inconsistently with the goal of strengthening company pensions relative to the statutory pension system. Now that company pensions are less favourably treated in connection with health insurance contributions, converting salary into a company pension will become much less attractive. The reasons for ending the exemption – namely the amount of contributions lost to the social insurance system – do not appear convincing as company pension recipients already have to pay quite considerable contributions towards financing the health insurance system following the increase in health insurance contributions payable on company pensions. Subjecting company pensions to social security contributions both in the contribution phase and in the disbursement phase will at least partially nullify the intention of promoting company pension schemes and further dampen employees’ trust in company pension schemes. The growth in the market for external company pension schemes in the form of pension funds, staff pension insurance and direct insurance in Germany initiated by the changes in 2002 and 2005 will be unnecessarily endangered.
If the German legislator remains interested in strengthening company pensions on a sustained basis, it should seek ways to continue the social security exemption for company pensions financed by salary conversion beyond the year 2008. The difficulties of funding the German health insurance system cannot be resolved at the expense of company pensions.
Matthias Sandmaier is Rechtsanwalt Associate at Taylor Wessing in Hamburg