The Pension System in Germany: How State and Private Pensions Work

Basic Principle – Pay-As-You-Go System

The German pension system works on a pay-as-you-go principle (Umlageverfahren). This means that today’s workers pay contributions which are used to fund the pensions of people who are already retired. Money is not saved up in a personal account for decades ahead. Instead, the contributions are used straight away to pay current pensions.

So, employees pay pension contributions from their salary, and the employer pays the same amount into the pension fund. This money is immediately used to pay those who are already retired. If there isn’t enough money for all pensioners, the government covers the shortfall from the state budget (see Germany’s spending on pensions and social insurance).

This model depends a lot on the population structure: if there are fewer people working and more people retired, the system comes under more pressure.

Structure of the Pension System: Three Levels in Germany

The German pension system has three levels. This means your income in retirement can come from several sources.

• Level 1 — State Pension (Gesetzliche Rente).
  This is the main part of the pension system. Most employees must pay into the state pension insurance. This pension is the main source of income for most retired people.
• Level 2 — Workplace Pension (Betriebliche Altersversorgung).
  This is an extra pension provided by your employer. The employer can pay all or part of the contributions, sometimes together with the employee. Not every company offers this, but it is quite common.
• Level 3 — Private Pension (Private Altersvorsorge).
  This means voluntary savings: insurance schemes, investments, private pension plans (like Riester or Rürup pensions), and personal savings.

The more sources of income a person has in retirement, the more financially secure they will be. State pension remains the foundation, but the other levels are becoming more and more important.

State Pension Insurance (gesetzliche Rentenversicherung)

State pension insurance is the foundation of Germany’s pension system. Most old-age, disability, and survivor’s pensions are paid from this system.

For most employees, it is compulsory to take part in the state pension insurance scheme. Pension contributions are taken directly from the worker’s salary. The employer pays an equal share into the scheme.

The contribution rate for pension insurance is 18.6% of the employee’s salary, with half paid by the employee and half by the employer.

Contributions are paid into the system and used straight away to fund current pensions. Each insured person also collects pension points.

The state pension insurance system is managed by Deutsche Rentenversicherung – the government pension agency. It keeps track of your insurance periods, awards points, and calculates your future pension.

Even if someone is not working for a while, certain periods can still count towards their pension – for example, when raising children or caring for relatives. You can find more information about the average pension amount, the standard pension amount, and the minimum pension in Germany on separate pages of our website.

Workplace and Private Pensions

As mentioned above, in addition to the state pension, there are extra ways to save for retirement in Germany. These help increase your income in old age and reduce your reliance on just the state system.

The workplace pension (Betriebsrente) is an extra pension provided by your employer.

With this scheme, your employer can pay all or part of your pension contributions. The employee can also choose to put some of their salary into this scheme. The details depend on your company and which model they use.

The private pension (private Altersvorsorge) means saving up for retirement yourself. This includes:

• special private pension plans (such as Riester or Rürup);
• endowment life insurance policies;
• investments, funds, property;
• personal savings.

The government sometimes offers tax breaks or subsidies to encourage private saving. (See also benefits for pensioners)

Challenges Facing the Pension System

The German pension system faces serious demographic and financial challenges. The main reason is changes in the population structure.

• An ageing population. People live longer, so pensions have to be paid for more years.
• Fewer workers – more pensioners. The number of people paying into the system is growing more slowly than the number of people receiving pensions.
• More pressure on the state budget. The government has to spend more tax money to support the pension system.
• Raising the retirement age. This is one way to help keep the system stable.

Because the system works on a pay-as-you-go basis, its stability depends directly on how many people are working compared to how many are retired. This is why there is now more focus on extra savings and reforms to make sure pensions stay secure in future.