Pension Reform in Germany: Introducing a multi-pillar system to cope with demographic change

1. Pension Reform in Germany: Introducing a multi-pillar system to cope with demographic change Dr. Anette Reil-Held Seminar on Pension Reform Instituto de Empresa, Madrid, July 19th, 2010

2. Many Few The motivation for a multipillar system Problem 1: Babyboom and Babybust „Problem 2:“ Increase of life-expectancy Solution 2: Increase retirement age Solution 1: Partial Funding 1950 2001 2050 Source: 11th Population Projection by the Federal Statistical Office

3. The Riester-Reform 2001: a Paradigm Shift towards a Multipillar System Three aims: • Sustainable contribution rates (below 20% until 2020, below 22% until 2030) • Secure long-term stability of pension levels: net replacement rate must stay above 67 % • Spread of supplementary private pension savings to compensate the lower pension level (individual and occupational pension plans) Instruments New Pension formula Retirement Saving Incentives Minimum Pension (means tested)

4. The Reform Package on the whole „Sustainability Commission“ in 2003 New set of assumptions about future demographic and economic development revealed that Riester Goals cannot be met. Paradigm shift: think in financial possibilities. Two main reform elements Introduce sustainability factor in pension formula(Gross Pension Level will further decline from 48% in 2000 to 41% in 2040) Increase retirement age from 65 to 67

5. The Framework of the „Riester-Pension“ Goal: Build up supplementary, voluntary, funded old-age provision assuring an overall level of provision of 70 % (like pre-reform) Subsidies in form of flat-rate benefits and tax relief (deferred taxation principle) In general, everyone is eligible who is affected by the reduction in public pension benefits (employees, wage compensation beneficiaries, and also spouses) Pension plans need to be “certified”, criteria are e.g: Regular saving payments Provider must guarantee a strictly positive rate of return Pension benefits must be disbursed as certain forms of lifelong annuities Administrative and marketing costs must be spread over initially 10, now 5 years 5

6. Sponsoring by income and family status State Spon-soring in % of savings Gross income per year Single Single, one child Married, single earner, no child Married, single earner, two children Saving incentives of Riester-pensions /300 Source: Gasche (2008)

7. Does it work? Development of Riester Pensions Riester Pensions in Mio. Building loan contract 13.6 Investment fund plans 10.8 Bank saving plans 5.6 1.4 Insurance plans 2001 1/2010

8. „Take-off“ after Amendment (mostly the „Old-Age Retirement Income Act“ in 2005) • Simplification of the regulation, e.g. • Introduction of a permanent subsidy appliance procedure • 30% of accumulated capital can be paid as one-off payment • Stronger sales incentives: aquisition costs have to be spread over 5 instead of 10 years • Introduction of a new tax-favoured product „Basic pension“ or „Rürup Pension“ which aims at high earners and self-employed • Tax advantage for whole life-insurance was abolished • Introduction of gender neutral tariffs for Riester Pensions

9. Does it work? Riester Pensions by number of children 2 children 3+ children No child 1 child Source: Coppola and Reil-Held (2010) 9

10. Does it work? Riester Pensions by income 2. Quintile 1. Quintile 3. Quintile 4. Quintile 5. Quintile ... of the disposable household income distribution Source: Coppola and Reil-Held (2010) 10

11. Alternative Approach: Income structure of flat-rate benefits recipients Source: Rieckhoff and Stolz (2009)

12. Does it work?Will the Riester Pension close the gap? % of avg. I ncome Pension gap Riester pension 2010 2020 2030 Year of entry into retirement Source: Börsch-Supan and Gasche (2010) 12

13. Conclusion • Riester Pensions „took off“ after the complexity of the regulation was reduced. • Nowadays about one third of all eligible persons has got a Riester Pension Plan. Good or bad? What is a realistic target? • Riester Pensions are very popular among parents. • Lower income groups are harder to reach. • 4% of gross income as retirement savings are (still) just enough to compensate for the reduction in the public pension level. • The higher retirement age contributes significantly to close the gap.

14. BACKUP

15. Promotion of occupational pensions with Riester-Reform Right to convert part of the salary into contributions to pension plans, either Gross pay: tax deductible and exempt from social security contributions (up to 4% of upper earnings threshold) Net pay: Riester incentives apply New investment vehicle: Pension funds Succesful: coverage increases from 35 to 46% of private sector employees