Mannheim Research Institute for the Economics of Aging www.mea.uni-mannheim.de

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

The motivation for a multipillar system

1950 2001 2050

Source: 11th Population Projection by the Federal Statistical Office

Problem 1: Babyboom and Babybust

„Problem 2:“ Increase of life-expectancy

Solution 2:

Increase retirement

age

Many

Few

Solution 1:

Partial Funding

3

The Riester-Reform 2001: a Paradigm Shift towards a Multipillar System

Three aims:

1. Sustainable contribution rates (below 20% until 2020, below 22% until 2030)

2. Secure long-term stability of pension levels: net replacement rate must stay above 67 %

3. Spread of supplementary private pension savings to compensate the lower pension level (individual and occupational pension plans)

New Pension formula

Retirement Saving Incentives

Minimum Pension (means tested)

Instruments

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

55

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

6

From ... on

Savings rate

Basic subsidy

Euro/year

Child subsidy

Euro/year

Tax deductible maximum

2002 1 % 38 46 525 2004 2 % 76 92 1,050 2006 3 % 114 138 1,575 2008 4 % 154 185 2,100

Saving incentives of Riester-pensions

/300

Sponsoring by income and family status

Gross income per yearSingle

Married, single earner, no child Married, single earner, two children

Single, one child

State Spon-soring in % of savings

Source: Gasche (2008)

Does it work? Development of Riester Pensions

1.4

13.6

5.6

10.8

Riester Pensions in Mio.

Insurance plans

Bank saving plans

Investment fund plans

Building loan contract

2001 1/2010

8

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

„Take-off“ after Amendment (mostly the „Old-Age Retirement Income Act“ in 2005)

99

Does it work? Riester Pensions by number of children

Source: Coppola and Reil-Held (2010)

4.88.5

12.8

17.9

22.226.0

8.1

12.3

19.1

25.8

36.332.6

11.9

21.6

29.6

40.4

45.3

49.2

15.0

23.3

38.2

58.159.9

56.9

010

%20

%30

%40

%50

%60

%70

%A

ntei

l der

Hau

shal

te

Kein Kind 1 Kind 2 Kinder 3+ Kinder

SAVE 2003 SAVE 2005 SAVE 2006SAVE 2007 SAVE 2008 SAVE 2009

No child 1 child 2 children 3+ children

1010

Does it work? Riester Pensions by income

Source: Coppola and Reil-Held (2010)

3.65.0

8.910.7

14.516.2

7.69.4

20.1

23.5

27.9

32.7

8.6

17.6

23.6

30.5

39.6

36.6

7.9

15.8

21.3

33.3

38.8

43.1

11.4

19.522.1

35.2

41.041.3

05%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Ant

eil d

er H

aush

alte

Quintil 1 Quintil 2 Quintil 3 Quintil 4 Quintil 5

SAVE 2003 SAVE 2005 SAVE 2006SAVE 2007 SAVE 2008 SAVE 2009

1. Quintile 2. Quintile 3. Quintile 4. Quintile 5. Quintile

... of the disposable household income distribution

Alternative Approach: Income structure of

flat-rate benefits recipients

Yearly Income (in Euro)

Share in % (2008)

Up to 10,000 31,5

10,000 – 20,000 20,2

20,000 – 30,000 18,8

30,000 – 40,000 13,8

40,000 – 50,000 7,1

More than 50,000 8,6

Source: Rieckhoff and Stolz (2009)

12

2010

2020

2030

Does it work?Will the Riester Pension close the gap?

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

Rentenzugangsjahr

Pro

zent

des

Dur

chsc

hnitt

sein

kom

men

s

Rentenlücke "Riester-Rente"

Source: Börsch-Supan and Gasche (2010)

Year of entry into retirement

Pension gap

Riester pension%

of

avg.

I ncome

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.

Mannheim Research Institute for the Economics of Aging www.mea.uni-mannheim.de

BACKUP

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