Why Company Pension Plans Don’t Make Sense in Germany

Upfront costs of direct company pension plans make them unattractive for job changers

Most direct company pension products charge upfront fees. The company contracts with an insurance company, which in turn bills you. Insurance companies charge up to 2,5 % of the total committed sum until retirement age in the first 5 years and usually do so. 

For example, if you invest 100 € per month or 1.200 € per year, and you are 27, these fees calculate to: retirement age of 67 — current age of 27 → 40 × 1200 € × fee of 2,5 % = 1.200 €. 

Meaning, within the first 5 years, you lose one year of contributions in upfront costs alone! That amounts to 20 % of your contribution in these 5 years.

In addition, the insurance company will charge an annual fixed cost and a fee of around 1 % on the asset value.

Why are these upfront fees so bad for your investment? After you change jobs, all subsidies fall away.¹ So most people cancel their plans. You are then left with a product accruing high annual fees that are worth less than the money you have invested, and on top of this, you no longer receive the subsidies you were counting on. This can affect many people, particularly with the shifts in employee priorities, we are seeing post the Corona pandemic.²

Many people may then say: “So what? I can take the money out and collect the subsidy and company support I already received.” Not so quick. 

1. Many people find themselves with savings they cannot access, i.e., “dead money,” as the contract does not allow cancellation. Only if the employer collaborates and the amount is modest (see table below).

2. Even if you can cancel the contract and get your assets paid out, you have to pay taxes immediately. Your total bill is likely to be more than what you got as so-called “tax subsidies,” as the taxes on a one-off amount will place you in a higher tax bracket.

3. The payments into the bAV reduce your public pension. Our calculations indicate that this reduces your overall pension, as the public pension has a higher implicit return.

4. Especially if you have not paid the full up-front cost yet, it nearly always pays to cancel your contract and get your money out immediately. The longer it runs, the more you pay, and the higher the tax bracket is when you get the money out. Also, if you wait too long, you may have to keep your money in forever, as it is dead money, as you exceed the limit.

¹  Changing jobs almost always means that your current company pension plan switches to a private pension plan without subsidies, so you are stuck with a costly private pension plan. Only in rare cases does your new employer have the same solution as your previous company, allowing you to continue your existing plan.

² Gallup Engagement Index reports that 23 % of German employees are looking to change jobs in the next year, and 42 % are looking to change within 3 years. The number of people planning to change jobs is especially high for younger employees (under 35) but substantial even for those above this bracket.

What makes the direct company pension plan so unattractive? In any case

Fundamentally, the returns on savings invested in a company pension plan are poor: at present, maybe 0-1% after cost. The reason is that legally, a minimum of the paid-in assets have to be guaranteed. And it is very costly to provide a guarantee.

It used to be that insurance companies would invest in bonds to guarantee certain returns. The return on bonds dropped to the point of no longer being able to offset insurance company fees (about 1,5-2,5 %). Hence, this no longer works. Insurance companies have, therefore, come up with complex strategies to offer somewhat higher returns, but if properly evaluated, it is clear these do not make sense in the long run. The figure below tells it all too well. The product's value before the cost is stable but poor, but after the cost (shown in red), it is really bad. It will not keep up with inflation. Investing in the index itself yields a much higher return (shown in blue).

You may then think: “But the tax subsidy is so high.” Many people think it doubles their money, i.e., in Figure 1. the red line doubles. Alas, that is not correct. Sure, in the first instance, it almost doubles your money. But then, in retirement, you have to pay that tax subsidy back when the assets are paid out, you have to pay some social security contributions, and finally, your public pension is reduced by more than what the company plan returns. 

Therefore, on balance, the company pension plan yields you a return that is considerably less than inflation.

Are you already signed up for a contract? Find out how to cancel your company pension plan (incl. templates for cancellation letters).

Another hidden cost surprise within company pension plans

Another cost that most people are unaware of is the vast implicit charge in the pay-out phase of your company pension. If you choose to have your built-up savings paid in the form of an annual guaranteed pension, e.g., to help pay the rent, then the pay-out is very low: for each 10.000 € saved, you only receive around 6.500 € (considering you reach the average current life expectancy of about 85). 

This is because the assets are not invested during the retirement phase--with the same problem as noted above for the pay-in phase, that they can only be invested in guaranteed products, now applies to 100 % of the assets. Moreover, insurance companies retain large buffers in case the insured lives longer than the average current life expectancy. This could potentially lead to some surprise extra payments for those who live long, but this is a very poor basis upon which to plan your retirement financially. 

If you take your pension as an annuity, the sum of your pension payments is less than the nominal amount you contributed yourself !! Indeed, this is a rather shocking result.

If you choose to have your company pension paid out as a lump sum, you avoid this tax, but you will be faced with an extra high tax rate as the sizable payment will put you in a higher tax bracket. 

Use our bAV Calculator to calculate your company pension plan situation.

Company pension plan vs. first home

Buying a home is a much better idea for your long-term financial safety!

• Firstly, the return on a home is much higher during the pension build-up phase than the company pension plan, which cannot be invested well. A house typically returns 3-4 % appreciation, minus maintenance, minus the interest rate, plus rental yields of around 3 %. Currently, on the order of 3%.

• Secondly, the tax treatment of a home is much better, as the return on a house is not taxed at all if you live in it yourself. Furthermore, if you stay a minimum of 2–3 years → there is no capital gains tax in the case of selling this investment (after 3 years). 

• Thirdly, unlike with a company pension plan, throughout retirement, your money continues as an investment, and your return is that you don't pay ever-increasing rents.

In addition, consider the following: 

1. As the value of your house will grow over the long run, it creates a great store of wealth for emergencies or to bequeath. 

2. Finally, your home is secure. Rent increases can’t force you to leave. You can raise a family there or grow old. You paint the interior walls however you like! 

Therefore, it makes a lot of sense to save for your first home instead of going for a direct company pension plan!

Check Hypofriend's rent vs. buy calculator for details

The best strategy for you

Really, the big picture is not difficult. 

It begins with saving for your first home. Your first home provides the best return and also offers you the best old-age insurance. Importantly, you can avoid the risk of dead money with a company pension plan.

If you already have a home or a wonderfully low rent and don't like the idea of an investment home, then the second-best solution is to invest in ETFs. We suggest doing that through a tax shield such as a Private Pension Plan.

Unless you are the MD and the company pension plan does not come with the return-killing guarantee requirement, don't go for it. Save in a bank account. You can also save in well-spread ETFs. You can also use a private pension plan as collateral when purchasing that first home if you don't have one yet. Remember that if you do so and the ETFs perform poorly, you may have to wait extra months to buy a home. 

If you already have a direct company pension plan but only for a few years, then you may not have paid for all your upfront costs yet. You are nearly always better off canceling your contract if you can or stopping contributing.

Discover your options with the Pensionfriend Pension Plan