The Expert Guide to Private Pensions in Germany (2025)

What Is a Private Pension Insurance/ Private Pension Plan?

Private pension plans also called private pension insurance, are very flexible pension products, and insurance companies offer plenty of products on the market. The basic function is easy: You pay in a part of your income every month or every year so that when you retire or need the money you get a lump sum or a pension in addition to the statutory pension. Your contributions are invested until you seek to be paid out.

A private pension plan also allows you to choose how you would like your pension to be paid out during retirement, notably as lump sums or a monthly or annual fixed pension also called an annuity. Most of the time, you don’t have to decide on this when closing the contract, but you can decide on this at a later stage. 

Usually, upon your death, the built-up capital, including return, is paid out. The sum paid to the beneficiaries in case of your death is capital gains tax-free. The annuity option is not inheritable, but in many cases, there is an annuity guarantee period (known as 'Rentengarantiezeit' in German) of 10 years. If you take out the annuity and die shortly afterward, your pension will be paid to your heir until the end of the guarantee period.

Additional Options for Private Pension Insurance

With many private/individual pension plans, you can include disability insurance, a survivor's pension, or additional accident insurance.

You can also elect to insure against conditions in which it is hard to pay your contributions, for example, if you become unemployed or destitute. However, experience shows that it is often cheaper to take out this additional insurance coverage separately. In addition, you will still have flexibility if you have liquidity problems.

Three Different Private Pension Options in Germany

First, there is the ‘classic model’ of private pension plans. With this model, you get a 100 % guarantee on your paid-in contributions. However, it is also tied to the guaranteed interest rate. This was just  0.25% for many years but has been raised to 1% since January 1, 2025. The guarantee implies that the classic private pension insurance is very conservatively invested in bonds with low or negative yields. As costs are deducted from the guaranteed return, your net return is most likely very small or negative.

For example, if your investment return equals the guaranteed 2,5 % and your cost is 2 % annually (this is a pretty common cost level), then the guaranteed product returns just 0,5 % annually, which is not enough to keep up with inflation!

Second, to address the poor reputation of classic private pension insurance companies have introduced partial guarantees. With this 'new classic model', you can choose the level of the guarantee. All investments above the guaranteed level are then better invested. 

In essence, this is the old wine in new bottles. It is no better than the classical model. It is a way for insurance companies to avoid having to advertise the low minimum guaranteed return. As long as bond rates are low, the guaranteed money is de facto, returning basically 0% after cost. In any case, you are better off putting any “guaranteed” part of your investment in a bank account or repaying your mortgage.

Therefore, we advise you to choose the third form of private pension insurance: an ETF or fund-based private pension insurance. With this form of pension insurance, you no longer have any guarantees, but you do have the opportunity to benefit from the developments in the stock market.

Sound Investment Choice for Your Private Pension in Germany

While a stock market-based private pension is the best option, we see that many investors make costly mistakes by not following basic advice to invest in broad based ETFs possibly supplemented with bond ETFs in case you want to limit volatility.

Many insurance companies offer their own funds or ETFs. These are often costly and perform worse. Some insurance companies also offer many ETF and Fund options, including actively managed Funds. They may show a high performance for a period or sound promising as a niche product benefitting from special products. These are all unsuitable for a long-term retirement portfolio. For a long-term retirement portfolio, you need to focus on broad-based market indices that have a high probability of achieving at least a minimum return of 5% over the long run. Attend our webinar to learn more about how we select the best portfolios based on years of advising some of the largest public pension funds in the world.

Costs of Private Pension Plans

The cost of Private Pension Plan is summarized in the so-called effective cost percentage (called 'Effektivkosten' in German). It indicates how much the fees reduce the average annual return. For example, if the funds in your contract are targeted to achieve a gross return of 6 % and your contract has 2 % effective costs, you will have a net return of 4 %. This number can be used to compare different contracts since it represents the impact of all fees on return. It is common to find the effective costs in the range of 1.4-2 %, but we have seen amounts as high as 3.5 % and as low as 1 %. As discussed below: we aim for costs that are lower than that.

The effective costs, in turn, are composed of several elements:  upfront fees, fees on the amount paid in, annual fees on the capital build-up, and monthly fixed charges.

Why Up-front Costs Are So Damaging

In particular, the upfront fees can be quite damaging. Most companies charge 2,5 % of the total insurance sum up front. For example, if you commit to contributing for 40 years, your up front is 2,5% of 40 years of contributions. This is equal to a full year of contributions. This is then charged in 5 annual installments, so in the first five years, you start with a negative annual return of 20%. It means that it takes a lot longer for your capital to build up and start earning returns and that if you decide to stop contributing, you have costs that are extremely high: much higher than the predicted overall effective costs. In addition, the money you pay up front is worth far more than the money you would pay in say, 30 years. The money you pay should accumulate significant returns over time. If you use the rule of 72--that is, with a return of 7,2% you double your money every ten years--the money you pay now is 2*2*2=8 times as valuable as the money you pay in 30 years. 

Tip: In the contract, the providers specify the maximum cost of canceling the pension, or changing the contract, called 'Kündigung wegen Vertragswechsel' and 'Kündigung mit Auszahlung'. 

Tip: We have seen really high penalties for canceling contracts, like forfeiting all returns. Review these clauses closely, and consider stopping additional contributions instead of canceling. For the retirement phase, there is also a one-off administrative fee of usually 1.75 % for the payout.

As you can see, fees can significantly cut your returns. So, it's worth looking closely when choosing your private pension insurance. At Pensionfriend, we are happy to compare your contract and use our effective cost calculator to show what works best for you.

The Tax Benefits of a Private Pension Plan

Private pensions plan benefit from a tax shield. 

1. Buying or selling ETFs within the portfolio is NEVER taxed. So you only pay tax once, when you take the money out. So your money accumulates tax-free. This is especially beneficial for long holding portfolios and when you rebalance your portfolio, for example, from stock ETFs to bond ETFs

2. Only 85% of the capital gains on the amount withdrawn from your plan is taxed at the normal capital gains tax rate of 26,375%. 

At the age of 62 or older and having held the plan for 12 years or more, your capital gains tax on the amount withdrawn is reduced by another 50%. This is the so-called Halbeinkünfteverfahren. Combined with the 85% taxation rule, only 42.5% of gains are taxed. The rate of taxation is the minimum of the capital gains tax rate of 26,375% and your income tax rate. For a typical well-to-do pensioner, the effective tax rate on the gains is then about 10%, or more precisely 42.5% * 26,375%. Currently, if your taxable income is under 54.000 € (tax class I), your marginal tax rate is less than 25 %. For a couple, this threshold is 108.000 €.

Taxation in Case of Annuities

If you withdraw your money as an annuity, that is in the form of a fixed monthly pension till you pass away, you are taxed differently: you are taxed at the normal income tax rates, but after a considerable reduction.

The taxable portion, the so-called 'Ertragsanteil', of the pension depends on when your annuity (known as 'Leibrente' in German) commences. For each age, there is a different corresponding percentage of pension that can be taxed. Generally, the older you are, the lower the tax rate.

For example, if you retire at 62, only 21 % of your pension is taxable. Therefore, if you receive a monthly pension of 1000 € and your personal income tax rate is 30%, you have to pay 30 % × 21 % × 1000 € = 63 € per month of income tax or about 6 % on your total gross pension. The share of pension income that is taxed remains constant for the duration of the payout phase.

Taxable share of pension income

For example, if you have an income tax rate of 20 % and start your annuity payment of 1.000 € at 71, the tax on your monthly annuity will be only 1.000 € * 14 % * 20 % = 28 €!

Note: This tax is levied not just on your gains but also on your contributions. You pay the calculated 6% tax rate in the above example over the entire sum and not just on what your investment has gained! So if your return on your private pension insurance is poor, the tax rate is rather high, and vice versa. Therefore, from a tax perspective, this option is especially suitable for high-return products and not for low-return ones, such as those with guarantees.

As the 'Ertragsanteil' depends solely on the age at which you start to pay out, it is beneficial, from a tax perspective, to start the private pension plan early if you choose an annuity: it means you have a long period to build up a high return. 

The lump sum payment is subject to a reduced capital gains tax: the beauty of the tax shield.

Your contract allows you to withdraw in a very flexible way. You can withdraw lump sums as needed while keeping the main investment intact. Or take out a monthly amount. Our flexible product also enables you to take annuities on a portion of the funds or invest in bonds. Note:  There is no social security charge on the PPP payout.

Pensionfriend Best in Class Solution

To address the standard problems in the industry, we at Pensionfriend decided to offer our own Private Pension Plans without the standard up-front and exit fees and real portfolio advice, with well-structured portfolios with ETFs selected based on the best international practices and insights from finance. In this we build on the ample experience of our co-founder Dr. Chris Mulder in heading the public investment advisory arm of the World Bank and his work on best practices for Sovereign Wealth Funds. Pensionfriend can also offer other solutions like Rurup or Basis pension and Company Pension plans, but we focus on the private pension plan as the best tax-optimized solution for long-term wealth building and pension creation. In addition, we set our pricing such that most customers should have better after-tax and cost returns than if they would invest the same portfolio with a broker. The aim is to make the choice of pension investing as simple and straightforward as possible. Tip: We have solutions that can eliminate all capital gains taxes, and help reduce inheritance taxes.

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Payout Options for Your Private Pension Plan: Annuity vs Lump Sum

We would recommend against choosing the annuity option in the vast majority of cases. The reason is that these annuities are now invested in low-return bonds and attract a lot of costs. Only if you expect to grow over 100 years old does it really pay. So, only if you cannot afford to take any investment risk or if other alternatives like an investment property are not available does it make sense to purchase an annuity upon retirement.

Picking the lump-sum option avoids the implicit cost of the annuity, is flexible, and always allows you later in life to buy an annuity. With Pensionfriend's Private Pension Plan, you can take out these lump sums yearly (and more). This allows your lump sum to continue to be invested.

You can always use part of your assets to purchase an annuity. This can be beneficial later in life when you do not want to be bothered with too much investment risk and have some more certainty. The annuity is much more beneficial at that time, as you have benefited much longer from a high investment return and low cost. Moreover, the tax rate on the annuity declines with age. Besides, if interest rates are much higher, annuities may become more attractive again. See more on this below.

The bottom line: you do not have to choose now. But do pick a plan that allows you the flexibility to keep investing at low cost and take the lump sum out frequently and again at low cost.

Annuity

With current interest rates and how insurance companies calculate life expectancies, the annuity is relatively unattractive. For a payment of 100.000 €, for example, you can expect a gross monthly pension of around 330 € from the age of 67. So you would have to get pretty old and draw the pension for more than 22 years to get your money back. 

In principle, you are better off buying your home or contributing as much as possible to the public pension. Also, working an additional year to create more of a buffer and then investing this money gainfully in ETFs would result in a much higher buffer later in life. But if you don't have those options and want to make sure you have a minimum guaranteed income throughout the rest of your life, then this is the option to choose.

Expected Returns for Private Pension Plans

A Misleading Practice Nearly all offers for private pension plans come with a standard forecast of the outcome, assuming returns notably 6% and 9% returns.  These are just assumptions! They bear no resemblance to reality as they are shown regardless of the investment product. It is a misleading practice used by many insurance sales representatives to pretend that these are actual forecasts, especially for high-cost products with poor performance. In contrast, at Pensionfriend, we forecast the returns of our portfolios based on the best macroeconomic predictions and finance industry insights. We make use of the relationship between profits and overall economic growth to predict long-term returns, and use the longest time series on stock returns to assess the minimum expected return and the risk to the portfolios.