Occupational pension scheme

Occupational Pension Scheme: A Meaningful Supplement to Retirement?

The state pension alone is not enough for many employees to maintain their accustomed standard of living in retirement. Therefore, there are various ways to provide additional savings – one of which is the occupational pension scheme (bAV). But what exactly is behind it? What forms of bAV are there? And for whom is this type of pension provision really worthwhile?

What is the occupational pension scheme?

The occupational pension scheme is an additional form of pension insurance that is organised through the employer. Contributions are saved during working life, which are later paid out as a company pension. The bAV is not only for retirement provision, but can also, in many cases, include benefits for survivors or in the event of disability.

Employees can either contribute a part of their gross salary to the bAV (so-called salary conversion) or – ideally – benefit from an employer contribution. Thanks to legal requirements, companies have been obliged since 2018 to pay at least a 15% contribution if employees convert their gross salary for a bAV. Some employers even finance the company pension completely.

A significant advantage of the bAV: Contributions are tax and social security contribution-free up to a certain amount. However, the later pension must be taxed, and those with statutory health insurance pay health and long-term care insurance contributions on it.

What types of occupational pension schemes are there?

The bAV can be implemented in five different ways. These so-called methods of implementation mainly differ in how the contributions are invested and what guarantees are in place:

1. Direct Insurance

The direct insurance is the most common form of bAV, as it is easy to implement for employers and employees. The employer takes out a life or pension insurance for the employee with an insurance company. Contributions are either financed by the employee through salary conversion or the employer contributes to it.

Advantages:

• Relatively easy handling and well regulated by law

• Contributions are tax and social security contribution-free up to certain maximum limits

• Capital disbursement or lifetime pension possible

Disadvantages:

• The later pension is taxable

• Contributions to health and long-term care insurance are due on the pension payment

2. Pension Fund

Pension funds are independent provision facilities, which operate similarly to an insurance company. They are subject to government supervision and offer a guaranteed pension in retirement. Employers pay contributions into the pension fund, which then takes over the pension obligation.

Advantages:

• Security through state regulation

• Employers and employees can contribute together

• Lifetime pension payments guaranteed

Disadvantages:

• Lower return opportunities compared to pension funds

• Restricted flexibility in capital investment

3. Pension Fund

Pension funds offer more flexibility in capital investment and therefore higher return opportunities compared to pension funds. They are allowed to invest contributions in riskier assets, which means the later pension can potentially be higher. However, payouts are not guaranteed, as the market risk is borne.

Advantages:

• Higher return opportunities than with traditional insurance models

• More flexibility in capital investment 

Disadvantages:

• No guaranteed pension amount – there is a certain risk of loss

• Contributions to health and long-term care insurance are due

4. Direct Commitment (Pension Commitment)

With the direct commitment, the employer takes on the obligation to pay a certain pension to the employee at retirement age. They do not invest contributions in external insurance or funds, but finance the later company pension from their own company assets. Often, provisions are made for this or additional insurance is taken out.

Advantages:

• High freedom of design for companies

• No contribution limits – high pensions are possible

• In the event of insolvency, the company pension is secured by the Pension Insurance Association (PSV)

Disadvantages:

• The employer bears the full financial risk

• Complex administration and long-term commitment for the company

5. Support Fund

The support fund is an independent pension facility that is financed by the employer. It is particularly suitable for higher incomes, as contributions are not limited by tax maximum limits. The support fund itself invests the money and later pays out the pensions.

Advantages:

• Tax advantages for employers and employees

• High contributions without limitation possible

• Companies do not have to create provisions on their balance sheets

Disadvantages:

• No statutory pension guarantee – depends on the financial situation of the fund

• Administration can be burdensome for small companies

When is the occupational pension scheme worthwhile?

Whether a bAV makes sense depends on various factors:

1. When the employer (partially) covers the contributions

If the employer pays for the pension provision, there is hardly any reason to decline the offer. The company pension is then an additional remuneration – a kind of "gift" for the employee.

2. When the tax and social security contribution advantages can be used

Salary conversion lowers the taxable income, resulting in employees paying less in contributions in the short term. However, they should consider that the later company pension will be taxed and that contributions to health and long-term care insurance will be incurred.

3. For employees with low incomes

Since 2018, bAV pensions are no longer fully counted towards the basic security in old age. Those who expect a low pension in retirement can therefore provide additional savings through a bAV without having to fear large deductions later.

4. For those who plan to stay long-term with the company

When changing jobs, it is not always guaranteed that the new employer will take over the existing bAV contract. Therefore, those who frequently change jobs should check whether the occupational provision is worthwhile or whether a private pension provision would be more flexible.

5. For employees who prefer a lifetime pension

Unlike many private pension insurances, the bAV typically offers a lifetime pension payment. Those who desire secure pension provision benefit from this.

Conclusion: An Attractive Supplement – But Not Ideal for Everyone

The occupational pension scheme can be a valuable addition to the state pension, especially when the employer contributes. It offers tax benefits and ensures an additional source of income in retirement.

However, the bAV is not the best solution for all employees. Those who frequently change jobs or prefer a more flexible form of provision should consider alternatives such as a Riester pension or a private pension insurance. A careful comparison and individual counselling will help to make the best decision for one’s own pension provision.