The Act to Strengthen Company Pensions (Betriebsrentenstärkungsgesetz) came into force on 1 January 2018. In particular, it introduces "pure defined-contribution schemes," which changes the system of company pension schemes. Lawmakers hope this will bring the German market closer to the defined-contribution systems common in Anglo-Saxon countries. However, the "pure defined-contribution schemes" must still be put to the test in practice, as soon as the necessary foundation has been established in collective bargaining agreements. It must be remembered that as of 1 January 2018, numerous statutory changes now apply to "traditional forms" of occupational pension schemes, which have implications for most employers.
In the following newsletter, we will go over the most important changes resulting from the Act to Strengthen Company Pensions, and point out important issues, and actions, which should be taken.
1. Introducing mandatory employer contribution to deferred compensation
A crucial change is the introduction of a mandatory employer contribution within the context of deferred compensation. Section 1a (1a) German Company Pensions Act [recast] (BetrAVG n.F.), included shortly before the end of the legislative session reads as follows: "The employer must pay 15 percent of the deferred compensation amount as an additional employer contribution to the pension fund (Pensionsfonds), retirement fund (Pensionskase) or direct insurance (Direktversicherung) if the employer saves security contributions due to the conversion into deferred compensation."
This introduces mandatory employer contribution, which not only concerns the newly introduced pure defined-contribution schemes (§ 23 (2) German Company Pensions Act [recast]), but affects all employers whose employees exercise their statutory entitlement for deferred compensation, and employees whose compensation is deferred by way of pension funds, retirement funds, or direct insurance. It was the lawmakers’ expressed purpose, however, that this employer contribution not be paid if compensation is deferred by way of a benevolent fund (Unterstützungskasse) or even a direct pension commitment (Direktzusage).
On the other hand, the employer contribution must be paid if the employer saves social security contributions due to deferred compensation. If the employer, however, does not save social security contributions (eg compensation is deferred because its income exceeds the contribution calculation limits), it is not required to pay the employer contribution. It may be difficult to determine the exact amount of social security contributions saved since calculating the employer contribution may involve considerable effort. Moreover, it is still unclear whether contributions to the statutory accident insurance scheme are to be taken into account when determining possible savings in social security contributions. This is one of the reasons why the German Association for Company Pensions (Arbeitsgemeinschaft für betriebliche Altersversorgung e.V.) had rightly requested that lawmakers revise the act.
The employer contribution is an integral part of the employee's contribution that is financed by deferred compensation. It shares the fate of deferred compensation and is vested immediately. However, there are still some questions regarding employer contribution that are unanswered and unclear. For instance, it has not yet been determined whether or not, and to what extent, already-promised employer contributions to deferred compensation can be deducted from the statutory contribution mandatory in the future. This remains to be clarified.
Employer contribution generally applies to all employers. In this respect, the obligation to pay employer contribution will apply with immediate effect to deferred compensation agreements concluded after 1 January 2019. A three-year transition period will apply to deferred compensation agreements concluded before 1 January 2019. In this respect, the employer contribution will not become a statutory requirement before 1 January 2022. It is likely, however, that employee representatives will request payment of the employer contribution as of 1 January 2019 in the principle of equal treatment for this group.
2. Introduction of pure defined-contribution schemes – priority of collective bargaining agreements
The Act to Strengthen Company Pensions introduces a pure defined-contribution scheme for the first time. This means that employers do not promise specific or calculable retirement benefits, but merely undertake to pay specific contributions to an external pension provider for employees. No specific or minimum amount is guaranteed regarding the retirement benefit paid out in the future ("guarantee prohibition"). Pension providers are thus able to reduce or increase retirement benefits, also during the pay-out phase, depending on the performance of the capital market. The employer's obligation is limited to the proper payment of contributions ("pay and forget").
Pure defined-contribution schemes may be implemented only by way of direct insurance, pension funds and retirement funds. It is not possible to implement such a scheme as a direct pension commitment or a benevolent fund. Moreover, rights to future pension benefits resulting from a pure defined-contribution scheme will always be vested immediately regardless of whether they are based on contributions paid by the employer or the employee. In the event a pure defined-contribution scheme is financed by deferred compensation, the employer will also be obligated to pay an additional employer contribution of 15 percent of the converted income to the pension provider. This occurs only if the employer saves social security contributions due to deferred compensation.
The decision how to structure the pure defined-contribution scheme is left to the parties involved in the collective bargaining agreement. This is the so-called social partner model. The pure defined-contribution scheme may be introduced only by way of a collective bargaining agreement, a works agreement based on a collective bargaining agreement, reference to a relevant collective bargaining agreement included in a works agreement, or by employment contract. Pure defined-contribution schemes must always be based on a collective bargaining agreement. Consequently, it will take time for pure defined-contribution schemes to be tested in practice. The reason for this is that the parties to the collective bargaining agreement (unions and employers' associations) must first negotiate and conclude the relevant agreements.
3. Introduction of the "opt-out" model for deferred compensation
To further spread company pension schemes an "opt-out" option is offered regarding deferred compensation. In the future, it will be possible to set out in a collective bargaining agreement or a works agreement based on a collective bargaining agreement in which the employer introduces mandatory deferred compensation for employees. So as not to participate in such a deferred compensation scheme, the employee can object to this within a specific "opt out" period. By introducing such a system, lawmakers hope that numerous employees will not object to deferred compensation, which will thus help spread company pension schemes.
4. Tax law changes resulting from the Act to Strengthen Company Pensions
So far, employees have been able to pay contributions of up to 4 percent of the contribution calculation limits of general pension insurance to a company pension scheme without having to pay tax and social security contributions. This is the so-called "support framework". With the Act to Strengthen Company Pensions, the support framework will be expanded from 4 percent to 8 percent of the contribution calculation limits (§ 3 no. 63 German Income Tax Act [recast] (EStG)). The additional tax allowance of EUR 1,800 per year will, however, be omitted. The contributions' exemption from payment of social security contributions will still be limited to 4 percent of the contribution calculation limits.
In addition, company pension schemes are now state subsidised for low-income employees (with a maximum gross income of EUR 2,200 per month). If employers pay these employees a contribution to their company pension scheme of between EUR 240 and EUR 480 per year, the withheld wage tax is reduced by 30 percent of the additional employer contribution, but not by more than EUR 144.
The changes mentioned above are significantly flawed, which could hamper the successful start of the pure defined-contribution scheme. According to the wording of § 3 no. 63, § 100 German Income Tax Act [recast], taxation incentives should apply only if the pension benefits are paid out in compliance with the requirements set out in § 1 (1) sentence 1 no. 4 German Law on the Certification of Private Pension Provision Schemes (Altersvorsorge-Zertifizierungsgesetz, AltZertG). This provision, however, provides that the benefits paid out during the pay-out phase are to increase, or at least remain the same. The pure defined-contribution scheme cannot fulfil this requirement by definition, because in this respect the benefits must be reduced if capital coverage does not reach 100 percent. According to the current wording of the act, the contributions to a pure defined-contribution scheme would thus neither be tax free pursuant to § 3 no. 63 German Income Tax Act nor eligible for subsidy pursuant to § 100 German Income Tax Act [recast]. Lawmakers surely did not intend this, and it thus remains to be clarified.
5. Social security law changes resulting from the Act to Strengthen Company Pensions
As for social security law, the subsidy for low-income employees provides an advantage for old-age social benefits. Voluntary additional pension benefits of up to EUR 202 per month will not be deducted from old-age social benefits any more. This rewards the effort to build up additional company retirement benefits, even if the statutory pension received after having reached the statutory retirement age is not enough, and must thus be topped up by the state with basic social benefits.
Regarding employees, there is also changes to the so-called "Riester subsidies" granted for occupational pension schemes. As of 1 January 2018, no social security contributions are to be paid on benefits received during retirement regarding "Riester agreements" concluded for occupational pension schemes. In addition, the "Riester allowance" paid by the state has been increased from EUR 154 to EUR 175 per year.
It remains to be seen whether the Act to Strengthen Company Pensions has indeed strengthened and expanded company pension schemes. Employers should, however, familiarise themselves with the changes implemented by this act. Owing to the mandatory employer contribution for deferred compensation, company pension schemes have become more complex and burdensome for employers. Internal processes, for example, must be adjusted to the mandatory employer contribution to deferred compensation, which must be paid as of 1 January 2019.