Occupational pension schemes in Germany

Occupational pension schemes

What are the main types of private pensions and retirement plans that are provided to a broad base of employees?

Until 1 January 2018, the BetrAVG provided five ways to implement occupational pension plans under German law. These were:

1. Direct pension promise: a promise by the employer to directly pay occupational pension benefits to the employee out of future profits (unfunded system).
2. Direct insurance: the employer takes out life insurance on the life of the employee and promises the employee (or the employee’s survivors) payment of the benefits due under the insurance contract.
3. Staff pension fund: the employer promises payments through a staff pension fund (usually operated by a life insurance company). In this case contributions are paid to the staff pension fund, which shall pay the benefits to the employees once they become due.
4. Pension fund: the pension fund operates similarly to a staff pension fund. However, the pension fund has reduced regulatory limits as to the investment of the funding capital.
5. Support fund: a support fund also operates similarly to a staff pension fund. It does, however, nominally exclude a direct claim to pension payments for the individual employee. This is due to historical reasons; in practice, the Federal Labour Court has decided that individual employees have a direct claim against the support fund.

The ways of implementation described under (ii) to (v) are called indirect ways of implementation as they always involve a third party as an implementation or funding vehicle, while the direct pension promise is usually financed through the (future) earnings of the employer. The main differences between the four indirect ways of implementation relate to the legal form of the implementation or funding vehicle, the regulatory provisions applying to the funding vehicle and effects in respect to the balance sheet of the employer as well as the tax treatment.

In addition to the distinction according to the way of implementation, German law distinguishes between the content of a pension promise. According to the BetrAVG, a defined benefit pension plan is the default system.

The BetrAVG further provides for the possibility that an employer may make a commitment to the employee to convert certain contributions into an entitlement for an old-age, invalidity or survivor’s pension (contribution-based payment commitment). Moreover, the employer may choose to make a commitment to contribute to the financing of occupational pension plan benefits by making payments to a pension fund, staff pension fund or direct insurance, while guaranteeing that the pension benefits will at least amount to the contributions paid (contribution commitment with minimum payment).

Under German law, an employer is always ultimately liable for the pension payments due to employees under an occupational pension or retirement plan, even in the event of an indirect way of implementation (BetrAVG section 1, paragraph 1, sentence 3) - except for the newly introduced true defined-contribution schemes. Such a true defined contribution scheme can only be implemented through (or on the basis of) a collective bargaining agreement. As of today, no such collective bargaining agreements have been reported. Consequently, a true defined-contribution plan did not exist under German law until 2018. However, certain pension plans may qualify as defined contribution schemes for accounting purposes.

Having said this, it is factually possible to design an occupational pension plan that is fully funded and thus - subject to the insolvency of the funding vehicle - functions as a defined contribution plan. There is an ongoing debate as to the legal consequences if an employer provides a pure defined contribution pension or retirement plan to its employees. Such a plan would, strictly speaking, not be covered by the BetrAVG. It seems most likely that such a plan will be treated like a contribution commitment with a minimum payment, in particular due to the limitations of the new true defined benefit scheme.

A final distinction under the BetrAVG addresses the financing of pension benefits. The BetrAVG provides regulations for employee or employer-financed occupational pension plans as well as plans financed by both employer and employee.

What restrictions or prohibitions limit an employer’s ability to exclude certain employees from participation in broad-based retirement plans?

The employer is under no statutory obligation to provide any form of a purely employer-financed occupational pension plan. Consequently, the employer is free to decide whether to offer occupational pensions and to which (group of) employees.

If a pension scheme is, however, introduced on the basis of a general system, the employer must adhere to the general equal-treatment principle. This means that distinctions between different groups of employees have to be based on objective reasons. In particular, the General Act on Equal Treatment (AGG) provides for certain ‘incriminated’ criteria that may not form the basis for a distinction between groups of employees. Moreover, if the employer provides funds for a collective occupational pension scheme, the distribution of the funds is subject to the co-determination of the works council (if any).

In addition, the BetrAVG provides for a statutory entitlement of employees to convert a certain part of their future remuneration claims into an entitlement for pension benefits of equal value (remuneration conversion). The employer can select the way of implementation for this employee-financed occupational pension plan (pension fund, staff pension fund or direct insurance) and may also select the funding vehicle (insurance company). As of 1 January 2019, the employer has to pay an obligatory subsidy to a remuneration contribution of an employee in the amount of 15 per cent of the converted remuneration. This obligation applies if the remuneration conversion is implemented through a direct insurance, staff pension fund or pension fund (excluding direct pension promises and support funds) and to the extent the employer saves social security contributions through the remuneration conversion. This could also lead to a subsidy of less than 15 per cent.

In respect of remuneration conversions that are agreed prior to 1 January 2019, this obligation only applies as of 1 January 2022.

Can plans require employees to work for a specified period to participate in the plan or become vested in benefits they have accrued?

Entitlements under occupational pension plans become vested if the employment relationship ends prior to a pensionable event, but after the employee reaching the age of 21, provided that the pension commitment has been in effect for at least three years. This statutory vesting period applies to all pension promises as of 1 January 2018 and is mandatory and is also important for statutory insolvency protection that only covers vested pension entitlements. For benefit entitlements promised before 1 January 2018, other (longer) vesting periods might apply. However, special transitionary rules may apply to benefit entitlements granted before 1 January 2018.

If an employee leaves the employment prior to a pensionable event, the pension entitlement is - subject to the plan rules providing differently - calculated according to BetrAVG, section 2. The basic principle of this calculation is that the benefits are reduced based on the ratio of years of performed service of the employee (m) to the possible years of service until the age limit of the pension plan (n). As (n) is always higher than (m), the ratio will reduce the benefit level.

An occupational pension plan may provide for waiting periods that have to be fulfilled prior to receiving pension benefits. These waiting periods exclude pension benefits if the pensionable event occurs prior to the lapse of the waiting period. To avoid a circumvention of the statutory vesting provisions, the waiting period can, however, lapse after the employee has left the employment of the company with a vested pension entitlement.

Under BetrAVG, section 2a, which came into force as of 1 January 2018, the employer has to ensure that former employees with vested entitlements are not discriminated in respect to their vested entitlement compared to employees that remain in service. The exact effects depend on the respective pension scheme; however, employers may be obliged to increase vested entitlements (eg, to reflect increases in salary if the (vested) pension benefits are calculated based on the salary).

What are the considerations regarding employees working permanently and temporarily overseas? Are they eligible to join or remain in a plan regulated in your jurisdiction?

The considerations depend upon the plan rules and the individual agreement regarding working overseas. As long as a (dormant) employment relationship with the German employer remains in effect, it is often the case that benefits continue to accrue under the German occupational pension plan, replacing any overseas plans. Obviously, it needs to be assessed in each individual case what is the most beneficial solution for the parties involved, also taking tax and social security considerations into account. The employer needs to make sure that any double pension entitlements are credited.

Do employer and employees share in the financing of the benefits and are the benefits funded in a trust or other secure vehicle?

The financing solely depends on the provisions of the occupational pension plan. These are, in general, based on an individual agreement with the employee or a collective agreement (see question 8). As mentioned above, the employee is entitled to salary conversion. As of 2019, the employer may have to pay a subsidy of up to 15 per cent to the salary conversion (see question 9). In the case that the employer cannot fulfil the benefit obligations, these are protected by the statutory insolvency protection fund (PSVaG).

What rules apply to the level at which benefits are funded and what is the process for an employer to determine how much to fund a defined benefit pension plan annually?

There are no statutory requirements in respect of the level at which a plan is funded. German law allows the employer to provide direct pension promises that are not funded in any way but are only reflected on the balance sheet as accruals. Having said this, the indirect ways of implementation obviously require a certain amount of funding as required under regulatory laws. However, if the funding is not sufficient to finance the promised pension benefits, the employer is ultimately liable (see question 8), unless a true defined benefit scheme under BetrAVG section 1, paragraph 2, number 2a, has been implemented.

What are customary levels of benefits provided to employees participating in private plans?

This depends on the pension plan and differs for each company and industry. The benefit level may range from a small one-time payment upon retirement to a lifelong pension in the amount of, for example, 75 per cent of the last (gross) remuneration.

Are there statutory provisions for the increase of pensions in payment and the revaluation of deferred pensions?

Under BetrAVG section 16, the employer is obligated in its equitable discretion to review the amounts of the pension payments every three years and to increase the pension payments subject to its economic situation. The employer is deemed to have fulfilled its statutory obligations in this respect if the adjustment of the pension payments is not lower than the increase in the consumer price index for Germany, or the net wages of comparable employee groups of the company. This obligation only applies to ongoing pension payments (not one-time payments) made after a pensionable event.

BetrAVG, section 16, paragraph 3, provides for possibilities to avoid such obligation to review (eg, by providing for an annual increase of at least one per cent). This is, however, only possible for occupational pension plans implemented after 31 December 1998.

Subject to the plan rules, there is no (statutory) obligation to re-evaluate deferred pensions. However, as of 1 January 2018 section 2a has been added to the BetrAVG providing for the obligation to (potentially) revaluate vested entitlements of former employees to avoid discrimination in relation to comparable active employees.

What pre-retirement death benefits are customarily provided to employees’ beneficiaries and are there any mandatory rules with respect to death benefits?

There are no mandatory obligations in this respect. The benefits thus solely depend upon the plan rules and consequently differ. A common survivor’s benefit level for spouses is 60 per cent of the pension that would have been due to the employee if invalidity occurred at the time of death or - if the employee already receives a pension - 60 per cent of the employee’s pension.

When can employees retire and receive their full plan benefits? How does early retirement affect benefit calculations?

There are no direct statutory regulations in this respect. Consequently, the pension plan rules also have to provide the relevant age limit for old-age pensions. A common age for full plan benefits was 65, matching the age limit for the state pension system. Although the age limit of the state pension system is gradually increasing to 67, many pension plan rules still provide for an age limit of 65.

Usually, the plan rules also provide for the possibility and the prerequisites of early retirement. Irrespective of the plan rules, employees can claim an early pension under BetrAVG, section 6, if they make use of the early old-age benefits from the state pension system as full retirement benefits, provided the other prerequisites of the occupational pension plan for a pension payment are fulfilled. BetrAVG section 6 therefore synchronises the state pension system and occupational pension plans.

The effects of early retirement are subject to the rules of the occupational pension plan. In general, it is possible to pay out the benefits reached at the time of early retirement, deduct a certain percentage of the pension benefits for each month of the premature pension or to apply section 2 BetrAVG (see question 10). If no specific rules and no mechanism are provided in the plan rules or can be derived from construing the plan rules, the Federal Labour Court only allows for a deduction taking the missing years of service (contribution phase) up to the ordinary age limit into account.

Are plans permitted to allow distributions or loans of all or some of the plan benefits to members that are still employed?

Any premature distribution of pension benefits would not qualify as a pension payment and would thus be considered an ordinary loan to the employee. While this would be - to a certain degree - legally possible, in general the implementation or funding vehicle would need to request adequate securities from the employee, making this a theoretical scenario.

Is the sufficiency of retirement benefits affected greatly if employees change employer while they are accruing benefits?

Please note that - at least employer-sponsored - occupational pension plans are, in general, specific to an employer. Consequently, the employee usually has to leave the plan upon leaving employment. If an employee changes employer while accruing benefits, the employee in general may lose all entitlements that are not vested (see, however, question 20). Vested entitlements against the old employer are calculated under BetrAVG, section 2 (see question 10).

Unless the parties agree differently, the employee starts to accrue new benefits under the plan of the new employer (if any), again vesting after three years (see question 10). Consequently, the employee will accrue a new entitlement with each new employment relationship - provided an (employer-sponsored) occupational pension plan exists. These multiple entitlements are usually lower than the entitlement under one pension plan if the employee stayed with the employer until retirement.

In what circumstances may members transfer their benefits to another pension scheme?

It is legally possible for an employer to replace an existing pension scheme by transferring existing pension benefits into a new scheme. Such an ‘internal’ transfer has to pay sufficient regard to vested entitlements and may require consent of the works council (if any).

In case of the employee changing to a new employer, BetrAVG, section 4, provides for the possibility to transfer vested benefits into a scheme of new employer. Subject to an agreement between the employee and the old and new employers, either the new employer may assume the pension commitment, or the value of the vested pension entitlement of the employee (transfer value) can be transferred by the old employer to the new employer (see BetrAVG, section 4, paragraph 2). If no agreement can be reached in respect of a transfer of the vested pension entitlement, the employee has a statutory claim under BetrAVG, section 4, paragraph 3, for a transfer of the transfer value within one year of the termination of the employment relationship under certain additional prerequisites.

In case a true benefit scheme has been established, the transfer value may also be transferred to the external pension institution that administers the true defined benefit scheme

Who is responsible for the investment of plan funds and the sufficiency of investment returns?

Ultimately, except for true defined benefit schemes, the employer is liable for the payment of the pension benefits under an occupational pension plan.

When a pension plan is implemented by an indirect method, the actual investment is handled by a relevant legal entity (eg, a pension fund) or an insurance company responsible for the implementation vehicle. The insurance company is responsible for the sufficiency of investment returns in line with the agreements with the employer and the applicable regulatory prerequisites. In practice, however, the risk - at least to a certain degree - remains with the employer.

In the case of a true defined benefit scheme, the parties of the respective collective bargaining agreement (ie, in general the trade union and the employer’s association) have to take part in the implementation and administration of the scheme (compare BetrAVG, section 21, paragraph 1). In general, this requires at least some form of supervision in respect of the investment of plan funds.

Can plan benefits be enhanced for certain groups of employees in connection with a voluntary or involuntary reduction in workforce programme?

This is generally possible under an employment law perspective. In defining the group of beneficiaries, however, the employer has to consider the general equal-treatment principle. Moreover, the pension scheme has to allow for one-time contributions to increase pension entitlements, in particular in case of an externally funded scheme. Finally, co-determination rights of the works council have to be taken into account.

Are non-broad-based (eg, executive-only) plans permitted and what types of benefits do they typically provide?

In general, the employer is - subject to the general equal-treatment principle - free to decide whether and for what group of employees it wants to provide occupational pension benefits. It is common to provide for higher benefits for executive employees, as their income usually exceeds the contribution threshold in the state pension system. Consequently, they usually rely more heavily on occupational pension benefits in order to reach a comfortable level of replacement income after retirement.

How do the legal requirements for non-broad-based plans differ from the requirements that apply to broad-based plans?

There are no legal differences from an employment law perspective. The BetrAVG also applies to managing directors and members of the management board. Only managers that also hold a substantial level of shares in the employing entity are not subject to the BetrAVG’s provisions.

In practice, collective bargaining agreements and works council agreements do not apply to executive employees and the top management of a company. Therefore, occupational pension plans for such individuals are usually based on individual agreements, which means that changes, in general, require individual consent.

How do retirement benefits provided to employees in a trade union differ from those provided to non-unionised employees?

Differences in this respect can only arise if the collective bargaining agreement specifically provides for a different treatment of union members and non-unionised employees. In practice, however, employers bound by collective bargaining agreements often include non-unionised employees in the scope of the applicable collective agreements on the basis of a reference clause in the employment contract. Therefore, collective bargaining agreements are usually applied to all employees, except for above-tariff employees and executive employees.

Collective bargaining agreements often provide rules for remuneration conversion. Such a conversion is often supplemented by a payment by the employer. This payment often compensates the fact that the employer saves employer contributions to the social security system through remuneration conversions and sometimes replaces other benefits (eg, capital savings payments).

How do the legal requirements for trade-union-sponsored arrangements differ from the requirements that apply to other broad-based arrangements?

The major legal difference is that labour courts usually do not review collective bargaining agreements for fairness, as parties of equal strength conclude them. Consequently, any review is limited to investigating whether agreements comply with mandatory laws.

Finally, BetrAVG section 19, paragraph 1, allows the parties of a collective bargaining agreement to deviate from certain provisions of the BetrAVG, to the detriment of the employees, which is not possible in an individual agreement or a works council agreement. Moreover, benefits based on collective bargaining agreements may more easily be amended or reduced against the will of the beneficiaries.

On the other hand, a trade union may initiate a strike to enforce changes to a collective bargaining agreement, including benefit levels.