Occupational pension schemes are becoming more and more popular as trust in the governmental pension scheme fades. Therefore, occupational pension schemes are an attractive benefit which companies can offer to employees in the ever stronger competition for a qualified work force. Besides, due to mandatory regulations entitling employees to demand employee funded occupational pension schemes, it is nearly impossible for any employer in Germany to avoid this issue.
As the German occupational pension system is very complex and differs hugely from both the English and American systems, the following background information should be considered in setting up an occupational pension scheme.
To begin with, German law does not recognise pure “defined contribution” schemes, so that such schemes do not qualify for tax or social security advantages and, in consequence, are very rarely used. In order to make tax and social security subsidies available for employees, an employer always has to accept a certain level of liability for pension payments, even if the pension scheme is employee funded. The scope of the possible liability depends on the type of pension promise made to the employees as well as the strategy used for the implementation of the pension scheme. Both the type of scheme and the appropriate strategy for its implementation are determined by the pension agreement entered into by the employer and the employee.
1 Types of pension promises recognized by German law
- Payment promise (Leistungszusage): The employer promises to pay the employee a pension amounting to a specific sum after his/her retirement.
- Contribution-oriented payment promise (beitragsorientierte Leistungszusage): The employer promises to grant a pension the amount of which is determined by actuarial calculations on the basis of specific contributions.
- Contribution promise with minimum payment (Beitragszusage mit Mindestleistung): The employer promises to make certain contributions to an insurance-based pension scheme (direct insurance, staff pension funds or pension funds) and promises at the same time that at least the sum of the promised contributions will be available for an old-age pension at the time of the insured event.
Depending on the strategy used for implementation, the employer always has a mandatory, at least secondary liability (see below) for the payment obligations arising out of the pension promise or the sum of the contributions as defined above – even if the pension scheme is employee funded. However, the subsidiary liability only becomes relevant in very rare cases, e.g. if (i) a breach of equality principles results in additional pension claims (e.g. widowers or life partners regarding dependants’ pensions) or (ii) an insurance contract does not exactly mirror the pension promise (e.g. does not include any pension for disabilities whereas the promise includes it).
2 Strategies to implement a pension scheme
- Direct pension promise (Direktzusage): In the case of a direct pension promise, no third party is involved in the scheme. The employer takes over the obligation to pay a certain amount by way of pension to the employee when the employee retires, so that this pension promise constitutes a direct liability for the employer.
- Support fund (Unterstützungskasse): Where a pension promise is arranged through a support fund, the employer promises to the employee that the employee will receive a pension from the support fund. Often, support fund schemes are reinsured so that the employer’s contributions match the necessary contributions of the support fund to the reinsurance. In this case, the employer has only a secondary liability for the pension payments.
- Direct insurance (Direktversicherung): In the case of a pension promise arranged through a direct insurance scheme, the underlying pension promise given by the employer to the employee defines the contractual relationship between the parties. The employer, as policy holder, takes out an insurance policy on the life of the employee, in order to fulfil the obligations arising from the pension promise. The insurance will pay the resulting pension directly to the employee, so that the employer has only a secondary liability.
- Staff pension fund (Pensionskasse): A staff pension fund scheme is also operated through a third party, usually a life insurance company. However, in this case the employees become members of the staff pension fund and they can claim their pensions directly from the fund while the employer has only secondary liability.
- Pension fund (Pensionsfonds): A pension fund is similar to a staff pension fund, except that in this case a third party may act as insurer or manage the investment of the assets. In addition, a pension fund has more freedom regarding investment of the funds. The pension is paid directly by the pension fund, so that the employer has only a secondary liability
Apart from the differences mentioned above, each of the strategies has different consequences especially with regard to tax and social security treatment of the contributions and the resulting pension payments. The details should be reviewed carefully in each individual case to find out which strategy best meets the employer’s needs.