Riester plans - a good way to supplement retirement savings?

The latest annual pension information in Germany kindly points out that statutory pensions will probably not be sufficient in old age and that people should start to put something else aside to supplement this income.

official information on German statutory pension insurance, provided by Benjamin Hartmann on June 15, 2022

Luckily, there are many different ways to supplement one's retirement savings.

The Riester pension – the most controversial government-subsidized pension plan

When it comes to subsidized pensions, perhaps no plan has created more controversy in Germany than the Riester pension plan. Proponents praise the high level of assistance and protection provided by the government. Critics cite the relative inability to access funds during the savings phase and the deferred taxation.

This article explores the pros and cons of Riester pension plans. All information is drawn from current regulations effective for 2022.

Direct and indirect beneficiaries

In principle, anyone who contributes to the statutory pension insurance scheme in Germany is entitled to participate in the Riester plan. Public officials, soldiers, families with children, and recipients of unemployment benefits are also included in this list. The state refers to these people as "direct beneficiaries."

However, certain independent workers (pharmacists, architects, doctors, lawyers, tax consultants, veterinarians, etc.), who do not pay into the statutory pension insurance scheme but instead contribute to their respective professional pension funds, are not eligible.
Self-employed workers who are exempt from mandatory pension insurance also belong to the group of non-eligible persons.

Nevertheless, people who are not eligible themselves, but whose spouse is eligible, are considered "indirect beneficiaries." These people can also benefit from Riester plans, but only within the framework of their partner's plan and without the full benefits of their partner.

Riester plans

In order to "riester," a person simply opens a certified pension plan offered by a company (e.g., a pension fund, a mutual fund, or a building savings contract) and starts to contribute to it. In addition, the company offering the Riester plan submits an annual request for allowances to the Central German Pension Authority (ZfA). This is usually done by applying for a permanent allowance.

Contributions – the 4 % rule

The allowances are however only credited to the plan in full if the contribution for the respective year corresponds to at least 4% of the gross income subject to pension insurance for the previous year. The contribution consists of the contributions (paid in by the beneficiary) and the allowances.
The beneficiary must pay in at least €60 per year.
In no case can the contribution exceed €2,100. With this contribution, the beneficiary will receive the full amount of the allowances, regardless of the 4% rule. It is also the maximum amount that is taken into account for tax purposes.

The advantages of Riester

One of the best reasons to opt for this type of supplementary pension is that the respective plan is subsidized by the state in the form of allowances.
Currently, each Riester beneficiary can request a personal allowance of €175 per year.
Recipients of family benefits can also apply for child allowances. The current child allowance is €300 per year per child born on or after January 1, 2008, and €185 for older children.
Finally, Riester savers who are 25 or under can obtain a one-time €200 "career starter" allowance during the first year.

In addition to the government subsidies in the form of allowances, the annual contributions can be claimed as special expenses on income tax returns and therefore (in the best case scenario) lead to a reduction in the amount of the beneficiary's taxes.

Since Riester plans must be approved by the government, the providers of these plans must be able to prove that they have sufficient capital on hand to cover any contributions they received. At the start of a payout, the provider must therefore be in possession (at least) of the amount of the contributions that were paid in, as well as all the allowances that were credited to the plan over the years.

The disadvantages of Riester

Nevertheless, as with all subsidized pension plans, Riester plans also involve the saving of money that may only be used for life after retirement. This means that the capital is tied up for the time being.

Riester payouts begin at the same time as the start of payouts from the statutory pension insurance scheme. Among other things, a pension approval certificate can be sent to the respective provider as proof that these payouts have indeed begun. Beneficiaries can choose to receive 30% of the capital as a lump sum. However, the remaining amount must be annuitized in the form of a life annuity.

Everything that is paid out will be subject to deferred tax liability (at the full rate). It should be noted that in Germany, progressive taxation also applies during retirement, so one should not necessarily defer taxes on the entirety of one's pension but rather consider whether a healthy combination of subsidized and non-subsidized funds might be a better choice.

A Riester plan can be terminated before the beneficiary reaches retirement, but in such a case all allowances received to date, as well as all associated tax refunds, must be re-deducted from the existing capital and returned to the state. This is therefore only recommended in the case of an emergency.

Funds may however be withdrawn during the savings phase without penalties if the money is to be used for housing purposes. Such purposes include the purchase of a property (to live in), the acquisition of a permanent place in a retirement home, and the installation of amenities for greater accessibility in one's home. The government recognizes these investments as provisions for retirement. Of course, the ZfA will record such a withdrawal and subject it to deferred tax liability once the beneficiary reaches retirement age. In this case, the withdrawn capital is even penalized 2% interest per year on a fictitious housing subsidy account. At retirement age, a larger amount of capital may therefore be taxed than what was withdrawn in the first place.

Anyone who does not comply with the 4% rule during the savings phase will have their allowances reduced in the corresponding proportion.

Conclusion

Riester plans tend to be seen as difficult and complex, which is why many people stay away from them altogether. However, this image is usually based on a negative, one-sided view, the incorrect handling of plans, and the failure to take advantage of benefits.
Those who fail to contribute in accordance with the 4% rule will of course not receive the full amount of the allowances, and may even have to repay over-allocated allowances.
And those who do not declare their Riester plan on their income tax return will, of course, not receive an additional tax refund.
Moreover, the common idea that a beneficiary must live to be 90 for the plan to be worthwhile is, in most cases, an entirely incorrect way of looking at things, as it almost always fails to take into account the additional tax refunds awarded during the savings phase. If this money (which would not be available without the plan) were reinvested sensibly and also put towards retirement planning (e.g., a supplemental private pension plan), and then included in the calculation, a totally different picture usually emerges that corresponds more closely to the truth.

In the end, however, each individual must weigh the pros and cons to decide whether a Riester plan is right for them.
For some groups of people, such as women with part-time jobs and two children at home, who in most cases would receive €775 in government allowances every year just by contributing €5 per month, Riester plans are almost indispensable.
Riester plans can also be attractive for those with large incomes in high tax brackets, as these individuals often benefit from a reduction in their taxes during the savings phase.

Whether or not these plans are recommended for "middle-class" people who have to make a relatively high personal contribution to comply with the 4% rule, and who usually do not benefit from a substantial reduction in taxes, must be evaluated for each individual case.
At any rate, one might ponder whether the original political goal of the Riester pension has now been overlooked.

The question certainly arises as to whether the plans will remain viable in the future. Recently, a proposition was introduced to reduce the 100% capital guarantee imposed upon Riester plan providers by the government to 80%. However, as the proposal was not approved, many Riester providers have now withdrawn from the market and only a few such companies still offer Riester plans at all. How long these few companies will continue to offer their products to the market remains to be seen.

In any case, thanks to our in|sure PSLife and in|sure GovInterface software, we at adesso insurance solutions can help our customers optimize their Riester plans and report all relevant documents to the authorities.

Interested in learning more about our solutions? Feel free to contact Thomas Dietsch, a software specialist and senior business developer at adesso insurance.