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What is meant by a stock-based pension?

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What is meant by a stock-based pension?

Germany's statutory pension insurance system has been criticized for years – and rightly so. Given current challenges such as a declining number of contributors and an increasingly aging population, retirement provision is in danger of collapsing. A solution is urgently needed. In March 2024, the German government presented a draft law based on international models: the introduction of equity-based pensions is intended to help stabilize retirement provision in Germany and bring about a turnaround.

The weaknesses of the statutory pension insurance

The German pension system is based on a pay-as-you-go model: current contributors finance the pensions of today's retirees and simultaneously accrue their own pension entitlements. However, this system is increasingly under pressure due to the aging population and the declining number of contributors. Added to this are the challenges posed by high unemployment and rising wages, which place further strain on the system.

The current pension level, which reflects the ratio between pension benefits and wages, is at risk. Another problem: Starting in 2025, the large baby boomer generation will gradually retire, further exacerbating the situation. Who will then finance the pensions?

To meet these challenges, there are various approaches to solutions:

Reduction of pension benefits
Raising the retirement age
Increase in pension insurance contributions

However, the federal government opted for a different approach that is less burdensome for policyholders: a reform of pension financing. In March 2024, the Pension Package II laid the foundation for equity-based pensions, a model that has already been successfully implemented in many other countries.

Equity-based pensions: A lifeline for the statutory pension insurance?

Originally proposed by the FDP in their election manifesto, the equity-based pension envisioned all contributors investing a portion of their contributions in funds, based on the Swedish model. However, this idea was not adopted by the federal government. Instead, the so-called generational capital scheme, also referred to as an equity-based pension, was introduced.

Unlike the original FDP proposal, the generational capital will be financed not by private funds, but by public money. Public loans and federal assets will be invested in the capital market via a foundation, pursuing a return-oriented and globally diversified investment strategy. Around €12 billion is to be invested this year alone, and a total of €200 billion is to be accumulated by the mid-2030s. From 2036 onward, the federal government's annual contribution will increase to approximately three percent.

The returns from these investments are intended to stabilize pension contributions and prevent further increases. The goal of this type of equity-based pension is therefore not to increase pension benefits, but to alleviate the burden on contributors. Furthermore, the pension level is to be stabilized, with the aim of maintaining it at least at 48 percent of average income until 2039.

No immediate change to the retirement age
Currently, there are no plans to raise the retirement age. However, this could change in the future. The retirement age is a controversial issue in the Bundestag, and an increase is often justified by the rising life expectancy of those insured. According to this argument, the retirement age can no longer be decoupled from life expectancy.

This is how the equity-based pension or the generational contract is financed.

The intergenerational contract is initially financed through new debt. Federal bonds are issued for this purpose to comply with the debt brake. The borrowed money is invested in the fund without being immediately disbursed. The interest on the loans is intended to be covered by the fund's investment returns. However, this significantly reduces the fund's return due to the interest payments.

From 2028 onwards, €15 billion annually will flow into the fund in the form of federal equity investments. However, withdrawals from the fund will only be permitted once it exceeds a certain predetermined limit.

When does the equity-based pension become effective?

The equity-based pension scheme, as proposed by the FDP, is unlikely to be implemented. Instead, the intergenerational contract will be built up by 2035, enabling it to make its first contribution to the statutory pension insurance from 2036 onwards. Until then, the current contribution rate will rise from 18.6 percent to 22.3 percent, before payments from the intergenerational contract stabilize and cap this contribution.

A generational contract is not the same as a stock-based pension.

Although referred to as an equity-based pension, the intergenerational contract differs significantly from the FDP's original proposal. According to the Free Democrats' initial plan, all contributors should pay two percent of their income into a capital-funded pension scheme to capitalize on the opportunities offered by the stock market. However, some politicians raised concerns due to the constant fluctuations in financial markets. Their worry was that such a form of equity-based pension might not provide the necessary security for contributors' pensions, which is crucial for safeguarding retirement provisions.

Can equity-based pensions save the statutory pension?

The capital market offers many opportunities, and expected returns are significantly higher than those of interest-bearing products. Especially with a long investment horizon, losses due to price fluctuations can be effectively offset. Nevertheless, it is understandable that the federal government does not want to withdraw its pension guarantee for its contributors. After all, the development of the financial markets cannot be predicted, which means that it would be impossible to guarantee contributors a precise amount of their retirement pension in advance.

Despite these uncertainties, the opportunities offered by the capital market should not be overlooked. If the profit-oriented form of equity-based pensions fails to gain traction, private retirement savings will become all the more crucial. While the measures planned by the federal government may help stabilize contributions, they will not increase the already inadequate state pension benefits.

ETF savings plan as an alternative to equity-based pensions

Generational capital can help you contribute to the statutory pension insurance, but it doesn't build up an additional financial cushion. Therefore, to truly provide for your retirement, it's important to take proactive steps yourself.

An ETF savings plan offers you a flexible way to save for your retirement without being tied to insurance companies. You pay a fixed monthly amount into your account and invest in exchange-traded equity index funds. The advantage of an ETF savings plan lies in its flexibility: you can adjust your payments and withdraw money if needed. Your investments are not tied to your income, and broad diversification significantly reduces the risk of loss.

The intergenerational contract can be a useful supplement to the statutory pension system. However, it takes time and is not an immediate solution to the growing pension gap. To close this gap, it is essential to make your own provisions for retirement. With an ETF savings plan, stocks, real estate, or funds, you can build a solid retirement nest egg. We would be happy to support you – schedule an appointment today!