Despite the current low interest rates, it is possible today to set up the so-called Riester pension, a state subsidized private pension scheme in Germany introduced 18 years ago, in such a way that everyone involved benefits from it. If the minimum payout at the end of the contract term is guaranteed only for the personal contributions, but not for the state allowances, significantly higher returns can be achieved. The bottom line is that not only private individuals will then have more money from their old-age provision, but the state will also collect more taxes and product providers will have more scope for product design that meets needs and better advice.
Two researchers from the Leibniz Institute for Financial Research SAFE and the Goethe University Frankfurt have summarized these points in a SAFE White Paper and thus proposed a reform of the current Riester pension scheme. "This reform proposal is intended to take away people's fear of losing their old-age provision. At the same time, providers are given the urgently needed leeway to invest funds profitably, which will also benefit public authorities through downstream taxation," says Andreas Hackethal, director of the research department Household Finance at SAFE.
Reform proposal predicts higher return on investment
For their calculations, two types of investors were initially modelled as examples and compared with the current status quo of the Riester pension. Then the calculations were reviewed on the basis of historical price developments of the German Stock Index DAX from 1948 to 2020 and compared with the Pan-European Personal Pension Product (PEPP) recently introduced by the European Parliament. The sample calculations assume a savings phase of 30 years with annually constant contributions. For this period, the assumed return on interest-bearing investments is one per cent per annum and for a diversified stock portfolio six per cent per annum. The accumulated capital is taxed once at the end of the term.
The calculations show that an investor with a gross annual income of 20,000 euros and two children gets 21,292 euros after tax if the entire premiums are invested in interest investments according to the Riester scheme. If the product providers invest only the paid own contributions in secure bonds and the state allowances in shares, as the reform proposal suggests, the same investor can expect an average old-age provision of 46,584 euros after taxes – with higher yields for providers and higher tax revenues for the state. For an investor with a gross annual income of 35,000 euros and one child, the same effects are evident, only somewhat lower due to the lower state allowances.
Calculations withstands risk scenarios from the DAX development
The results of the sample calculations also stand up to comparison with the historical DAX development. For both types of investors and under all observed market conditions, the reform proposal predicts higher returns and investment income at the end of the term than the current Riester model. In addition, the draft reform presented by the authors of the SAFE White Paper has proven to be compatible with the PEPP, which, in addition to a guaranteed contribution, also allows a standardized risk-based investment strategy as a consumer protection instrument. "Our proposal for a reformed premium guarantee together with standardized risk-based investment strategies would make the Riester pension more attractive and suitable for Europe," says Raimond Maurer, Professor at Goethe University and researcher at SAFE.