Occupational Pensions
Occupational Pensions: 9 technical terms explained – definition, synonyms and legal basis.
Occupational Pension Commutation
Synonyms: Abfindung von Betriebsrenten
Occupational pension commutation is the one-time lump-sum settlement of an occupational pension entitlement in place of ongoing pension payments.
Concept
Occupational pension commutation refers to settling an ongoing or vested occupational pension entitlement through a single lump-sum payment in place of recurring pension payments.
Statutory Restrictions
§ 3 of the German Company Pensions Act (BetrAVG) significantly restricts the ability to commute pensions: an employer may only commute a pension upon termination of employment and only for minor entitlements below certain de minimis thresholds, to prevent employees from prematurely depleting their retirement provision.
Significance
The restrictive treatment of commutation serves to protect the retirement security purpose of occupational pensions. Outside the statutorily permitted cases, a commutation requires the employee’s consent and is subject to further conditions.
Legal basis: DE: § 3 BetrAVG
Pension Adjustment Review Duty
Synonyms: Anpassungsprüfungspflicht
The adjustment review duty requires employers to review, every three years, whether ongoing occupational pension benefits should be adjusted for inflation.
Concept
The adjustment review duty under § 16 of the German Company Pensions Act (BetrAVG) requires employers to review, every three years, whether an adjustment of ongoing occupational pension benefits for changes in purchasing power (inflation) is warranted, and to decide the matter using equitable discretion.
Standard of Review
In exercising this discretion, the interests of the pension recipient and the employer’s economic situation must both be taken into account in particular. An adjustment may be withheld if the company’s economic capacity does not permit an increase in the pension burden.
Exceptions
The adjustment review duty does not apply under certain conditions, such as where the employer has committed to an annual adjustment of at least one percent, or where the pension is provided through a contribution-based direct commitment with profit participation.
Legal basis: DE: § 16 BetrAVG
Pension Offset Method
Synonyms: Anrechnungsverfahren
Under the offset method, benefits from the statutory pension scheme or other retirement systems are credited against an occupational pension promise to cap total retirement income.
Concept
Under the offset method, used within total-income occupational pension promises, the benefit from the statutory pension scheme or other retirement systems is credited against the promised total retirement income. The employer then pays only the difference between the promised total income and the offsettable statutory pension.
Application
The offset method is used primarily in older, final-salary-based total-income pension promises, where a specific percentage of final salary is set as the target total income from both statutory and occupational pensions.
Significance and Risks
The offset method carries a risk for the employer, in that changes to the statutory pension scheme — such as pension cuts or increases — directly affect the size of the occupational pension the employer must bear, which complicates the predictability of the pension obligation.
Mandatory Employer Subsidy for Deferred Compensation
Synonyms: Arbeitgeberzuschuss zur Entgeltumwandlung
The mandatory employer subsidy requires employers to pass on part of the social security contributions saved through deferred compensation to the employee's occupational pension.
Concept
Since Germany’s Company Pension Strengthening Act took effect, employers have been required to contribute at least 15 percent of an employee’s deferred compensation amount as a subsidy to the occupational pension, to the extent the employer saves social security contributions as a result of the deferral.
Legal Basis
The obligation is set out in § 1a(1a) of the German Company Pensions Act (BetrAVG) and has applied to new contracts since 1 January 2019, and mandatorily to existing deferred compensation contracts via direct insurance, Pensionskasse, and Pensionsfonds since 1 January 2022.
Relevance for Employees
The mandatory employer subsidy effectively increases the capital built up for an employee’s occupational pension without requiring additional contributions from the employee, making it a significant financial incentive to use deferred compensation.
Legal basis: DE: § 1a Abs. 1a BetrAVG
Employee-Financed Occupational Pension (Deferred Compensation)
Synonyms: Arbeitnehmerfinanzierte Altersversorgung, Entgeltumwandlung, Deferred Compensation
Employee-financed occupational pension arises when an employee funds their occupational pension by converting part of their own salary into pension contributions.
Concept
Employee-financed occupational pension arises when an employee converts parts of their future gross salary, such as bonuses or ongoing pay, into contributions to an occupational pension (deferred compensation), rather than having them paid out directly.
Statutory Entitlement
Under § 1a of the German Company Pensions Act (BetrAVG), employees generally have a statutory right to require their employer to allow deferred compensation of up to four percent of the contribution assessment ceiling of the general pension scheme, unless the employer’s collective bargaining agreement specifies a different implementation method.
Tax and Social Security Advantages
Converted salary remains free of tax and social security contributions up to certain thresholds, which makes employee-financed occupational pensions financially attractive compared to a direct salary payout. In return, the employer is required to pass on part of the social security contributions saved as a mandatory employer subsidy.
Legal basis: DE: § 1a BetrAVG
Contribution-Oriented Defined Benefit Promise
Synonyms: Beitragsorientierte Leistungszusage
A contribution-oriented defined benefit promise is a German occupational pension commitment where contributions are converted into a guaranteed pension benefit the employer promises.
Concept
A contribution-oriented defined benefit promise is a commitment type provided for under the German Company Pensions Act (BetrAVG), under which the employer first commits to specific contributions and converts them, using a defined actuarial basis (conversion factor), into a specific, guaranteed pension benefit.
Distinction from Defined Contribution Plans with Minimum Benefit
Unlike a defined contribution plan with minimum benefit, which guarantees only the sum of contributions, under a contribution-oriented defined benefit promise the employer commits to a specific benefit amount fixed at the time of conversion, for which it bears full liability under Section 1(1) sentence 3 of the BetrAVG.
Practical Relevance
The contribution-oriented defined benefit promise is one of the most widely used commitment types in occupational pension provision in Germany, as it allows the employer a predictable contribution burden while giving the employee a transparent benefit promise already fixed at the time of conversion.
Defined Contribution Plan with Minimum Benefit (Beitragszusage mit Mindestleistung)
Synonyms: Beitragszusage mit Mindestleistung
A defined contribution plan with minimum benefit is a German occupational pension commitment type where the employer guarantees only the contributions paid, not a specific pension amount.
Concept
A defined contribution plan with minimum benefit is one of the pension commitment types provided for under the German Company Pensions Act (BetrAVG), under which the employer commits to making specific contributions to fund retirement provision without guaranteeing a specific pension amount.
Scope of the Guarantee
Under this commitment type, the employer only guarantees that, at the time of payout, at least the sum of contributions paid, less the cost of biometric risk cover, will be available; the employee bears the investment risk above this minimum guarantee.
Relevance in a Low Interest Rate Environment
Defined contribution plans with minimum benefit gained relevance during periods of low interest rates, as they impose a significantly lower and more predictable guarantee obligation on the pension provider compared to a classic defined benefit commitment with a fixed pension amount.
Company Pension (Betriebsrente)
Synonyms: Betriebsrente, Occupational Pension
A company pension is an old-age, disability, or survivors' benefit promised or co-financed by the employer as part of occupational pension provision.
Concept
A company pension is an occupational pension benefit that the employer promises or co-finances for employees by reason of the employment relationship, paid out in old age, upon disability, or in the event of death to the employee or their survivors.
Implementation Vehicles
The German Company Pensions Act (BetrAVG) distinguishes five implementation vehicles: direct pension commitment, support fund, pension fund (Pensionskasse), pension fund (Pensionsfonds), and direct insurance, which differ in terms of financing, tax treatment, and insolvency protection.
Relevance for Retirement Provision
Alongside the statutory pension system and private retirement provision, the company pension forms the second pillar of the German retirement provision system; since the introduction of the statutory right to salary conversion in 2002, occupational pension provision has grown considerably in prevalence in Germany.
Direct Insurance (Occupational Pension)
Synonyms: Direktversicherung
Direct insurance is one of five statutory implementation vehicles for occupational pensions in Germany, where the employer takes out a life policy for the employee's benefit.
Concept
Direct insurance is one of the five statutorily recognized implementation vehicles for occupational pensions in Germany, under which the employer, as policyholder, takes out a life insurance contract on the life of the employee, with the employee or their surviving dependents directly entitled to the benefits.
Funding
Direct insurance can be employer-funded, employee-funded through salary sacrifice, or structured as a combination of both funding forms; under salary sacrifice, the employee forgoes part of their gross salary in favor of contributions to the direct insurance policy, allowing contributions up to certain limits to remain free of income tax and social security contributions.
Tax and Social Security Treatment
Under Section 3 No. 63 of the German Income Tax Act (EStG), contributions to direct insurance are tax-free up to a certain amount and, provided the eligibility conditions are met, also free of social security contributions; in return, the subsequent pension payments or lump-sum payouts are subject to full taxation on a deferred basis as well as, for members of statutory health insurance, full health and long-term care insurance contributions.