The German Parliament has passed pension reform legislation, marking the first radical break with the country's 120-year old pay-as-you-go pension system.
The most significant part of the legislative package is the introduction of a privately funded component, inspired by the US 401K plan, which will begin in January 2002 and is due to be fully operational by 2008.
Germans will now be allowed to invest 1% of their gross wages in a variety of new products - from bond and stock funds to insurance and real-estate products - a level which will be gradually increased to 4% by 2008. Although the lower house, the Bundestag, had already passed the bill in January, Chancellor Gerhard Shroeder's centre-left coalition needed to win the upper house or Bundesrat for final passage.
Thomas Mayer, chief economist of Goldman Sachs in Frankfurt said that although the final reform package was far from ideal, the new legislation marks a significant paradigm shift in the public mind.
People will now take responsibility for their futures and decide how best to invest their money, he said.
Indeed, the introduction of private pension comes at a time when an equity culture is just taking root in Germany. Equities will now be viewed as a tool for long-term savings and an integral part of pension savings said Franz-Josef Leven, an economist with German Shareholding Institute.
But because the new law requires that the return on the private investments be guaranteed, experts have been quick to point out the many shortcomings of the new system. More reform is needed. There are far too many restrictions that curtail the effectiveness of the plan, said Leven.
The plan complements another piece of pension legislation under which the government will reduce publicly funded benefits from the current 70% of net income to about 67% in 2030. Private pensions are expected to bridge the gap. To encourage the acceptance and use of private pension plans the government plans to offer tax breaks and subsidies totalling DEM21bn (EUR10.50bn) a year starting in 2008. If Germans embrace the new package, private pensions could swell to EUR300bn by 2011, according to Deutsche Bank research.
Compulsory pension contributions to the state scheme - evenly divided between workers and employers - are now 19.3% of gross pay and are not meant to rise above 20% for the next 20 years. But given demographic forecasts, the government came to accept that private pensions were the only forward.
It is estimated that the proportion of retired people to workers will rise to 56% in 2040, from 25% in 1999. In the long term, private pension plans could supply as much as 40% of overall pension income, with 60% still funded by the state, compared to 85% today (versus 65% in Britain and 45% in the United States).
The drama now turns to the private sector where banks, insurance firms and independent financial advisors will each step up their marketing strategies to win new customers. Competition for private pension savings will be intense, but experts say product requirements such as guarantees fit naturally with both traditional life insurance and unit-linked insurance products.
By Jessica Skelly
This week's edition of Professional Pensions is out now
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