Pensions in Germany

Germany's pension system has a multi-pillar structure and relies increasingly on privately funded plans. Its public pillar is not as generous or redistributive as is often claimed. Germany's pension system was originally designed as a scaled premium system. It formally became a pay-as-you-go system in 1957. Participation in the system is mandatory for all dependent employees and only some groups of self-employed. The system is greatly fragmented in terms of institutions, coverage, contributions, and benefit levels. In recent years, a big discrepancy has emerged between the system dependency ratio (the relationship between pensions and contributors) and the demographic old-age dependency ratio. This has been caused by the use of early retirement and disability pensions as a means of tackling high unemployment, especially in Germany's five new states. Except for the high incidence of early retirement and disability pensions - and hence the low average retirement age - the system does not suffer from the problems that have afflicted pension systems in Southern and Eastern Europe and Latin America. Evasion seems not to be a major problem. The expected demographic aging poses a major challenge. There is little if any room for increasing the contribution rate, so benefits will have to be cut, most likely through an increase in the normal retirement age and through tighter rules for disability pensions and early retirement. The pension contribution rate is currently 19.2 percent of wages, shared equally by employers and employees. The government covers about 23 percent of total spending - for benefits not directly related to contributions. The break-even contribution rate of the system would be closer to 25 percent. Germany's system is not overly generous, compared with other OECD countries. The average replacement rate (calculated as average in...