Can Germany's Riester Pensions Fill the Pension Gap?

Featured in print Bulletin on Aging & Health

Many developed countries have reduced the generosity of public pension benefits in recent years to improve the long-term financial outlook of their pension systems. Yet these reforms will create a gap in old-age income relative to current benefit levels. To avoid a drop in replacement rates, workers will need to bolster the second and third pillars of retirement security, occupational pensions and private savings.

One interesting recent effort to strengthen retirement saving is Germany's Riester pensions. Somewhat like Individual Retirement Accounts (IRAs) in the US, Riester pensions provide tax incentives as well as subsidies to encourage people to save. A decade after their introduction, are Riester pensions demonstrating promise as a way to fill the pension gap? This question is explored in a new study by researchers Axel Boersch-Supan, Michela Coppola, and Anette Reil-Held, Riester Pensions in Germany: Design, Dynamics, Targetting Success and Crowding-In (NBER Working Paper 18014).

Riester pensions are state-subsidized voluntary individual savings accounts. While all contributors benefit from a tax deduction, there are additional direct subsidies for low-income households and households with children, since it was assumed by policy makers that these groups would have the most difficulty saving. Upon retirement, the majority of the pension benefit is converted to an annuity.

Due to the complex design, the value of the subsidy varies considerably across households, ranging from 24 percent to 90 percent depending on family income and the number of children. Overall, government subsidies (including the value of the tax deduction) average about 45 percent of contributions.

Riester pensions have proven popular with German workers. The number of accounts grew to 4 million within several years of the introduction of the scheme, and jumped again after the subsidy design was simplified in 2005. By the end of 2009, about 40 percent of eligible households had at least one Riester plan. This figure exceeds the share of households with occupational pensions. Moreover, the share of households with no private supplemental pension fell sharply after the introduction of the scheme, dropping from 73 percent in 2001 to 45 percent in 2009.

The authors explore the characteristics of those taking up Riester pensions using the SAVE data, a panel study of saving behavior by German households. They find that takeup is strongly age-related, with young households, who were more affected by recent benefit cuts, being much more likely to have a pension. Takeup is also higher in families with more children, as might be expected since subsidies increase linearly with the number of children. However, reaching low-income households has proven to be more difficult -- only one in five households in the lowest income bracket have Riester pensions, as compared to nearly half of those in the two upper income brackets. Interestingly, high-income households have also greatly increased their participation in occupational pensions and unsubsidized private pensions since Riester pensions were introduced.

Riester pensions generate costs for the government, including both the direct costs of the subsidy and the foregone revenue from the tax deduction. In 2010, costs were 3.5 Billion Euros, 80% of which came from the subsidies. This expenditure is modest compared to the total cost of public pensions, 225 Billion Euros.

An important (and difficult) question to answer is whether Riester pensions have increased private and national saving, given that they may have displaced other forms of private saving and entail direct government spending. While the authors "cannot provide an analysis which unambiguously isolates the causal effect of the subsidies on total saving," they note that occupational and unsubsidized pension plans remained flat or increased during the rise of Riester pensions. The aggregate household saving rate also rose from 9.4 percent of disposable income in 2001 to 11.4 percent in 2010. The authors conduct an empirical analysis of the demand for Riester pensions and other saving products and find results that are "consistent with a form of 'crowding in' among pension products."

"Finally, the authors explore the extent to which Riester pensions will fill the pension gap created by recent benefit cuts. They suggest that while on average Germans will be able to more than close the gap, one in four will have lower retirement income than under the old system. Lower-income households have particular difficulty in closing the gap.

In concluding, the authors note "this new pension instrument can be regarded as a success story for the middle of the income distribution in Germany," though it has not been equally successful in reaching lower-income households. They conclude, "Riester pensions have produced some interesting achievements although clearly they are not a panacea to fully solve the challenges of adequate retirement income levels."

The authors acknowledge financial support from the Research Institute for Policies on Pension and Aging (RIPPA) and the German Science Foundation (DFG).