The stock pension is coming – just different

Germany now wants to use stocks for pensions. This is a small revolution. But what exactly will change as a result?

It was announced as a pension revolution, as the beginning of something big. For many, it is now just a lazy compromise. The share pension, which the FDP threw into the ring for the first time in 2021, is set to become a reality in just a few months. But it is no longer called a share pension, but “generational capital” and otherwise has little to do with the original proposal. This is not the only reason why some of them are controversial.Play

The outlook is bleak

It is best to first clarify what the problem actually is: the pension system in Germany is in need of restructuring, if you will. The pension is financed on a pay-as-you-go basis, which means that how much we get paid out later does not just depend on how many pension points we have previously collected through our earnings. Another decisive factor is how many employed people will be paying contributions at that time. In short: the younger people finance the older people. In principle, this is a sophisticated concept, but one that begins to falter when there are fewer and fewer young people and more and more old people. In the 1960s, there were six employed people for every pensioner, but now there are only 1.8 contributors to finance one retiree. According to estimates by the IW Cologne, this figure will be as low as 1.5 by 2030. The outlook for tomorrow’s pensioners is therefore becoming increasingly bleak.

Politicians now want to counteract this and have now agreed on so-called generational capital: the model envisages that pensions in the future will be funded in part by returns on the capital market and no longer solely by contributions from younger generations. The statutory pension will therefore not be abolished, but simply supplemented by another building block. Countries such as Sweden and Norway have already gone further and have set up their own state funds that invest in stocks for their citizens.

Statutory pension should not be “weakened”

The idea of ​​the Swedes was originally to be followed when the FDP’s idea of ​​the “share pension” was still being discussed. Initially, it was said that 2% of pension contributions would go into shares or other securities. This is roughly equivalent to the Swedish model, in which every employee automatically invests 2.5% of their gross income in a state fund. A further 16% goes – as in Germany – into a pay-as-you-go pension. In this country, the contribution rate is currently 18.6%, which is shared equally between the employee and employer. With the share pension, the state would have taken 2% of this and invested it in the capital market. So nothing would have changed in terms of the contribution amount, just the investment target.

This idea is now off the table. The generational capital, which the traffic light coalition agreed on a few weeks ago, is not intended to weaken the statutory pension, according to the current plans. Instead, the government wants to build up its own capital stock, which will be invested in the capital market and will supplement the statutory pension. How large this capital stock should be has not yet been finally clarified. Initially there was talk of a one-off payment of 10 billion euros, but now Finance Minister Lindner wants this to be increased annually. This would mean that after 15 years, 150 billion euros in payments would have flowed into the generational capital. The idea is that the first pensions could then be paid out in 2038.

Contributions should increase less

Tomorrow’s retirees should not expect higher pensions thanks to the capital market. Generational capital is primarily aimed at “stabilizing” pensions. In concrete terms, this means that pension levels should not fall any further than before, and contributions should not rise as much as they have been partially funded. In other words, employed people should be protected from rapidly rising contributions. The government also wants to relieve the burden on the federal government itself and thus indirectly on taxpayers. The federal government already subsidizes pension insurance with more than 100 billion euros annually, and the trend is rising. This development is also to be dampened with additional capital market income.

Debts should finance it

For a long time it was unclear where the money for the capital stock would come from – if not from the contributors themselves. There is now an answer to that too: the government wants to go into debt. And because the era of zero interest rates is over, Germany must now pay interest on loans again in order to go into debt. But the Ministry of Finance estimates that these will still be lower than the expected returns on the capital market. Nevertheless, the interest will reduce the return. Some critics of the model also fear that the debt will be at the expense of future generations . For example, the head of the Council of Economic Experts, Monika Schnitzer, criticized the WDR: “You are taking on debt now in order to stabilize contributions in the future. This is actually supposed to help the generation in the future, but in reality the generation in the future will also have to pay off the debt. Nothing is gained at that point.”

Stocks, bonds, private equity: How the money should be invested

In order to generate income, the billions borrowed must be invested profitably. According to the Ministry of Finance, the federal government wants to set up its own public foundation called “Generational Capital” and manage the money as a fund. There is no further information about the specific investments yet, but at least the direction is now known: the aim is to use the operational structures of the Kenfo, the Federal Ministry of Finance recently told the press. This is the fund for nuclear rehabilitation, which has so far invested around 24 billion euros. The federal government founded the Kenfo in 2017 to finance the nuclear phase-out, for example to make the interim and final storage of radioactive waste affordable. It can therefore be assumed that the pension money will be invested in a similar way.

35% equities, 3.8% target return

Kenfo’s current portfolio is broadly diversified, but has a few special features. For example, the portfolio currently only consists of 35% stocks. 25% goes into “risk-bearing bonds”, including selected corporate bonds and government bonds from emerging markets. A further 10% is made up of low-risk government bonds, i.e. securities from industrialized countries with a high credit rating. The portfolio also includes illiquid investments. For example, Kenfo is also involved in private equity projects (direct investments in companies) and private debt transactions (credit financing). The fund also contains infrastructure and real estate investments. At 30%, this share of over-the-counter assets is not small.

According to reports from Handelsblatt, the Kenfo is pursuing a target return of 3.8%. This is slightly less than individual global stock indices have achieved in recent years. The MSCI World, for example, achieved an average annual return of 8.2% between 1970 and 2022. But the Kenfo has also exceeded its own targets in several years. According to its own information, it generated a return of 10.4% in 2021.

Federal government wants to step in if losses occur

And what if the fund does not perform well? Or the market as a whole simply crashes? This is one of the most frequently cited arguments against models such as the share pension among those with reservations – and it is not completely unfounded. The generation capital is intended to stabilize the contribution rates. If there is actually a long-term downturn in the market and the fund records losses for years, the stability of the pension contributions would also be at risk. Even if the generation capital only makes up a small proportion of the total pension investments, the contributions would be tied to market fluctuations to a certain extent. Finance Minister Lindner does not want to allow such worries to arise and recently announced that the federal government would bear this risk. If the fund does not perform well, it will be compensated with funds from the federal budget. This means that German citizens would ultimately have to pay for the losses, even if only indirectly with their tax money.

Ten billion will not be enough

The stock pension in its current form is often described as a “drop in the ocean”. Some economists criticize the fact that much more money would have to be invested to actually avoid increases in contributions. Christian Lindner recently announced to media such as Handelsblatt and FAZ that he wanted to significantly increase the targeted capital stock of 10 billion euros. If it were up to him, a further 10 billion euros would flow into the fund every year, so after 15 years there would already be 150 billion euros in contributions. But apart from the fact that parts of the coalition are opposed to it, even this amount is unlikely to be enough.

Reinhold Thiede from the DRV’s social policy working group had already calculated during the 2021 election campaign that in order to prevent a contribution increase of just one percent, 17 billion euros alone would be needed. The generation capital would therefore have to generate this return at least once a year so that contributions remain stable and the capital stock is still maintained. How much start-up capital would be needed for this also depends on the return. Assuming that the fund increases in value by 7% annually, there would already have to be almost 243 billion euros in start-up capital in it (17 billion / 0.07 = 242.8 billion euros). And what if the fund – as proposed by Lindner – is increased by 10 billion euros every year? Then after 15 years and contributions of 150 billion euros, the total capital would be 269 billion euros – assuming the fund actually increases by 7% every year. However, Kenfo itself considers a return of 3.8% to be more realistic. In that case, 447 billion euros would already be needed to be able to distribute income of around 17 billion euros every year. After 15 years, with a return of 3.8% and an annual savings rate of 10 billion euros, the total capital would have amounted to 205 billion euros – and would therefore still be too low.

Better than nothing?

The pension prospects of today’s working population are bleak. And few doubt that a change or addition is needed. In a country where one in five people is already over 66 and the birth rate is stagnating, the situation will not change on its own any time soon. Taking a cue from countries like Sweden or Norway is not a bad idea. With their sovereign wealth funds, governments have proven that the pension pot can be filled considerably if the stock market is used as a help. Since its launch in 2010, the Swedish AP7 fund has generated an average return of just under 11% per year. With more than 88 billion euros now invested in the fund, this corresponds to an annual return of around 9.6 billion euros – almost as much as Germany is currently planning for start-up financing. The Norwegian sovereign wealth fund, which manages income from the oil and gas business and social insurance, recently reached a volume of 1,200 billion euros.

Stock pension would have increased pensions by up to 30%

A generational capital of 10 billion euros would have difficulty keeping up with such a magnitude and – as things stand – it is doubtful that it would actually provide lasting relief for contributors. With the originally planned share pension, into which every employee would have automatically paid 2% of their gross income, pensions would have increased, or at least that is what Martin Werding, Professor of Social Policy and Public Finance at the Ruhr University Bochum, calculated at the time on behalf of the FDP parliamentary group. The results of his study sound more like what some people might have expected: for example, anyone born in 1992 or later and who has worked full-time and for an average salary since the age of 20 would be entitled to a statutory pension of €1,531 at the end of their working life without a share pension. According to Werding’s calculations, by paying into the share pension for decades, the amount would have increased to €1,988. An increase of 29.8%. But that would have required that 40 pension points had been collected over the course of a lifetime . In many cases, this is not possible – either because the income was below average or because the career was interrupted by parental leave or part-time work. If 15 pension points had been collected, the FDP’s share pension, for example, would have only brought an increase of 21.6%. In euros: the pension would have risen from €578 to €703.

But the stock pension is off the table and generational capital is almost ready to go. This means that German citizens will pay at least as much into the statutory pension fund in the future as before. The federal government wants to continue to subsidize this and invest partly in the stock market. It was foreseeable that the model would raise eyebrows in parts of society. Events such as the dotcom bubble and the crash of the popular Telekom share still have a deep impact on parts of society. But the generational model is a step in the right direction, even if it does not bring about fundamental reform. If designed correctly, however, it can perhaps strengthen people’s trust in the capital market – and encourage more people to build up a financial cushion in addition to state pension provision. Private pension provision, for example with the help of ETFs, is likely to be the best way to prepare for bleak pension prospects in the coming decades. You can find the best savings plan offers for this in our ETF savings plan comparison .

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