Germany: cross border pension provision
Written by Gavin Watkins and Reiner Schwinger
Sept / Oct 2009
Germany has one of the most complicated occupational pension frameworks within the European Economic Area, comprising of five different models.
Unfunded pension promises are by far the most popular form of provision, but these are not covered by the IORP Directive and are therefore unsuitable for cross-border pension provision. Only two of the German pension models, Pensionsfonds (PF) and Pensions-kassen (PK), are covered by the Directive. Both are funded legal entities, separate from the sponsoring employer.
The pre-funding of pension benefits through a separate legal entity offers greater security for members than provision reserved in company accounts and, for this reason, might present PF and PK as an attractive proposition.
There are also potential advantages for an employer in establishing a PF or PK. Germany operates an insolvency protection scheme (PSVaG), which is funded by a levy. That levy is determined by reference to the liabilities PSVaG has to cover due to business failures.
The levy payable where pension provision is made through direct promise (book reserve) is five times that payable where pension rights accrue in a PF. And where the pension vehicle is a PK, there is no levy payable (although funding costs of a PK are higher than a PF).
Although these might appear sound reasons for establishing a PK/PF, the reality is that the PF and PK remain relatively unpopular. The most significant negative factor is the tax treatment attached to contributions/accrual.
Pension provision made through direct promise and/or support funds is fully tax deductible for the employer and is not treated as a fringe benefit for the employee, irrespective of the promise level.
In contrast, while contributions to PK and PF are fully tax deductible for employers, they are tax exempt and exempt from social security contributions for employees only up to 4% of the social security contribution ceiling. This equates to around €2,500 a year. An additional flat-amount exemption (tax only) of €1,800 is also available (for new plan members since 2005), but amounts in excess of these are taxable benefits for the employee, irrespective of whether the contribution is made personally or by the employer.
This different tax treatment places PK and PF at a clear disadvantage to direct promise and the starting point for most multinational employers must be, therefore, that including German employees within a cross-border plan is not attractive.
However, this is no greater a disadvantage for a cross-border plan than it is for a PF or PK and, given that these vehicles do exist, it must also be the case that there are circumstances in which they are appropriate. Those circumstances would include, for example, where the PK or PF is (1) to be used as a top up to a base level of unfunded provision; (2) the main source of provision where the contribution is modest; (3) a transfer vehicle for retirees.
The latter is, in fact, one of the key populations for whom German employers are establishing PFs. While ongoing accrual can attract adverse tax consequences for employees, because of a special tax regime for PF no tax charge arises on the transfer of retirees to a PF. This tax exemption does not apply to PK.
Whatever the rationale, any multinational considering esta-blishing a PK or PF - whether as the sole pension vehicle or as a top up - should consider the alternative of a cross-border plan. Administering the German section of a cross-border pension plan is no more difficult to administer than a PK or PF. It brings the same security and levy advantages as a PK or PF, and it delivers optimal governance, control and reporting, while holding out the potential for economy of scale savings.
Indeed, if an employing organi-sation has any significant number of internationally mobile employees (IMEs), a cross-border plan can also be an ideal vehicle through which to make pension provision for those individuals. A cross-border plan is likely to be more tax-efficient than a traditional international (offshore) pension plan and it solves the portability issues. The merits to pensioning IMEs through a cross-border plan are, however, just another reason - not the key driver - for considering such a plan. A cross-border plan can accommodate multiple domestic workforces and IMEs side-by-side.
The choice of location for a cross-border pension depends on many factors, including the countries to be covered, headcount in each of those countries and the cultural fit of a particular domicile with the membership profile. Generally, there is no single solution.
Wherever the location, German tax privileges would be allowed only if the pension vehicle complied with the conditions for either a PK or PF. The German Regulator, BaFin, would determine whether those conditions were met.
Within the context of cross-border provision, the PF is likely to be more favourable than the PK. The latter is more akin to an insurance company, with stricter investment conditions and stronger (more expensive) funding requirements than a PF. Also, if there is any intention to transfer accrued rights from a direct promise or support fund a transfer to a PF would be tax free while a transfer to a PK would produce an income tax charge for the members.
Another difference between the PF and PK relates to the underlying guarantee on the investment return. Within Germany, all occupational pension provisions include some form of guarantee. PF typically provides a minimum return of 0%, PK typically provides a minimum return of 2.25% up to 4% a year. If direct promises are transferred to PF, the minimum funding requirement amounts approximately to the DBO of the pensions in payment. In this case there is no interest guarantee and investment policies follow the prudent man principle.
Irrespective of the EEA country in which a cross-border pension plan is established, a plan that makes pension provision for German employees, as well as needing to comply with German tax requirements (if tax privileges are required), must also comply with certain aspects of social and labour law relevant for corporate pensions. For Germany, this includes the PSVaG - so moving pension provision to a different country does not avoid the levy, nor remove the security of this insurance.
While a cross-border plan might not be suited to an entire German workforce, it could still be attractive for different groups or for certain elements of provision. And main-taining a domestic plan doesn't detract from the rationale for a cross-border arrangement. In fact, some of the advantages, the gains deriving from cross-border pooling, can flow through to the domestic arrangement.
A cross-border plan pools (normally) both liabilities and assets and, in relation to the latter, requires an investment platform. It is perfectly feasible, where the domestic plan is funded - such as a support fund - to use the same asset pooling vehicle for both the cross-border and domestic plans. As well as presenting the opportunity for potential scale economy savings, this also brings closer oversight and control of the different plans.
Although a German-head-quartered multinational might consider a cross-border pension plan unsuitable as the main source of retirement savings for its German workforce, interest in these vehicles is increasing. The governance benefits are recognised clearly and, with pooling platforms no longer seen as novelty beta testing, Germany is adding its weight to the momentum behind cross-border pensions.
Written by Gavin Watkins and Reiner Schwinger, Principals at Towers Perrin