The ‘Equity Pension’ Experiment
Germany’s retirement reform — and where the ‘Aktienrente’ falls short
If you are relying on a state pension anywhere in the world, you might wonder whether, by the time you reach retirement age, the government will really be able to afford to pay you one. This question is justified, especially in countries where it represents the majority of retirement income, while demographic change puts the entire ‘pay-as-you-go’ system at risk. That is the problem Germany is trying to tackle — with the introduction of a pension buffer component funded with returns from investments in the capital markets. However, while such an idea clearly has merit and offers a step in the right direction, there are a few problems with it at the moment.
The content of this post does not constitute financial or investment advice. It is intended for information and education purposes only.
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The current system is unsustainable
The German pension system, like those of most European countries, consists of 3 pillars: (1) statutory pension insurance (Gesetzliche Rentenversicherung), (2) corporate pension plans (Betriebliche Altersvorsorge) and (3) private pension insurance (Private Altersvorsorge). Participation in the first pillar is mandatory and current contributions are almost immediately used to pay for current pensions (hence, the name ‘pay-as-you-go’ or PAYGo), without investing the funds. Participation in the second and third pillars is voluntary and takes various forms, many of which involve investing the contributions.
The first pillar is from where the majority of the pensions of German citizens and residents are paid. Working people pay into it, without the funds forming capital stock, just earning the right (in the form of points) to, one day, if the system still exists and one is still alive, receive a pension from those who will work and contribute in those future periods. That right is acquired after contributing for a certain number of years (generally, only 5 in Germany) and reaching a certain age (in 2024, that is 66 years for men and women, but will rise to 67 years by 2031), although early retirement is currently allowed at 63 with some additional conditions and restrictions.
Sounds like a reasonable way for retirement provision, right? Well, here is the crux of the problem: this system is critically dependent on a favorable demographic structure and a consistently high proportion of working-age contributors in it. Which is not what is happening in most of the developed countries in the world, especially in Japan and Europe. In Germany specifically, the projections are quite bleak — over the next 20–50 years, the number of younger people is expected to keep declining (especially if the net migration rates are relatively low), meaning that fewer people will be entering the workforce.
And as life expectancy continues to rise and outpace this trend, this is projected to result in an ever-smaller share of the working-age population — per some projections, falling from just under 65% to below 59% by 2039–2040. According to the OECD, the old-age dependency ratio (i.e., the number of people aged >65 years per 100 people of working age 20–64) for Germany is expected to exceed 45% already this decade (much higher than most other major developed economies such as the US, UK and France). Therefore, we have on our hands both a higher share of the population in retirement depending on a shrinking workforce to pay for their pensions, as well as a longer period on average for people to draw from the system. This means rising pressures on working people but also significant difficulty in maintaining pensions of reasonable size that allow for a decent quality of life.
The signs of how unsustainable this is are already visible now: for years the system has been ‘subsidized’ with additional financing using tax revenues. The hole between contributions and retirement obligations has effectively been filled by re-routing funds that could have been used for investments in other areas that also need attention. In 2020 for the first time, this co-funding exceeded €100bn which is over a quarter of the federal budget. Experts predict that without reform, this could rise to over 50% of the budget in the coming decades.
The ‘Aktienrente’ or ‘Equity Pension’ Proposal
To resolve the problems just described, something must be changed — e.g., more contributions and/or lower payments. Increasing contributions (or raising taxes) is something that is bound to be deeply unpopular — for the obvious reason that it decreases the disposable income of working people. In addition to that, the rise in contributions will likely have to be done multiple times (as government plans also show), to levels where the burden becomes too high and could be damaging to economic growth. At the same time, guaranteeing some minimum level of pension (currently 48% of average wages) is also necessary, and reducing pensions is also not an option — the goal is to preserve the pension-to-wage link over time. The German government’s proposal to address both problems (at least to some extent) is an additional third source of funding for the first pillar — the ‘Aktienrente’ (share or equity pension) or ‘Generationenkapital’ (inter-generational capital).
The idea is supposed to work as follows: the government sets up a public wealth fund called Stiftung ‘Generationenkapital’, whose purpose is to invest its assets (provided by the government) and generate returns. The assets are formed/acquired by receiving federal own funds (cash and assets amounting to €15bn by 2028) and proceeds from the issuance of federal debt (starting in 2024 with €12bn and increasing by 3% every year). The latter is intended to take advantage of the relatively low funding costs of the German government due to its credibility in international debt markets and will be exempt from the federal debt limit. The fund should reach a minimum capital stock of €200bn by 2036 (i.e., 2024–2036 is the ‘saving phase’) and is planned to start distributions to the traditional statutory system from that point onward (€10bn annually).
The proposal outlines that the fund’s capital must be invested in the capital market in a return-seeking and globally diversified manner. Until 2036 (when the distributions are supposed to begin), any income earned would be reinvested. The investment policy and strategy are to be decided by the board of the fund but within a framework of federal investment guidelines and respecting ESG/sustainability requirements. At the start, the existing structures of the Nuclear Waste Disposal Fund (KENFO, which already makes active and passive capital investments professionally and globally with sustainability factored in) are to be utilized. However, a notable reminder is relevant here — KENFO made a €3.1bn loss in 2022.
All this means that the fund will need to generate sufficiently significant returns to be able to repay the debt + interest over time back to the government (especially if long-term Bund yields keep rising) and to cover the planned annual distributions that will help fill the funding gap between pension obligations and contributions + tax subsidies. Anything earned in excess of what the distributions require will remain invested. But yes, you heard right, this new fund will not replace tax subsidies for Pillar 1, it will be in addition to them. And neither will it prevent contribution rates from rising, nor will have any direct impact on individual pension sizes.
not a great solution
The existing proposal does not expand on the idea of private exposure to the stock market, in the same way as Pillars 2 and 3 of the system do, or that individual investment accounts would do. It is essentially publicly-funded leveraged exposure to capital markets that intends to fill a gap and provide minimal relief to those who must carry the burden of the system, which can probably be best described as ‘too little, too late’. I believe the following points highlighting some key drawbacks of this proposed solution will clarify why.
1. The size and impact are too small to make a difference
The current social security contribution rate of 18.6% will remain stable until 2027. Without generational capital, it is then supposed to rise to 20% in 2028, 20.6% in 2030, 22.3% in 2035, 22.6% in 2040 and 22.7% in 2045. The introduction of the new fund and the annual €10bn distributions will only help slow this increase a little bit (i.e., reaching 22.3% in 2045) but this difference is likely to be insignificant. What would have had a more material impact is increasing the contributing population base by more employment and more in-scope employees.
2. The risk is not on the individual but on all taxpayers
If there are losses from the investments, the government states it will foot the bill. But that still means — the taxpayer. There will be some safety buffers and countermeasures, and yes a long time horizon would in principle likely work in favor of these investments. But the portfolio will need to be stress-tested and if losses do persist in times of a sustained global depression, for example, what will that cost us? What will the impact be on the retirees? Important questions to address.
3. Federal investment guidelines could result in insufficient performance
There is not sufficient evidence that ESG investment mandates help generate consistently high returns. It will also be of great importance how much risk tolerance such a fund should have, as this will be a key input in the allocation decisions. Again, a reminder that if KENFO is a case study for this, it does not bode well for a ‘public fund with federal investment guidelines’.
4. The old system is preserved instead of reformed
What we are witnessing is an attempt to fill a gap with public funds again, just in a slightly more market-oriented and riskier way (still constrained by federal guidelines). There is no reform of early retirement, which is very costly for this system, no proposals related to employees currently out of scope of social security contributions, there are no further incentives and a push for better development and further utilization of the private pillars which already offer private investments.
5. This decision is late…
… as stated on the webpage of the Federal Ministry of Labour and Social Affairs: “An earlier introduction of a capital stock for the statutory pension insurance would have brought relief for contributors earlier.” So at this point, it is not about whether to go for a change, it is about how and how much — and in both these aspects, this plan seems to fall short.
6. Trust
Based on the Winter-2023/2024 survey by the German Institute for Wealth Creation and Retirement Provision (DIVA), Germans trust the state the least to manage investments for them. Why would the average person then prefer to rely on government-built investment funds (even if they are presented as ‘professionally managed’ — again, see KENFO) instead of those managed by professional investors or — and this is where a great potential solution may lie — investing on their own? Based on historical gaffes in policies and investment decisions, the German government can hardly be seen as a successful risk manager (which is what investing at this scale requires).
conclusion
The proposal for generational capital makes an effort to take a step in the right direction (wealth building through capital markets) but does it in a way that is neither sizeable enough to make a difference, nor paves the way out of the unsustainable state-funded PAYGo retirement system. Private investing can offer a much more powerful solution and independence from the statutory system, if only the plan was built around that goal. Instead, it keeps that dependence — and hence, the link to the demographic crisis, without enabling true individual wealth creation that could also increase retirement income.
Author: Nikolay
Founder of MoneyCraft
