Company pension scheme often disadvantageous: private pension beats deferred compensation

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Intermediaries and employers are liable for failing to provide information to reduce social pensions – around €6 billion liability potential annually!

 

 

Advertising for deferred compensation with tax and social security savings

The conversion of remuneration is made palatable to the employee by advisors or intermediaries, above all because of the tax and social security savings. For example, an employee with a medium income saves about EUR 100 per month in taxes and his employee share of the social security contribution if he converts EUR 200 of his salary into a pension. The company pension scheme therefore costs him only EUR 100 net – and for this he will perhaps receive, with surpluses, a monthly company pension of around EUR 700 in 40 years. This is then taxed on a deferred basis, but the taxes in old age are low. In addition, the full (not only employee’s share) contributions for statutory health and long-term care insurance are due.

 

Company pension falls fully into tax progression

Social pensions are 100% taxable in 40 years, as are occupational pensions. The occupational pension added to the social pension thus falls fully into a correspondingly high progression bracket. For example, with even only 23% tax due to progression and approx. 17% for the full health and long-term care insurance contribution, a total of 40% in contributions is deducted from the company pension, leaving a net amount of EUR 420.

 

Private pension insurance as an alternative?

If the employee were to forego the deferred compensation and instead make provisions with a private pension insurance, he would have to pay the contributions from taxed income subject to social security contributions. With the same net expenditure, he could then invest only EUR 100 per month – the old-age pension from this in a comparable tariff would therefore also only amount to half, i.e. EUR 350 per month. However, although no social security contributions are deducted from this, taxes are – although not from the full amount as in the case of deferred compensation. Rather, when the pension starts at 67, only the income share of currently 17% is taxable, i.e. EUR 59.50, and only about EUR 12 in taxes is due on this because of the lower progression level. This leaves him with a net monthly pension of around EUR 338 – at first glance, the private pension is therefore EUR 82 per month worse than the occupational pension through deferred compensation.

 

Reduction of the social pension is concealed

However, the savings in social security contributions in the qualifying phase are bought at the price of a lower social pension. Even with only a small increase in pensions and taking into account tax and pro rata health and long-term care insurance contributions, the reduction in income subject to social insurance contributions by the EUR 200 in deferred compensation over 40 years leads to a net pension reduction of around EUR 100. An increase of EUR 82 in the comparison of occupational and private pensions is therefore offset by a reduction of EUR 100 in the social pension. The occupational pension was therefore a losing proposition when the overall impact on retirement income was considered.

 

Contribution for reduced earning capacity pension not yet taken into account

The reduction in income subject to social insurance contributions also leads to a loss of entitlement to the statutory reduced earning capacity pension. To compensate for this, part of the deferred compensation would have to be spent on a pension for reduced earning capacity – the total pension in old age would then be reduced again, and private provision would then be even better off in comparison.

 

Disadvantages in case of unemployment and incapacity for work

The entitlement to sick pay from the statutory health insurance is also reduced. In order to compensate for this, a private daily sickness allowance insurance policy could be taken out at the same time as the deferred compensation, but this may also cost another EUR 2 per month, which again shifts the ratios further to the detriment of deferred compensation. The lower unemployment benefit, on the other hand, simply has to be accepted – there is hardly any possibility of voluntary coverage here. Whether you can then collect the difference from the liable adviser or employee is a matter to be determined on a case-by-case basis.

 

Employers, advisers and intermediaries liable for defective advice

The usual consulting approach to deferred compensation focuses on tax and social security savings. Not taking into account the associated reduction in the social pension constitutes a serious error in the provision of advice, for which both the adviser and the employer are liable vis-à-vis the employee who has suffered damage as a result. The employer, for his part, saves his share of the social security contributions as a profit from the deferred compensation, while the employee, on the other hand, bears the resulting loss in social pension and other entitlements alone. Since the employer would have to be aware of this, it may even be possible to regard the concealment of this effect as intentional immoral damage – even with the motive of an advantage from saved employer shares. It must not be overlooked that the employer has comprehensive duties to provide information and a duty of care irrespective of fault: The employer may even be held criminally liable in this context.

 

Liability potential increases annually

If one calculates with only 5 million affected salary conversions below the compulsory insurance limit in the pension insurance, there will already be future pension reductions in the social pension of a total of approx. 6 billion EUR annually, if these salary conversions are carried out as planned until the start of the pension. With each year of further deferred compensation and reduced social security contributions, the liability increases further – now that the exemption from social security contributions is not expected to end in 2009. With an average of 20 years of pension payments, the potential liability achieved over the years amounts to 120 billion from the reduction in the social pension alone. In addition, there is a risk of liability due to lost entitlements to sick pay, reduced earning capacity pensions and unemployment benefits if, as is usually the case, the employee was not made aware of this clearly enough.

 

Broker must offer private old-age provision as an alternative

If they are properly and fully informed about the effects on their retirement income, employees will predominantly prefer private pension provision to occupational pension provision via deferred compensation. The financial impact alone speaks in favour of private pensions in many cases. Of course, each individual case must be calculated and examined on its own merits so that qualified advice can be given. But even if the results in some individual cases do not already speak against deferred compensation from a financial point of view, the more flexible structuring option of private provision is also a weighty argument.

 

Liability trap of faulty consulting software

In 2007, a renowned trade journal for the insurance industry found that around 96% of the occupational pension software solutions it examined calculated incorrectly. Especially sales-oriented brokers often close their eyes or are hardly able to perform plausibility checks. In particular, so-called “certifications” are to be questioned from the employer’s point of view, because the vast majority of providers have neither a quality management nor an ongoing professional control of the consulting tools for the correctness of the calculations: This offers employers and employees the possibility of demanding reversal up to 10 years later – including compensation for all accumulated disadvantages by way of damages.

 

by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm

 

by courtesy of

www.experten.de (published 10/22/2007))

and

www.bi-medien.de (published in bauwirtschaftliche informationen GaLa Bau 10+11.2007, 10)

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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