What will happen to Germany's senior citizens: What the reform will affect

The aging population in the EU and the pressure it is putting on pension systems has led many countries to consider reforms. The Netherlands has embarked on major reforms, France has adopted comprehensive reforms scheduled for 2023, and the German government is working on a package of reforms but has so far been held back due to budgetary constraints.

Pension system in Germany

The public pension system in Germany, like many other European countries, is pay-as-you-go: contributions paid by working people go to cover the income of senior citizens. The German pension system is particularly large, but faces problems common to all pension systems. In Germany, the ratio of the elderly (65+) to the working-age population (20-64) is projected to increase from 37.3% in 2022 to 49.8% in 2050, meaning that by 2050 there will be one senior citizen for every two working people in Germany, and the ratio will increase thereafter.

Net pensions

Net pensions (reflecting income before taxes) currently account for 48% of average wages in Germany and are expected to gradually decline to 44.9% by 2040. This is due to the "sustainability factor" introduced in Germany in previous reforms, which limits the level of pensions if the number of senior citizens grows faster than the number of contributors. By linking pension levels to demographic changes, the sustainability factor is an important element in ensuring the financial stability of the pension system.

A new reform program

However, the new reform program guarantees that the pension level will be maintained at 48% until 2039. This minimum pension level in the reform program contradicts the stability factor. On the contrary, contributions will increase, which will put a burden on the labor force and the younger generation.

However, this burden will be partially offset by a new investment fund managed by a public fund, to which the government will contribute Euro 12 billion for the first time in 2024 and which will be financed by public debt. The government's contribution to the fund will increase by 3% per year thereafter. By 2028, the government also plans to transfer another 15 billion euros from other assets into the fund, and the fund is expected to exceed 200 billion euros by the mid-2030s.

Starting in 2036, the government plans to allocate an average of 10 billion euros a year to the fund to cover pension costs and stabilize rising contribution rates. The current contribution rate of 18.6% of gross salary will rise to 22.3% in 2045 for those in the fund and 22.7% for those not in it.

Paradigm shift

In March, German Finance Minister Christian Linder called the investment fund a "paradigm shift." However, the fund will be financed by government debt, not pension contributions. The German government will have to guarantee that the fund will be used exclusively for pensions and that the fund will not be subject to political interference. In addition, the fund would have to compensate for higher contribution levels only to a certain extent. Disputes over these issues are hampering reform in Germany.

While diversifying income sources in a large pension system with an aging population is a good idea, it is clear that Germany's proposed reforms will hit the younger generation. The burden of reform should be shared across generations, even if it is politically difficult.

Current reform

The current reform is far from a comprehensive fiscal reform. It creates an off-balance sheet element invested in public debt. Instead, the government should consider other measures, such as extending mandatory pension plans to all the self-employed, most of whom are currently not required to join a pension plan.

Germany's pension system could also benefit from an increase in labor pensions. The introduction of real pensions would allow households to take advantage of the potential risks and returns of financial markets while reducing dependence on the public budget, even if initially in small amounts. This is true for other European systems that rely heavily on pay-as-you-go pensions.

Cash and deposits

In Germany, 42% of household assets are cash and deposits, much more than in France, the Netherlands and the US. In the long run, GDP must be high enough to meet the needs of senior citizens and workers. High pensions mobilize savings, finance real investment, and ultimately support long-term growth to meet these future needs. Unfortunately, current reforms in Germany are unlikely to introduce funded pensions.

David Pincus: A researcher who cares about an aging population

David Pincus joined Bruegel in May 2023 as a research associate. He is an applied economist interested in social policy and the intersection of financial markets and the real economy.

His research focuses on the challenges faced by social security systems as a result of population aging. He is also interested in the broader economic implications of funded pension plans and institutional investors. From 2014 to 2016, he served as an advisor to the OECD's "Long Term Investment Initiative" (LTI) program, where he researched the policy of infrastructure financing by institutional investors on behalf of the G20.

He holds a PhD in Economics from Copenhagen Business School and is currently working at the Pension Research Center (PeRCent) at the University of Copenhagen. He also holds a Master's degree in Economics from Bocconi University in Milan and a Bachelor's degree in Economics from Ludwig Maximilian University in Munich.