401K plans and their German counterparts

Introduction

Residents of the USA planning their retirement may well have a 401K plan and their German counterparts have access to a similar facility, to help them in their financial planning for retirement. Of course planning for your retirement isn’t just about planning your long term financial security - but knowing that you’ll be able to live at the standard to which you now enjoy and will be able to do all the things you’d like to when you have more leisure time, will be very significant in any retirement plans you make. So, what is the USA 401K financial retirement plan and what is its German counterpart?

401K retirement plans in the USA

The idea behind 401K pension plans arose in the late 1970s when the US Congress passed a Tax Reform Act in 1978, that allowed for any savings from earnings being put into a retirement financial plan could be exempt from taxes, until such time as the pension starts to be paid out or withdrawn. After being written into the statute books as Internal Revenue Code section 401, para (k) - hence the term 401K pension plans - the first of these 401K private pension plans began in 1982. The 401K pension plans allow for money from an American’s salary to be transferred into their 401K account directly by the employer, before the person receives their monthly pay check; and can vary in value up to 15% of the annual salary. 401K accounts are mutual funds, which by a variety of devices, basically means the money put into a 401K account is invested into stocks and bonds. Some companies offer their employers special 401K account facilities that the employer also makes a contribution to. These employers usually then use at least a portion of the money in the 401K accounts to invest in the company(s) that the employer owns. This has benefits and risks to it. The employer is, in effect, enhancing your remuneration package and the employee saving into the 401K pension account knows the company they’re working for and the sort of investments he/she is making through their pension fund. They are also incentivized to work to ensure the continuing success of the employers company(s), thereby safeguarding their pension plan. The risk, of course, is that the person saving for their retirement could end up with all their savings reliant on the success of just one company.

Germany’s 401K equivalent

In line with most European Union countries, Germany had for many years more of a ‘welfare state’ approach to the issue of pensions and pension funding than did the USA. However, in this topsy-turvy world of modern politics it could be that under the new Barack Obama administration the USA could take a veer to the left towards a more ‘welfare state’ approach, whilst Germany currently seems to be moving towards lurching right a more capitalist, ‘every man for himself’, approach. Several demographic factors are motivating this shift in policy by the German government toward individual personal retirement pension plans: unemployment is the highest it has been for years, in Germany whilst fertility, or at least child births, are falling the age profile of the nation is rising with more and more people living longer into their retirements and finally, the after effects of reunification are still being felt on the nations social security system. Subsequently the new millennium ushered in several FRG pension reforms - the Riester Reforms. The essence of these reforms is that every German is now responsible for their own retirement savings and pension plan - gone is the “purely collective Pay-as-you-Go” state pension plan. Individuals make voluntary contributions to their own pension saving plan, to which employers do not have to contribute. Subsidies and tax incentives have been put in place to try and ensure participation in these retirement savings plans by even the lowest paid workers. Also, the German government anticipates that many pension funds will be collective occupational ones, rather than strictly individual ones - retaining an employer element. Almost ensuring this point was the right, from 2002, for employees to demand access to employer pension plans, where part of the employee’s salary is automatically deducted by the employer, whether or not the employer contributes to the scheme.