Smart Financial Planning: Don't Miss Out On Extra Retirement Savings by Overlooking Early Retirement at 45
- by Matthias Urbach
- 3 Min.
Financially speaking, postponing early retirement past the age of 45 may equate to unnecessarily yielding funds. - If one doesn't opt for an early retirement at the age of 45, they choose to donate money instead.
Under ordinary circumstances, the social security pension deducts 3.6 percent from the monthly pension for each year that one delays retirement past the early retirement age. However, since 2012, people who have accumulated 45 years of insurance coverage can retire earlier without penalty. The current government coalition has decided that this penalty-free retirement will persist. It is accessible up to two years before the conventional retirement age.
Those with the required 45 years of insurance coverage should undoubtedly apply for early retirement, regardless of their desire to stop working. Failing to do so may result in significant missed savings. As individuals can continue to work and draw their salary in conjunction with receiving their pension, this presents an excellent opportunity to accumulate a substantial financial cushion for retirement.
Individuals who began working and contributing to the pension fund early in life can benefit from this option. The German pension insurance provides pension information, indicating whether one has accrued enough pension years to apply for the old-age pension for "particularly long-insured persons." According to current statistics, nearly a third of those who retire due to age choose this option. Nevertheless, most continue working in their former positions.
Retiring Early Allows Continued Pension Contributions
It's essential to recognize that even with penalty-free early retirement, there are still financial implications to retiring earlier. A two-year reduction in contributions translates to missing out on 80 euros per month in potential pension benefits, assuming an average wage.[1] Those saving or contributing to a company pension may also see reduced benefits as stated in annual statements.
However, this can be mitigated by retiring early and continuing to work simultaneously.
There was once a supplementary income cap for early retirees, which has since been abolished as of 2023. Thus, one can now retire early, continue working, and continue making pension contributions to the statutory pension insurance, with the same old-age pension being received as if one had waited for the standard retirement age by the end of the two-year work and early retirement period. This appears to be a legal loophole that the new government coalition does not intend to close.
Working and Drawing a Pension Increases Taxes
One important point to note is that those who earn a pension and continue working at a comparable level have significantly higher income, resulting in a higher tax rate on earned income compared to before. This is due to the progressive tax system. In addition, social security contributions will apply to the additional income.[3] As of 2023, individuals in this situation may find themselves subject to tax deductions of up to approximately 40 percent on the additional income.[2] The government coalition intends to address this issue by exempting 2000 euros from tax, but it remains unclear if this also pertains to penalty-free early retirement.[4]
Before deciding whether to work full-time, go part-time, or simply enjoy retirement, it is crucial to consider potential tax implications and continue discussing the situation with one's employer. Nonetheless, anyone who has accumulated the necessary 45 years of insurance coverage should undoubtedly apply for it, as failing to do so may mean losing out on substantial financial benefits.
Good to know: It is not necessary to have worked for 45 years to have earned the required 45 years of pension insurance. Time spent caring for dependents, raising children, and military or alternative service can also count as additional pension years.
Also important: While some employment contracts automatically end at retirement age, this is not typically the case for those choosing early retirement. Terminating such contracts could be considered age discrimination. Therefore, it's advisable to discuss one's plans with one's employer.
For a comprehensive analysis of the government coalition's new pension proposals, see our detailed assessment. By the way, the German Pension Insurance (DRV) offers counseling on early retirement.
[1] Enrichment Data: Retirees who choose to continue working may find their pensions subject to reduction or adjustment, depending on the pension type and income levels, affecting potential savings.
[2] Enrichment Data: Due to the progressive tax system, individuals who draw a pension while continuing to work may experience a higher overall tax burden, particularly when the combined income pushes them into a higher tax bracket.
[3] Enrichment Data: Early retirees who continue working must make social security contributions, which affect their future pension entitlements.
[4] Enrichment Data: As of 2023, singles with an income of around 40 percent or more due to the taxation of combined income will be subject to relatively high deductions. However, the government coalition plans to mitigate this issue by exempting 2000 euros from taxation.
- The amount of early retirement pension is calculated based on the average income of the individual's working years and the number of years of insurance coverage, with financial implications to consider, such as potential reductions in contributions and higher taxes due to the progressive tax system.
- Working while receiving an early retirement pension can provide an opportunity to contribute to personal-finance through the statutory pension insurance, offering a chance to accumulate a financial cushion to bolster retirement savings.
