How to Invest in Germany: Taxes on Investments (ETFs, Real Estate, Pensions, etc)
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Taxes are an extremely boring topic. But in a country like Germany – where you pay a lot of taxes – it is also an extremely important topic. Because if you understand just enough about taxation to use it to your advantage, you can save Thousands of Euros every year and Increase Your Income in Germany.
Taxes are besides Inflation one of the two factors that weigh heavily on your return on Investment. Ignoring taxes and inflation might make you think you have a return on your investment even though you don’t. Generally speaking, the German government wants its share of every earning. It doesn’t matter what it is (except lottery wins).
Saving Taxes is one of the biggest Misconceptions in the financial world. So let’s take a look at what “tax savings” even mean. Because this misunderstanding leads very often to Investment decisions that are made solely for the reason of saving taxes.
You hate paying Taxes. We hate paying taxes. Everyone hates paying taxes. But please do not make any Investment decisions only for the reason of saving taxes. The highest tax rate in Germany is 45% (Income Tax Rate after earning more than 270.501€ in 2020).
Most of the time, people Misunderstand saving Taxes like this: putting 1€ into something that is Tax-deductible and therefore getting a maximum of 45 cents back. But that is not a REAL tax saving, because you still had a minimum of 55 Cents in costs. In order to have REAL tax savings, you need to get more than 1€ in taxes back when you put 1€ in.
"Investing into something because it is tax deductible is a myth."
It’s just like when stores offer discounts or a sale. It doesn’t make sense to buy an Investment Product simply because it has a 20% if you do not need it. Because you still have to pay 80% out of your pocket.
Please keep that in mind before making any Investment decisions. Tax deductions are nice and can boost your return, but they cannot be the major factor for or against a certain Investment Product.
3. Taxes in Germany
Income up to 9.409€ per year is Tax-free in 2020 (twice as much for married people). All (rental) income after 9.409€ is taxed with at least 14%.
Example: with an income of 9.410€ per year you would pay 14 cents in Income Tax (14% of 1€ after 9.409€). The (Rental) income tax rate rises fast up to 42% for income higher than 57.052€ per year. So 42 cents of every Euro you earn is paid to German Finanzamt.
Example: If you earn 60.000€ Income From Work and 3.000€ Rental Income, you earn in total 63.000€ taxable income. The bad news is that your 3.000€ rental income is Taxed with 42% (see graph above). The good news is that real estate Investors can counterbalance most of the costs they have from renting against the Passive Rental Income they generate:
Depreciation is the single most underrated tool for financial success when investing in Real Estate. From a Tax perspective, a Property loses 2% of its value per year (can be more for i.e. historical buildings). So after 50 years, the property would be worthless from a tax perspective. Only the property, not the ground your property stands on.
Every employee has at least Level 1: the Public Pension (Deutsche Rentenversicherung). Together with your employer you are paying in 18,6% of your salary in 50:50 split (only salary up to 82.800€ in 2020 – everything more than that is free of public pension).
As Pensions Level 1 are tax-deductible during payin, put your contributions into your tax declaration and get up to 42% in Taxes back. Because during payout, pensions level 1 will be taxed. Same with Pensions Level 2.
While payin is not tax-deductible, payout offers certain Tax Benefits. The amount of tax benefit and the variation depends on the payout you choose. Because Pensions Level 3 is the only level where you can decide if you want a life-long pension or if you want a one-time sum of all the Savings you accumulated over the decades.
An example with the best-case scenario would look like this:
Another Tax Benefit for these products is that everyone with a German Tax ID (so everyone) is allowed to make 801€ in capital gains per year completely tax-free. Married couples can make 1.602€ in capital gains per year. German Banks will therefore not tax you before you make 801€ in profits if you give them your “Sparer-Pauschbetrag.”
There are more than 70.000 funds available on the German market – Investing into basically everything. We strongly believe that no Financial Product should rule over your freedom to choose your Personal Investment Strategy without any limitations. If you need help in deciding which funds with which investment strategy are right for you, click the button and secure a Free 30m session with us.