How to Invest in Germany: Taxes on Investments
In this post, you will learn about taxes on ETFs, real estate, pensions, and other investment options. Just enough so you know how to use taxes to your advantage.
Introduction
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).
But Gambling with your Life Savings in hope of a tax-free lottery win is not the Best Investment Strategy. Germany knows 7 Different Types of Income that are Taxed in different ways. But before we start, let’s clear up the myth between FAKE tax savings and REAL tax savings.
The Myth of Saving Taxes Explained
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 274.613€ in 2022).
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.
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% discount if you don’t 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.
Taxes on Real Estate
Income up to 10.347€ per year is Tax-free in 2022 (twice as much for married people). All (rental) income after 10.347€ is taxed with at least 14%.
For example: with an income of 10.347€ per year you have to pay 14 cents in Income Tax (14% of 1€ after 10.347€). The (Rental) income tax rate rises fast up to 42% for income higher than 57.918€ per year. So 42 cents of every Euro you earn is paid to the German Finanzamt.
The big advantages of rental and Investment Income are, that firstly you do not have to work for it, and secondly, most Investments are taxed much better than income from work. Except for taxes on rental income that are taxed exactly the same way as income from work. But Real Estate is nevertheless a very interesting asset class from a tax perspective.
When buying a property in Germany, you have to pay the so-called additional purchasing costs that can amount to about 10% of the property value:
- 3,5% – 6,5% Ground Taxes (depends on the state)
- 1,5% – 2% Notary & Ground Book
- 3,57% Real Estate Agent (if you need one)
Real Estate Investors can deduct these costs from their taxes. Homeowners have to pay these additional purchase costs out of their own pocket.
The running tax implications while renting out your Investment property are different than the one-time purchasing tax situation. As rental income is taxed like Income From Work, you have to declare it the same way you declare any other income you have.
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:
- (+) Gross Rental Income
- (-) Interest Rate for Loan
- (-) Incidental Rental Costs (Property Management Company, Renovations, etc)
- (-) Depreciation
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.
Therefore it is extremely Tax-efficient to have a high Property Value and a low ground value in your purchase agreement before you buy an Investment Property. Knowing and acting on this Underrated Trick will save you thousands of Euros over the next 50 years.
Taxes on Pensions
The German government wants its citizens to save for Retirement. Because when we get old, we could become an expensive problem for the German social security system. That is why Germany has such a big pension system and also why All Pensions (Level 1, Level 2, or Level 3) offer some kind of tax benefits. This is the German government’s way of incentivizing its citizens to save money for the long term. Very beneficial for all Investors, who want to save money anyway.
The German Pension System is built in 3 Levels that we have to differentiate between payin- and payout-phase.
Every employee has at least Level 1: the Public Pension (Deutsche Rentenversicherung). Together with your employer, you are paying 18,6% of your salary in a 50:50 split (only salary up to 84.600€ in 2022 – 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.
A very popular question from expats when learning about Pensions is: “What is the point of postponing my tax bill?” The delayed paying of taxes will most likely save you a lot of taxes. There are 2 reasons why pensions level 1 and pensions level 2 can be very beneficial from a tax perspective:
- Paying Taxes later is better than paying taxes right now (because of Inflation)
- Your tax rate while Working is probably higher than in Retirement
Pensions level 3 is different than the other pension levels In Germany.
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:
- 30.000€ payin (85€/month over 30 years)
- 100.000€ Pension value (historical average 7% rate of return of Stock Market over 30 years)
- 70.000€ profit (that would be Taxed without it being a pension)
- 35.000€ is taxed (the benefit of level 3 pensions is that only 50% of the profit is taxed)
- 10.500€ Taxes (with a Personal Marginal Tax Rate of 30%)
- 89.500€ net payout
Another advantage besides the tax benefits becomes obvious when taking a look at the taxation of ETFs and Mutual Funds.
Taxes on ETFs, Mutual Funds & Bank Accounts
As Pensions are Taxed only in the moment you get money out of them, other investments like ETFs (Exchange Traded Funds), mutual funds, and Bank Accounts are taxed every single year that you hold this Investment Product.
Banking and Investing products have very easy Taxation rules compared to Real Estate or Pensions. They are taxed with a maximum 25% Tax Rate + Solidarity Surcharge + Church Tax in case you are a member of the church. If your Personal Marginal Tax Rate is lower than 25%, your tax rate on banking and investing products will be also lower.
Another Tax Benefit of 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 in 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 secure a Free 30m session with us here.
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