Are Pensions In Germany Tax-Free?
Does the German tax-free pension exist? 🤔 In this blog post, you will learn about the taxation of all different pensions we have in Germany (all three levels).
- Level 1 pensions are tax deductible up to an annual amount of 25.369€. However, you will have to pay income tax in retirement.
- The company and Riester pension is also tax deductible. Additionally, you can get some employer/governmental bonuses.
- Private pension level 3 is taxed with capital gains tax in retirement. However, compared to an investment account, you pay much less.
- In general, German pensions are not tax-free. Nevertheless, you can receive huge tax benefits to help you secure your retirement.
Pensions are an essential aspect of retirement planning in Germany. While they are not entirely tax-free, they offer significant tax advantages that retirees can benefit from. The German pension system operates in three levels, each with its own rules and regulations. It is crucial to understand the differences between each level to make informed decisions about retirement planning.
In this blog post, we will examine the tax advantages and disadvantages of each level and help you understand how pensions work in Germany. Whether you are planning to retire in Germany or elsewhere, understanding the intricacies of the German pension system is essential. So, let’s dive in and explore the tax implications of each level in detail.
Taxation of pensions in level 1: Public & Rürup pensions
Level I pensions in Germany, which include public pensions and the Rürup pension, offer significant tax benefits. These pensions allow us to make tax-deductible contributions, meaning that we can deduct everything we invest, up to 25.369€ per year, from our income when filing our tax declaration. However, there is a catch – the tax-deductible nature of these pensions means that when we retire and start receiving payments, they are treated as regular taxable income. As a result, we will be required to pay tax on these payments at our regular personal income tax rates.
Despite this potential disadvantage, there is still an advantage to this situation. When we retire, we may have a lower total income, which could push us into a lower income tax bracket. This could lead to lower tax payments on our pension income, thereby reducing our overall tax burden. It is essential to understand the implications of the tax-deductible nature of these pensions and how they can affect our retirement income planning. In the next section, we will explore level II pensions, which offer different tax benefits and rules.
Taxation of pensions in level 2: Riester & Company Pension
Moving on to level II pensions in Germany, we have two options: Riester pension and company pensions. Both of these offer tax-deductible contributions, just like level I pensions. However, there are some additional benefits to be aware of. For instance, contributions made to a company pension plan are also exempt from social security contributions, which is certainly a perk to keep in mind when considering your options.
With regards to the Riester pension, the government provides bonuses to encourage people to save for retirement. In order to receive these bonuses, you need to make contributions to the pension plan yourself. Depending on your income level and family situation, the bonuses can be quite substantial, and can even amount to several hundred euros per year. This can help boost your retirement savings and provide some additional financial security.
However, there are some drawbacks to level II pensions as well. One of the biggest disadvantages is that the tax-deductible amount for the Riester pension is relatively low, at just 2.100€/year. This means that if you are looking to save a larger amount for retirement, this may not be the best option for you. Additionally, just like level I pensions, the income you receive from these pensions in retirement is also subject to personal income tax, which can be a significant expense depending on your retirement income and tax rate.
Taxation of pensions in level 3: Private Pension
Private pensions. Our contributions to level III pensions are not tax deductible, but the income is tax deductible in retirement. When taking our level III pension benefits, we can choose to take the money as a lump sum, which is not possible in levels I and II.
We can work through an example to understand how our level III benefits will be taxed. If we make 100.000€ in after-tax contributions and investment growth of 100.000€ increases this to 200.000€ total by the time we retire. If we take the total 200.000€ as a lump sum, only 50% of the gains (so 50.000€) are subject to income tax. At a 20% tax rate, this would mean we only pay 10.000€ in taxes on our 100.000€ in profits. The tax advantages of pensions can be seen if we compare this to someone who had invested the money in a normal stock or ETF portfolio instead – they would be liable for 25% capital gains tax on the full 100.000€, or 25.000€ in taxes.
If we take the money as a regular withdrawal, it becomes a little bit more complicated. We have to calculate an Ertragsanteil, which is a percentage of the pension withdrawals which are taxed, depending on our age at retirement. This decreases the later we leave it to access our private pension. It can vary from 22% at 60, meaning 78% of our payments are tax-free, to 15% at 70, where 85% of the pension is free of tax. This means that from 100€, 85€ are tax-free and 15% will be taxed. If you have a 20% income tax rate in retirement, then you pay 20% in taxes on the 15€. This will amount to a total tax burden of 3€ (on the 100€ pension).
Conclusion: Are Pensions in Germany tax-free?
In conclusion, pensions in Germany offer several tax advantages, but they are not completely tax-free. Understanding the different levels of the pension system is crucial to take advantage of these benefits. While public and Rürup pensions offer tax-deductible contributions, they are subject to personal income tax when taken as income in retirement. On the other hand, Riester and company pensions also provide tax-deductible contributions, and we can secure government bonuses with a Riester pension. Private pensions, on the other hand, do not offer tax-deductible contributions, but the income is tax-deductible in retirement.
If you find the information provided in this blog post overwhelming and need personalized guidance regarding your financial situation, we are here to help. We offer free meetings where we can discuss your specific circumstances and provide you with a clear understanding of how pensions work in Germany. We understand that planning for retirement can be daunting, but we are here to make the process as straightforward as possible.
In addition to our free meetings, we also provide a retirement income tax calculator on our website that can help you estimate how much tax you can expect to pay based on your projected income sources in retirement. By inputting your expected retirement income from each source, the calculator can give you a clear picture of what your tax burden may be. It’s a helpful tool to have when planning for your future and can give you the confidence to make informed decisions about your retirement. So, if you need help or want to check out our calculator, please visit our website or book a free meeting with us today.