Current taxation of pensions and the German Retirement Income Act
The way pensions are taxed at present is a result of the pension reform in early summer 2004. At that time, the aim was to switch over from taxation in the accrual phase to a system of deferred taxation. However, for constitutional reasons, this may not give rise to double taxation at any time.
Currently, it is not possible to claim full tax benefits in an income tax return for the pension contributions that have been paid. Instead, merely a percentage – variable according to the year when retirement starts – of the contribution payments obtain a tax exemption. Conversely, only a certain percentage of the pension that is paid in the future to the taxpayer would be taxed.
In the Retirement Income Act (Alterseinkünftegesetz, AltEinkG) German lawmakers introduced long-term transitional rules, which came into effect on 1.1.2005. The aim of these rules was to bring about the incremental taxation of pensions and, in parallel, increase the level of tax deductibility of pension contributions that have to be paid.
- While 50% of pension amounts that started to be paid up to and including 2005 were tax exempt, now, it is only 18% of the pension amounts that started to be paid out in 2021. Pensions that will start to be paid out in 2040 will have to be fully taxed.
- Conversely, in 2005, it was only possible to claim a tax benefit for 60% of pension contributions paid by way of a special expenses deduction. For 2021 it will already be possible to deduct 92% of contributions as special expenses.
- The original intention was for the contributions that had been paid to be fully deductible as of the 2025 assessment period.
The ‘traffic light’ coalition agreement
The new coalition agreement provides for pension contributions that have been paid to be fully tax deductible as of 2023 already via the special expenses deduction. Furthermore, from this point in time, the portion of the pension that is taxable would only go up by 0.5 percentage points per year and no longer – as originally envisaged – by 1 percentage point per year. The consideration here resulted from the fact that, in a considerable number of cases, there could be a situation of so-called double taxation if the original timetable was adhered to.
According to the established case law of the Federal Fiscal Court (Bundesfinanzhof, BFH) – see, e.g., ruling of 19.5.2021, case reference: X R 20/19, margin number 48 –there would be no double taxation if the sum of the pension inflows likely to remain tax-exempt was at least as high as the sum of pension contributions made from taxed income.
According to the BFH, when calculating the pension inflows that will remain tax-exempt, items such as the basic personal tax allowance, special expenses for contributions to health insurance and long-term care insurance schemes or the standard deduction for allowable costs should not be included – this was in contrast to what the German lawmakers had first started to think about and had previously also been applied – (ruling of 19.5.2021, case reference: X R 33/19, margin number 33).
The calculation involves multiplying the (tax-exempt) pension drawn by the statistical life expectancy, which is taken from the official mortality tables. To this are added the amounts that will probably have to be paid out to surviving dependants. If a comparison with this sum shows that the amount from pension contributions made from taxed income is higher then this would be deemed to be a case of double taxation that, from the perspective of constitutional law, would have to be objected to (cf. Federal Constitutional Court ruling of 6.3.2002, case reference: 2 BvL 17/99, BVerfGE [Federal Constitutional Court Decisions] 105 p. 73, margin number 206).
Conclusion: All that glitters is not new. The changes to the way pensions are taxed, which were announced in the coalition agreement, more likely serve the purpose of preventing constitutional complaints with regard to inadmissible double taxation from being lodged on a massive scale in the future.