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Tax aspects of private pension insurance: Lump-sum payment or pension payment?

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Investment with advantages: Tax aspects of private pension insurance

Private pension insurance is one of the most popular forms of retirement savings and offers various options and payout methods. Depending on the chosen pension plan and the type of payout, tax implications can arise both during the savings phase and at retirement. This article explains the tax implications of private pension insurance.

Can private pension insurance be claimed as a tax deduction?

Neither traditional nor unit-linked pension insurance policies are tax-deductible, as these products do not receive government subsidies. This means there are no allowances or tax advantages. However, savers benefit from income tax during the payout phase, which we will explain in more detail later.

However, Riester pensions, Rürup pensions, and contributions to the statutory pension insurance can be taken into account for tax purposes. These options are considered state-subsidized retirement savings and will not be discussed further here. The same applies to company pension schemes, where the tax advantages result from the reduction of gross income and the associated reduction in the tax burden.

Exception for older contracts: Tax benefits for contracts concluded before 2005

The Retirement Income Act, which came into force on January 1, 2005, reformed the taxation of pensions in Germany. Since then, private pension insurance has been classified as a non-tax-advantaged retirement savings product and therefore cannot be deducted from taxes. However, an exception applies to contracts concluded before 2005.

If you took out a private pension or life insurance policy before December 31, 2004, you may be able to claim the premiums as special expenses on your tax return. This is conditional upon the contract meeting the requirements of Section 10 Paragraph 1 Number 2 Letter b of the German Income Tax Act (EStG) 2004.

The contract has a minimum term of 12 years.
Both the start of the term and the first contribution payment took place before January 1, 2005.

If you meet these criteria, you can deduct 88 percent of the contributions as special expenses. These expenses must be entered under "Other pension expenses" in line 49 of your income tax return.

Note, however, that a maximum amount applies to other precautionary expenses. Since health insurance contributions are also included, the deductible amount may already be exhausted. In this case, tax advantages also cease for pension insurance policies concluded before 2005.

Tax advantages of private pension insurance upon payout

The tax advantages of a private, non-subsidized pension insurance policy become particularly apparent upon payout. Unlike other retirement savings products such as the statutory pension, the Riester pension, the Rürup pension, or company pension schemes, which are fully taxed at a later date, only the so-called income portion of a private pension insurance policy is taxed. This income portion depends on the insured person's age at the start of the pension payments.

Age at retirement	Revenue share
57	25 %
58	24 %
59	23 %
60 to 61	22 %
62	21 %
63	20 %
64	19 %
65 to 66	18 %
67	17 %
68	16 %
69 to 70	15 %

The personal tax rate is then applied to the income portion, which is usually lower in retirement than during working life.

Example:
Let's say you retire at age 63 and receive a monthly pension of €300 from your private pension insurance. The taxable portion is 20%. This means that €60 of the pension is subject to your personal tax rate, while the remaining €240 is tax-free.

Tip: The later you retire, the less you have to pay taxes on your retirement savings.

Special features regarding capital payout

Instead of a pension payment, you can also choose a lump-sum payment, depending on your contract. In this case, there are some special considerations regarding taxation:

Contracts before 01.01.2005If the contract term was at least 12 years, the capital payouts are tax-free.
Contracts after 01.01.2005These contracts may qualify for tax relief. Only half of the return (i.e., the difference between the invested capital and the payout) is taxed (half-income procedure).

TipIf you took out a private pension insurance policy before 2005 and a capital option was agreed upon, you should consider receiving a lump sum payment, as this allows you to take advantage of tax benefits if all conditions are met.

Half-income procedure

The half-income procedure applies under the following conditions:

The contract must have been in effect for at least 12 years.
The payout cannot be made before the age of 62 (for contracts concluded before 2012, the limit is 60 years).

In this case, 50 percent of the proceeds are tax-free, while the remaining 50 percent are subject to your personal income tax rate. It is important to declare the capital payout in your tax return (Schedule KAP) to receive a refund of any overpaid taxes.

Example:
A saver has accumulated €30,000. At the agreed retirement date, he receives a payout of €40,000, resulting in a return of €10,000. Half of this €10,000 (€5,000) is subject to tax. At a tax rate of, for example, 20 percent, this results in a tax liability of €1,000. €39,000 of the capital remains.

Flat-rate withholding tax

When you receive a lump-sum payment from a private pension insurance policy, the insurer automatically deducts 25 percent capital gains tax, the solidarity surcharge, and, if applicable, church tax. If you do not meet the requirements for the half-income procedure, the entire amount is subject to a flat-rate withholding tax.

Example:
In the example given, the saver would have to pay tax on the entire €10,000 return. This corresponds to €2,500 in capital gains tax (25 percent of €10,000) plus solidarity surcharge and, if applicable, church tax. The tax burden in this case is more than €1,500 higher than under the half-income procedure.

TipIf the so-called 12/62 rule is met, the half-income procedure is worthwhile. In this case, the saver should reclaim the overpaid tax in the year of payout via their tax return.

Lump sum payout or annuity payment: Which is more advantageous?

The question of whether a private pension plan is better suited as a pension or as a lump-sum payment cannot be answered in general terms. The decision depends heavily on your personal circumstances. It is advisable to calculate all options and the tax deductions before making a decision.

An exception applies to contracts concluded before 2005, as these are generally tax-free upon lump-sum payment. If you opt for an annuity, you must pay tax on the income portion. In such cases, it is often more advantageous to withdraw older contracts as a lump sum.

Our experts at Badent & Klemm Consulting are happy to answer any further questions you may have about private pension insurance and its tax treatment. We will also assess whether a pension payment or a lump-sum payout is more suitable for your individual situation. Simply schedule an appointment with our consultants!