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(2023) What does the 2005 Pension Income Act regulate?

The Pension Income Act governs the taxation of pensions, affecting everyone, both those who retired in 2005 and all future retirees. The tax burden for new retirees increases each year, but there are also benefits for employees.

Tax-advantaged pension schemes

In addition to the statutory pension insurance, private pension insurance is also recognised as a form of retirement provision, particularly the so-called basic pension or Rürup pension. Contributions to private pension insurance are only tax-advantaged if the insurance provides a lifelong pension for the policyholder. Furthermore, the insured person must be at least 60 years old at the start of the pension. For contracts concluded from 2012 onwards, pension payments may not begin before the age of 62. This ensures that these are retirement products. These pension entitlements must not be transferable, pledgeable, sellable, or capitalisable. In addition, the pensions must be paid out as annuities; lump-sum payments are generally not permitted. However, you can extend these tax-advantaged pension products with additional insurance, such as occupational disability insurance.

Investment products that are not necessarily intended for retirement provision, such as freely available capital investments, including endowment life insurance, are not tax-advantaged. An exception is endowment life insurance policies concluded before 2005 – they remain tax-free.

For pensioners, this means:

Since 2005, 50 per cent of pension income has been taxed. From 2006 to 2020, the taxable portion of pensions increased by two percentage points each year, and from 2021 by only one percentage point per year.

Originally, people retiring from 2040 onwards were to fully tax their statutory pension income. However, from 2023, starting with the 2023 retirement cohort, the taxable portion will no longer increase by 1 percentage point per year, but only by half a percentage point, reaching 100 per cent for the first time in 2058 (§ 22 No. 1 a) aa) EStG, amended by the "Growth Opportunities Act").

For pensioners who start receiving their pension in 2023, the taxable portion is 82.5% of the pension amount.

Also regulated in the Pension Income Act: Temporary pensions, such as disability pensions, and non-temporary pensions, such as old-age pensions, have been treated equally for tax purposes since 2005. Pensions from insurance policies that were tax-advantaged during the accumulation phase are taxable during the payout phase.

 

At the end of May 2021, the Federal Fiscal Court published its two rulings on the possible double taxation of pensions. However, the lawsuits filed by the affected pensioners were unsuccessful. The Federal Fiscal Court considers double taxation to be possible only in a few individual cases. It considers the basic system of pension taxation to be lawful, including the limited deduction of pension expenses during working life and the partial tax exemption of pensions during the payout phase. Double taxation is only emerging for later retirement cohorts (Federal Fiscal Court rulings of 19.5.2021, X R 33/19 and X R 20/21). However, the unsuccessful plaintiffs have lodged a constitutional complaint against the two Federal Fiscal Court decisions (Ref. 2 BvR 1143/21 and 2 BvR 1140/21).

The issue is how double taxation is calculated in detail. The Federal Fiscal Court has taken a very schematic view, which only leads to excessive taxation of pensions in individual cases. For the calculation of possible double taxation, the nominal value principle applies. The actual contributions paid and the tax-advantaged pension expenses must be compared with the actual pension payments received later, which are partially exempt. Amounts are neither to be discounted nor adjusted for inflation.

However, some experts, as well as the plaintiffs in case X R 33/19, argued that during the working phase, no pension amounts in cash are acquired, but rather pure pension points. The actual amount of the pension only becomes clear much later. However, the Federal Fiscal Court did not delve into the "depths" of financial and insurance mathematics but compared amounts paid in with amounts paid out. Whether this is correct or whether there is a more favourable calculation for taxpayers will be clarified by the constitutional judges in Karlsruhe.

Currently, the federal and state governments have agreed to issue affected tax assessments on a provisional basis regarding the disputed point. Specifically, tax assessments are issued provisionally with regard to the "taxation of annuities and other benefits from basic provision under § 22 number 1 sentence 3 letter a double letter aa EStG". The provisional note is added to all income tax assessments for assessment periods from 2005 onwards in which an annuity or other benefit from the so-called basic provision is recorded (BMF letter of 30.8.2021, V A 3 - S 0338/19/10006 :001).

This means: Pensioners will now receive income tax assessments with a note on the - partial - provisional nature of the tax assessment. If the Federal Constitutional Court finds that the current taxation of statutory pensions and pensions from professional pension schemes and similar pension schemes is unconstitutionally high, the tax assessments issued now and in the future can be changed without a prior objection.

Important: Affected individuals should keep all tax and pension statements, even those from many years ago, regardless of any potential outcome.