Double taxation: Why does it exist in pensions and who is affected?

Previously, employees had to make pension payments from taxed income, but the pension payments were then tax-free. That was the upstream taxation. But the legislature had to change this system because it led to unequal treatment of employees and civil servants. The transition to downstream taxation has been in effect since 2005, which means that pension contributions have remained tax-free step by step since then, initially at 60 percent, later more. While pension payments were gradually taxed. At least 50 percent since 2005, a little more every year.

Originally, pensions would be taxed at 100 percent in 2040. But now that point in time has moved back and full taxation will not take effect until 2058. However, pension contributions have been completely tax-free since 2023.

The reason for this were complaints from pensioners who had been taxed twice since 2005: They made pension contributions from income that had already been taxed and were also subject to tax deductions during the retirement phase. One sticking point was that this was in addition to the change in taxation. The gradual change in the system makes the whole thing somewhat complicated.

So why wasn’t taxation changed all at once? If the downstream taxation had been suddenly introduced in 2005, then firstly the federal government would have lost a lot of tax revenue in one fell swoop (because no employee would have paid additional contributions on pension contributions), and secondly, all pensioners would have had to pay taxes on their payouts from 2005 onwards – which would mean that they would all have been taxed twice, which would not be constitutional.

That is why the legislature decided on an extremely long transition period in order to prevent this double taxation. Nevertheless, the Federal Finance Court (BFH) confirmed in two judgments in 2021 that double taxation could occur, whereupon the legislature was urgently required to make improvements. The traffic light coalition introduced a transitional regulation in 2023 – pension contributions are now fully deductible, but full taxation will not take effect until 2058. This will already lead to a “significant relief”, stated a report from the universities of Würzburg and Berlin, which was prepared on behalf of the Federal Ministry of Finance (BMF). Especially for generations from around 1973 to 1990. Overall, “fewer pensioner cohorts are now affected”, but the report also says: “Nevertheless, there is a need for further reform”.

Even the traffic light government admitted this after the improvements to the Retirement Income Act: “In order to completely avoid double taxation both for future pension cohorts, but also to eliminate any double taxation that may have already occurred in individual cases in existing pension cases, further regulations are required, which will soon be regulated by law in a third step.” So a new law is needed.

Double taxation is still possible. However, it currently only affects very few people. According to the report, those who are already retired are often taxed less than before. However, the BMF report found that double taxation could potentially affect many people who will soon be retiring. In general, this depends on four main factors: primarily the salary (i.e. the number of pension points collected annually), the year of retirement, the number of years of contributions to pension insurance and the amount of personal contributions to pension provision. The type of employment is also relevant, i.e. whether someone is self-employed or employed or combines both in their work biography. As well as the spouse and their profession.

Men living alone are often affected because they do not benefit from the more favorable spouse taxation and cannot receive a survivor’s pension and also statistically have a shorter life expectancy. As a result, they also receive fewer pension payouts on average.

The experts calculated several case studies as examples and determined: “Double taxation occurs for numerous cohorts who will retire in the next few decades.” The extent of double taxation differs for all pension access cohorts, but reaches its peak (due to the transitional regulation) around 2058. So for those born around 1991 who then retire. For later generations: “The double taxation problem will disappear” when they retire in 2070, as only this cohort will have fully claimed all pension insurance contributions as pension expenses. This should no longer affect those born around 2003.

Double taxation also occurs more frequently the more pay points employees collect per year of employment. A low-income earner (with around 50 percent of the German average salary of currently around 50,000 euros) is affected much less often; for them, the cumulative double taxation volume would be around 10,000 euros. For an average earner, the burden already grows to 13,700 euros. For high earners who are above the contribution assessment limit, the cumulative peak is already 28,300 euros when they retire in 2058.

The problem is also significantly more pronounced among the self-employed than among employees. Self-employed people pay entirely into the pension fund themselves without receiving employer contributions. A good 55 percent of people who do business experience double taxation, and even 66 percent of freelancers. For them, the cumulative volume could be over 80,000 euros.

For those who are already retired and affected by double taxation, the new law has not brought any changes. The experts continue to say that its double taxation volume remains unchanged. Self-employed people in particular are faced with the highest double taxes, which is why additional legal adjustments urgently need to be made for them in order to completely avoid double taxation, as the Federal Finance Court has demanded. Additional pension allowances could provide relief in the future.

There is only an all-clear for everyone whose pensions are below the allowances for pensioners. So anyone who receives less than around 1000 euros per month is not taxed twice.

By the way, double taxation is calculated like this: If the total of taxed income (until retirement) is higher than the tax-free portion of the pension, then, according to the Federal Finance Court, there is double taxation. The following amounts may be included in the tax-free portion of the pension not The following are calculated: the tax-free subsistence minimum, the health insurance and nursing care insurance contributions, the flat rate for business expenses and the flat rate for special expenses.

The basic rule is: All tax assessments since 2005 carry a provisional note that relates to the taxation of pension contributions and pension taxation. Anyone who suspects that they may be subject to double taxation should have all pension payment notices and all tax documents ready, as they must be presented in case of doubt. However, only tax assessments issued after August 30, 2021 can be challenged. All older tax payments are now considered legally binding and are therefore unassailable.