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Financial Planning Germany financial products Post

Guide to Income tax in Germany

I have been asked to write about personal income taxes in Germany and the German tax system a few times. Things get complicated with taxes when you are an immigrant, like an NRI from India with income in India and work in Germany. How do you then pay taxes in Germany and file tax returns? Do you hire a German tax consultant or do it yourself? Lets try to break it down to the basics.

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Tax Rates in Germany (2020)

Germany has a concept of progressive taxation, simply put the tax rates go upwards the higher your income is.

Income (Single)Income (Couples)Tax Rate
Less than 9,408 eurosLess than 18,816 euros0%
9,409 – 57,051 euros18,817 – 114,102 euros14%
570,52 – 270,500 euros114,103 – 541,000 euros42%
More than 270,000 eurosMore than 541,000 euros45%
Income tax rates Germany 2020

As a couple, the tax limits are doubled because taxes are calculated as a household. This tax rate is not complete it inself, apart from this your payslips will also have entries of Kirche Tax(Church Tax 8-9%) and Soli(Solidarity Surcharge at 5.5%).

Other Essential Charges which aren’t Tax

Apart from the tax payments each month, you also pay for Health Insurance (Krankenversicherung), Pension Insurance (Rentenversicherung), Disability and Unemployment Insurance (Pflegeversicherung & Arbeitlosenversicherung). The impact of all these payments is on your take home pay (nettolohn) which dwarfs when compared to your gross pay(bruttolohn).

So, how do you optimize your tax payments such that your take home pay isn’t tiny?

Tax Classes in Germany

Enter Tax Classes. If there is a concept which I have seen people confused with, it is the selection of tax classes. So here are two key principles to understand:

Principle #1: A tax class does not change your overall tax due to Finanzamt for a given year, that number is calculated based on your income level and applicable tax rate.

Principle #2: A tax class only changes your tax prepaid each monthto Finanzamt. So if you pick aggressive tax class, you get lower payslip now and a higher tax return at the end of the year. If you choose to pay too little tax now, the payslip is higher but at the end of the year you might have to pay back to Finanzamt.

  • Class I = single/separated
  • Class II = single parent
  • Class III = married and spouse has no income or lower income
  • Class IV = married and similar income to spouse
  • Class V = opposite of class III, i.e. this is the class your lower earning spouse has if you have III
  • Class VI= Employees who receive income from other employment

Most of the time classes are allocated by default, it is usually the Class III/V combination or Class IV where there is some choice to be made.

International Income and Double Taxation

If you have invested in your home country, then what is the impact on taxes? The answer to this is to first check if there is a Double Taxation Agreement between Germany and your country (you can see this here). The goal of such an agreement is to reduce taxes to be paid on the income earned, so that you do not end up paying taxes in both countries.

DTAA means you do declare your income from all sources in Germany and will get reductions in taxes in either Germany or your country. The actual rules will be as per the agreement and might need more digging into.

Now I can speak a little more for Indians living in Germany who have investments in India, you need to read this link.

Filing tax returns

You are supposed to file tax returns for the current year in the next year July 31. For example; for 2020 you should file returns by July 31, 2021

Tax returns are allowed retroactively, for the very first time, for upto 4 years. Finally, returns are made to a tool called as ELSTER.

You can choose to use software tools like wundertax, steuergo or have a tax consultant help you.

It takes a few weeks to get confirmation from Finanzamt, and the amount is usually transferred by the time you get your confirmation. In case of discrepancies, Finanzamt can ask you to submit more proofs.

Who needs to file tax returns?

If your income was more than minimum levels (above) in the year and if

  • There is income in another country during the financial year for you
  • You are married and one spouse has opted for tax class (Steuerklasse) III or V
  • The tax office (Finanzamt) has granted you an allowance (Freibetrag) on the employment tax statement.
  • There is income or benefits like parental or maternity leave payments.
  • You have received extraordinary income, such as severance payments for which your employer retained employment tax.
  • You have more than one employer at the same time (excluding mini-jobs).

Do you have more questions on Income tax in Germany? If yes, please leave a comment.

Categories
Financial Planning Germany financial products Pension Schemes Post

What is Rürup or Basis Rente?

Basis Rente

I am kicking off a new series on financial topics used in Germany. The first financial product that I would like to talk about is Rürup or Basis Rente (Rente in German means pension). We also explore common terms and their meaning to build up the concept of Rürup.

Concept #1: What is altersvorsorge and Gesetzliche rentenversicherung?

Altervorsorge (old age provision) is a general term used to describe various products and options which are available to support you for your old age. These are usually described into three pillars (or categories):

  • Basisvorsorge (basic provision) : This includes statutory pension insurance (also called gesetzliche rentenversicherung) scheme from the German state, and other products like Rürup . The products are usually tax efficient and are design to work as a pension should.
  • Privat vorsorge (private provision) : This is a private measure, people can use products in this category to top-up their Basic provision. This will include products like Employer pension, Reisterrente or Directfonds. There is usually some subsidy available.
  • Ungeförderte Private Vorsorge (unsubsidized prevention) : This is also a private measure usually focused on Lebensversicherung (Life insurance) products. It can also include products which offer pension with a life insurance.

Now, this post only focuses on Rürup , and I reserve some of the other topics for more posts in this series.

The question of Rürup Rente. Where does it fit in retirement planning

Rürup is a self invested pension scheme, this is well positioned for freelancers who may not be invested in the statutory pension program. At the same time it is also a choice for those who have statutory pension but want to top that with additional pension.

Rürup pension is named after Bert Rürup who is an economist and a politician. His focus was on pension reform and this pension scheme was launched in 2005 named after him. It is also often referred as Basis Rente

Why is this relevant as a top-up? The simple answer is that statutory pension payouts may not be sufficient to help you survive in old age. It is predicted that only around 48% of your last paid income will be your statutory pension (*the actual calculation is more complex). So Rürup is a way to supplement your pension and avoid

Key features of a Rürup pension program

  • Behaves like a pension, you cannot withdraw this in advance and it is only paid as a pension after retirement. You cannot exit a Rürup but stop paying into it.
  • There is no minimum contribution limit. Contributions can be stopped, this is helpful for freelancers.
  • As it is a pure pension plan, it also gives you tax benefits. Upto 24,900 EUR investment are tax free.
  • It cannot be transferred to another person, loaned against or inherited. It can be setup to get paid to your immediate dependent (spouse) or children if <25 years upon death.
  • It is designed to save taxes if you have a lot of tax liability, upto 100% tax rebate during accumulation from 2025
  • Pension will be taxable as per prevailing rules in future.
  • It is possible usually to change providers, but there can be fees.
  • Two versions usually exist: Fixed classic pension and Unit linked Pension
  • Fixed Classic pension has returns around 1.25%, while Unit Linked is linked to market performance.
  • Expense costs are high, between 3-6% annually.

Should I take a Rürup / Basis Rente?

This is a very debatable topic. Lets make it clear, if you are an immigrant and may move out of Germany, you will still get paid out but will need forwarding address. It might just add more hassle.

Having said that, many complain (and rightfully so), that Rürup has very small returns and when costs are considered the value of tax benefits is only realized when you are 70+ or something.

At the same time, you can think of Rürup as a bond investment, which is about capital preservation and not exactly about big returns. This is at the cost of losing access to capital, low returns and potentially high maintenance expenses.

Will Mr A invest in this?

No, I think I can potentially get better returns with index funds/ETFs and lower costs. I might think of it during the consolidation phase of retirement planning when capital protection is a goal.

Categories
Financial Planning Germany financial products Index Funds and Stocks Post

What is a Sparplan? What is Mr A really doing with his Sparplan?

Sparplan (I am so tempted to add a meme on this is SPARtaa..) is the way out of automatically managing your investments each month. It is an equivalent of a SIP (Systematic Investment Plan) if you are an Indian investor.

….when I login to my bank account, I notice two options, geldsparplan and wertpapiersparplan. What is the difference?

I use comdirect, and they have these two options, the main difference is:

  • geldsparplan – This savings plan simply takes money from your account and deposits into a Tagesgeld account which earns a whopping 0.01% interest (as of this morning) p.a. In other words, not worth it.
  • wertpapiersparplan – This savings plan is the one we need, we can setup a monthly investment amount and usually declare ETFs or even stocks to invest in each month.

….how much do I invest in a Sparplan? How much does Mr A invest each month?

As of this morning, I am investing 1098 EUR into my sparplan each month. This is mostly focused on diversified ETFs and 1 tiny piece of Amazon stock. I will write more about this in Portfolio page soon.

Let my number not scare you, I started really slow. I was investing less than 300 EUR/month an year ago and less than 200 EUR/month 18 months ago (2018).

As I have mentioned before and might do so again, we have to start with small steps and get comfortable. It took me a while to get comfortable with the idea of investing, and I started really slowly. I had never invested in Germany and had been programmed to be more cautious.

Can’t guarantee the numbers, but you catch the drift!

You can start with even 25 EURs/month, then and grow from there.

….what do I invest in? What are the pitfalls?

Picking your investments is a massive undertaking, but has been extensively covered in reddit.com/r/finanzen or on frugalisten.de forums.

The key pitfalls are, all investments carry risk, transaction costs charged by your depot account per transaction and TER (annual expenses) must be considered very carefully. I am personally a big fan of Index funds, which are lower in costs and deliver average returns.

….but can I not simply buy ETFs each month on the go and not bother with a sparplan?

Yes, of course you can, or you can automate it and forget about it. This is the whole premise of the famous book, The Automatic Millionaire. If you really look at it, it just makes sense, one automated step which simplifies your steps to your Financial Independence.

It makes it easier for me to plan it and worry about one less then thing to do each month.

Update: 22 June 2020

How do you open your Sparplan?

Comdirect:

Schritt für Schritt Anleitung für die Einrichtung eines ETF ...
If you have an account, get to the Wertpapiersparplan
  • Find your preferred ETFs on justETF and find its WKIN number.
  • Login to Comdirect> Geldanlage> Wertpapiersparplan
  • Click on Sparplan Einrichten
  • Enter your amount, minimum being 25 EUR. In the next screen you pick the funds.
  • Search for the WKIN which you had picked, add multiple funds if you nede.
  • Note the amount and the provision fees, i.e. 1.5% of the money invested goes into the fees.
  • In the next screen pick the frequency (monthly/once in 2 months/4 times a year), the date to buy and length of the plan.
  • Furnish your confirmation TAN and you are ready.

Quick questions on Tax and Residency

  • What is Capital gains taxes in Germany? The tax rate is 25% plus 5.5% solidarity surcharge, this should be paid at source. Some depots like Degiro do not offer this at source, and you need to take care of it in your returns.
  • Any tax exemptions on Capital gains? Capital gains of upto 801EUR are tax free, so for a family, this can be 1602 EUR.
  • Any special exemptions on Long term capital gains? Sadly, none.
  • Can I open a Depot account as a Work permit holder or PR holder? Yes, this is absolutely fine as you are tax resident of Germany.

If you have more questions on sparplan, then write into the comments section.