The tax consequences of deferring the start of retirement, with particular focus on the tax-free portion, are explained below on the basis of a case decided by the BFH.
The Case
The plaintiff is a member of a professional pension scheme and turned 65 in October 2009. In principle, he was therefore entitled to begin drawing his pension without deductions. However, the plaintiff applied to defer his pension payments by three years in order to further increase his pension entitlement. When he ultimately began drawing his pension in the 2012 assessment year, 64 % of his pension benefits were subject to taxation, instead of the 58 % taxable share that would have applied in 2009. In the plaintiff's view, the tax-free portion should be determined based on the original year in which the pension entitlement arose.
Calculation of the Tax-Free Portion of the Pension
The taxable portion, and accordingly the tax-free portion, of the pension is determined by the table in § 22 No. 1 sentence 3 a) aa) EStG. The year in which the pension commences is decisive for the relevant taxable share. The tax-free portion of the pension then corresponds to the difference between the full annual amount of pension benefits and the share subject to taxation. This calculation is carried out in the year following the start of the pension (§ 22 No. 1 sentences 4 f. a) aa) EStG).
BFH Ruling: Case – Deferred Pension Commencement
The BFH held that the actual start of the pension is decisive for determining the taxable portion of the pension. This must be taken into account in cases of deferred old-age pensions. If the start of the pension is deferred, the tax-free portion of the pension benefits is reduced accordingly. The reason is that the taxable portion of the pension rises continuously until 2040, after which pensions commencing in that year or later will be subject to full taxation.
Frequently asked questions
Frequently asked questions
Which year is decisive for the taxable portion of the pension?
Pursuant to § 22 No. 1 sentence 3 a) aa) EStG, the year of the actual commencement of the pension is decisive. The taxable portion applicable at that time, as set out in the statutory table, is applied to the pension. An earlier possible pension start date (e.g., upon reaching age 65) is irrelevant if the pension is in fact only drawn later.
What are the tax implications of deferring retirement?
Anyone who postpones the start of their pension is subject to a higher taxable portion, as this is gradually increasing to 100% by 2040. As a result, the tax-free portion of the pension is smaller than it would be with an earlier retirement date. This tax disadvantage must be weighed against the higher pension benefits achieved through deferral.
How is the tax-free portion of the pension calculated?
The tax-free portion is the difference between the full annual pension amount and the taxable share determined by the table in § 22 Nr. 1 S. 3 a) aa) EStG. The calculation is performed in the calendar year following the start of the pension (§ 22 Nr. 1 S. 4 f. EStG). The resulting tax-free allowance generally remains unchanged for subsequent years.
How did the BFH rule on deferred retirement?
The BFH clarified that the taxable portion of a pension is determined exclusively by the actual start of the pension. In the case at hand, deferring the pension start by three years (from 2009 to 2012) meant that 64% of the pension was taxable instead of 58%. Retroactive application to the year in which the pension could originally have been claimed is not permitted.
Is it tax-beneficial to defer the start of retirement?
From a tax perspective, deferral is generally disadvantageous, as the taxable portion increases with each later starting year while the tax-free portion is permanently reduced. This is offset, however, by higher pension payments resulting from the upward adjustment of accrued entitlements. An individual comparative calculation is therefore advisable before making a decision.