Many-a-person in Germany breathes a sigh of relief upon entering retirement: “Finally, an end to all that taxation!” It may come as a nasty surprise, therefore, that around a quarter of pensioners in Germany still have to pay income taxes - and the number is set to increase over the next few years.

One in four pensioners in Germany paid income tax in 2015

According to official figures from Destatis, the Federal Statistical Office, in 2015 around 21,2 million people in Germany were receiving either a statutory, private or company pension (or a mixture of all three). Of these, 27 percent - some 5,8 million people - paid tax on their pension income.

This tax is only payable on retirement benefit payments that exceed the tax-free personal allowance (9.168 euros in 2019). For couples who are married, the allowance is doubled. This means that, of the 278 billion euros given out in pension payments in 2015, only 43,4 billion euros (16 percent) were subject to taxation.

Taxation on pensions set to increase in Germany

Although this seems like a relatively small proportion, the taxable share of pension income is set to gradually increase over the next 20 years. The background to this is a change in pension law that provides for the transition from so-called “upstream” to “downstream” pension taxation. In common parlance, this means that pension contributions are gradually made tax free and in return pension benefits are taxed more highly in the payout phase.

If you’re worrying about a sudden tax hike, however, fear not - the transition is going to be very slow. Since 2005, an increasing proportion of pension contributions have become tax-deductible in annual income tax returns. The rate at which you are taxed on your pension, however, depends on exactly when you retire. Up until 2005, you were entitled to the old regulation, in which only 50 percent of your pension counts as taxable income. Anyone who retired in 2018 is taxed on around 76 percent of their pension, and from 2040 the proportion this will be 100 percent.

More money during working life

It may sound like an extreme turnaround, but the evidence suggests that over the course of a person’s whole life, the new model is more beneficial. Employees will be able to take advantage of tax-deductible pension contributions that significantly lower their overall tax burden during their working life.

This makes perfect sense when you consider that this period, characterised by high expenditure on things like rent, mortgages and raising a family, generally lasts a lot longer than retirement. This should ensure that everyone working in Germany has more money in their pockets when they need it most.