Peter Scheller
Berater für Wirtschaftsprüfer, Rechtsanwälte, Steuer- und Unternehmensberater

„Wenn es knifflig wird.“

401(k)-Plans and German taxation

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US pension plans are an important cornerstone of retirement planning both for US citizens and US residents. As long as citizens and residents remain in the USA the tax consequences are straight forward. However, if a US citizen or a citizen of another state relocates to Germany and withdraws money from such a plan, the tax situation changes and becomes more complex. This is particularly so because many questions regarding the German taxation of withdrawals form 401(k)-plans or IRAs are still unresolved. However, a recent ruling of the German Federal Fiscal Court clarified one outstanding point.

The court case related to a German citizen who worked in previous years in the USA for a US employer. He was in a company pension plan (401(k). The citizen returned to Germany and withdrew money from the 401(k)-plan while being tax resident in Germany. There was no dispute between the German tax authorities and the complainant that the withdrawal was taxable income in Germany. In cases like this, Article 18 (1) of the Double Taxation Convention between Germany and the USA (DTC USA) gives Germany the right to tax payments from US pension plans. The question was which provision of the German income tax law is applicable in such cases.

  • The German tax authorities took the view that the full amount of the withdrawal has to be taxed in Germany as regular income. The argument they took was that contributions to qualified US pension plans are subject to special tax benefits in the USA since they are paid out of non-taxed income (pre-tax). As withdrawals from qualified German pension plans would be subject to a full taxation in Germany, the view was that the same should apply to US pension plans which enjoyed the same tax benefits in the pay-in phase.
  • The argument of the claimant was that the relevant German provision is only applicable to qualified German pension plans because only German tax benefits are specified in the relevant tax code. Foreign tax benefits are not specified in the list and should therefore be disregarded. The view of the claimant was that another provision of the German income tax code is applicable, namely the provision allowing the taxation of the difference between a withdrawal and the contributions attributed to that withdrawal.

Example: A person who is tax resident in Germany withdraws 100,000 $ from the 401(k)-plan. The funds of the plan before withdrawal were 200,000 $. In the pay-in phase the employee and the employer paid contributions to the total amount of 80,000 $. If the opinion of the tax authorities is correct, 100,000 $ should to be taxed in the year of withdrawal. If the other opinion is correct only 60,000 $ (100,000 $ minus ½ of 80,000 $) would be taxed in Germany.

The Fiscal Court of Cologne ruled in 2018 that only the difference between the withdrawal and the attributable contributions is taxable income. The Federal Fiscal Court (which is Germany’s highest fiscal court) confirmed the judgement. It ruled that the provision in the German income tax code does not include foreign tax benefits and it is not the function of a court to alter the wording or meaning of a law or legal provision of it. Therefore only the difference between the withdrawals from a plan and the appropriate attributable contributions can be taxed in Germany.

This ruling is also applicable to US citizens who relocate to Germany and withdraw money while being tax resident in Germany. The difference to the above mentioned court case is that US citizens have to declare such withdrawals in their US tax return as ordinary income. This is due to the fact that the so called saving clause (Article 1 (4) DTC USA) allows the US to tax its citizens regardless of where they are resident. A double taxation scenario is mitigated by the fact that the USA will credit the German income tax against the federal US income tax. If the German tax on the withdrawal is higher than the US tax the combined tax burden will be higher than the US income tax alone. Therefore this ruling also applies for US expatriates who relocate to Germany and withdraw money from a plan of major importance.

Various questions surrounding withdrawals from foreign pension plans are still to be resolved:

(1) Which plans are covered by the above ruling?

The ruling covers withdrawals from a 401(k)-plan. The same should also apply for other company plans and plans of the US government or other institutions. Protocol 16 (a) aa to the DTC USA specifies the following plans which are accepted by the German tax authorities:

  • qualified plans under section 401(a) of the Internal Revenue Code
  • individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k)
  • individual retirement accounts, individual retirement annuities, and section 408(p) accounts
  • section 403(a) qualified annuity plans
  • section 403(b) plans
  • section 457(b) governmental plans

The same should apply for private plans such as Individual Retirement Accounts (IRA). It is unclear whether the ruling also applies to non-qualified retirement plans. My opinion is that a plan should be be classified as a pension plan if it covers a significant biometric risk such as longevity, death, incapacity to work, disability or care for dependents and are in general paid after reaching retirement age. Pension plans from other countries have to be analysed carefully. They have to be comparable in legal and economical structure to German pension plans or pension insurances in order to be covered by the ruling.

Withdrawals from Roth-401(k) plans or Roth IRA should also be covered by the German provision (withdrawal minus attributable contributions) even without the ruling since contributions have been made out of taxed income (ie after tax). These plans are not favorable for persons who are tax resident in Germany because in the USA the withdrawals are tax free but not so in Germany.

The ruling is applicable on these kinds of pension plans as well.

(2) What happens to roll overs?

Roll overs are transfers of funds from one plan into another plan. Often funds of a 401(k)-plan are transferred into a (private) traditional IRA. There are various kinds of roll overs such as direct roll overs when funds will be directly transferred from one plan into another. There are indirect rollovers when funds are paid out to the beneficiary and he or she pays the funds into another plan within a 60-day period (also called 60 days roll overs). In general roll overs are not taxed in the USA. An exception is the rollover from a 401(k)-plan into a Roth IRA which is subject to US income taxation.

In Germany the transfer of funds from a qualified pension plan into a private pension plan is in general a taxable event. The withdrawal from the plan will in most cases be subject to German income tax. However, Article 18A (1) DTC USA states that Germany does not have the right to tax roll overs from one US pension plan into another one.

This is a special provision of the DTC USA. Double Taxation Treaties between Germany and other countries do not have a similar provision. Nonetheless, other countries such as the United Kingdom also recognise tax-free roll overs. Expatriates from these countries should be careful if they intend to roll over funds from one plan into another plan while being tax resident in Germany. This could end up in very unpleasant tax consequences.

(3) Is half of the difference applicable?

Germany’s above mentioned rule has a special extension. If the beneficiary is 60 years of age or more and the plan or insurance contract has existed for more than 12 years, only half of the difference between the withdrawal and the attributable contributions is taxed in Germany. In the above mentioned example only 30,000 $ would be taxed. If the contract was agreed after 31 December 2011 the beneficiary must be 62 years of age to benefit from this rule. The ruling of the Federal Fiscal Court did not clarify whether this specific rule is applicable to foreign pension plans. However, in my opinion there is no obvious reason why this rule should not be applicable to foreign pension plans.

Still unresolved is the question of whether a roll over would be ignored in determining the 12-year period or whether the 12-year period starts new with the date of the roll over? There are no statements of the German tax authorities nor any rulings of German fiscal courts in this respect. Therefore expatriates should be careful to roll over funds from one into another plan before or after relocating to Germany.

(4) Is the penalty tax deductible?

In general a person who withdraws money or funds from a qualified US pension plan before he or she reaches 59 ½ years of age would have to pay a penalty tax of 10% (in addition to the regular income tax on the withdrawal) in the USA. Still unresolved is whether this penalty tax is then tax deductible in Germany. There are pre-court proceedings pending where German tax authorities have to decide whether to allow the deduction or not. Whether these cases will lead to court cases remains to be seen.

(5) How to prove the total amount of contributions?

Often it is difficult or impossible to provide proof of paid contributions. This is especially the case with plans that have been running for a long period of time or with inherited IRAs. If there is no full documentation available it is sometimes advisable to ask financial institutes (trustees) or insurance companies for help but even then it is not always possible to get conclusive documentation. In this case the only way to proceed is with educated guesswork. Whether German tax authorities would accept such estimates remains to be seen.

Authors:

Peter Scheller, Steuerberater, Master of International Advisers, Fachberater für Zölle und Verbrauchsteuern

Alexander Wangerowski, Steuerberater, https://aw-stb.de/

Bildquelle: www.fotalia.com

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Kommentare

Kommentar von Ulrich Dr Tillmann |

Dear Mr Scheller,

Think you very much for sharing your valuable insights. I would hope that Rollover IRAs will find the same consideration taxwise as 401 k accounts. Upon leaving an
employer employées are offen asked to take their 401 k funds with them. Upon arriving on their new employer‘s payroll, there are often waiting periods before participation in the new employer‘s plan is allowed. In many instances, the new employer’s plan offers less attractive investment options
In other scenarios, employees can stay in their old employer’s plan but are typically kicked out once their former employer changes plan providers. In all of these cases, the Rollover IRA is the recipient solely of 401 k plan funds and hence closest in purpose to the 401 k where the funds came from. That would argue in favor of applying the same German tax ruling that now applies to 401 k funds. Kind regards, UT

Antwort von Peter Scheller

The ruling is applicable: However, if there a roll over within the last 12 years took place it is questionable whether half of the difference between withdrawal and attributable contributions is applicable.

Kommentar von Ulrich Dr Tillmann |

(3) Is half of the difference applicable?

Dear Mr Scheller,

Can you please clarify the source of the ruling that only half the difference between withdrawal and contribution are taxable given the other conditions ( age, duration of contracte)are met? Best regards, UT

Antwort von Peter Scheller

If you are 60 years of age or more and the plan or insurance contract has existed for more than 12 years, only half of the difference between the withdrawal and the attributable contributions is taxed in Germany. If the contract was agreed after 31 December 2011 the beneficiary must be 62 years of age to benefit from this rule.

Kommentar von Hannelore |

Hello Mr. Scheller: looking at your example above, why is it $100K -1/2 of $80K that is taxable and not $100K-$80K? ALso if you are a tax resident of Germany and have a 401K does the US RMD rule at age 72 still apply?

Thanks

Antwort von Peter Scheller

You can only deduct 50% of the contributions because you withdraw only 50% of the plan's assets.

If you withdraw all assets you can deduct all contributions.

The German law does not require any minimum distributions!

Kommentar von Hannelore |

Mr. Scheller: thanks for the quick reply. If you are a dual citizen, but a tax resident of Germany does the RMD rule still apply for the US?

Thanks

Antwort von Peter Scheller

Yes

Kommentar von Joe |

How would 401k contributions be taxed at the time the contributions are made for an American living in Germany working remotely for an American company? Would they only be taxed at the time of withdrawal like in the US? Or would Germany tax 401k contributions as regular income?

Antwort von Peter Scheller

Contributions to a US-plan are tax-free (if paid by the employer) or can be deducted up to certain maximum amounts.

Kommentar von Joe |

Thank you for answering my previous question. It is much appreciated. I am considering accepting a job based in the US and which pays $49500. Assuming I contribute $19500 to my 401k, how much income would I pay German taxes on in 2022? Would it be $30000 like in the US?

Antwort von Peter Scheller

This requires a analysis of your overall situation and a tax calculation. Please contact as tax adviser.

Kommentar von Scott Nisbet |

I understand from your article that a US citizen with German tax residency will not be subjected to German tax for a direct rollover of a 401K to an IRA according to Article 18A (1) DTC. If the same person converts a 401K or aIRA to a Roth, is it subject to German tax? USA Tax only? or a combination?

Antwort von Peter Scheller

I think that a roll over will be covered by Art, 18 (1) DTC USA even if Roth-401(k) plans are not explicitly mentioned in No. 16 of the protocol.

Article 18A
Pension Plans

1.  Where an individual who is a resident of a Contracting State is a member or beneficiary of, or participant in, a pension plan established in the other Contracting State, income earned by the pension plan may be taxed as income of that individual only when, and, to the extent that, it is paid to, or for the benefit of, that individual from the pension plan (and not transferred to another pension plan in that other Contracting State).

Protocol

16. WITH REFERENCE TO PARAGRAPH 4 OF ARTICLE 18A (PENSION PLANS)

a) For purposes of paragraph 4 of Article 18A, the term "pension plan" shall include the following and any identical or substantially similar plans established pursuant to legislation enacted after the date of signature of this Protocol:

aa) In the case of the United States, qualified plans under section 401(a) of the Internal Revenue Code, individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, and section 408(p) accounts, and Roth IRAs under Section 408A), section 403(a) qualified annuity plans, section 403(b) plans, and section 457(b) governmental plans.

Kommentar von Juergen Zimmermann |

Dear Mr Scheller,

I worked from 1994 to 1998 in US and participated in a Savings and Retirement Plan at this time - 401(k). Now I am retired (66). As I understand I have to pay taxes in Germany regarding the withdrawal. Can I avoid paying taxes in US and how?

Antwort von Peter Scheller

You have to declare this kind of income in the US. However, you may be able to claim the foreign tax credit in the US. Speak to your US advisor.

Kommentar von Cecile Cuppens |

Dear Mr. Scheller,
I have read your information about how the German tax authority defines the 401K and IRA carefully and still feel that it is a grey area if the German Finanzamt will accept the IRA as a pension plan and not as a private investment fund. I am living in Germany and have a 401K in the US that I like to transfer to an IRA with Charles Schwab International, direct rollover. From there I can make payments to my German bank account when I retire and pay the appropriate taxes. What would you recommend I should do to get something in writing from my local Finanzamt that they agree on the status as pension fund of the IRA and not as a private investment fund. I cannot make a partial transfer to the IRA, have to make transfer the full amount or else I could test it out. Looking forward to your ideas. Freundliche Gruessen Cecile

Antwort von Peter Scheller

It is no grey area since the No. 16 Protokoll to Double Taxation Convention USA/Germany explicitly defines 401 (k) plans and IRAs as pension plans.

A roll over will not be taxed (Article 18A (1) Double Taxation Convention USA/Germany).

Whether you want to inform the German tax office or not is your own choice. I would not do it since the legal status is pretty clear.

Kommentar von Cecile Cuppens |

Thank you very much for your quick answer. Your answers and this website is very insightful. Kind regards Cecile

Kommentar von Gregor Falke |

Are withdrawals from an individual retirement account (IRA) that was used to invest into US-ETFs (such as S&P500 index funds) taxed as
- regular income (prorated difference between contributions and current value converted to EUR at the time of the respective transactions)
- or as Kapitalerträge (25% + Soli, in case of Aktien-ETFs potentially even with a 30% Teilfreistellung)?

If one continues to contribute after moving to Germany and deducts ones' IRA contributions from German taxes, I assume that these contributions will not be subtracted when calculating above difference (as for those the argument of the German tax authorities in above ruling should apply)?

Antwort von Peter Scheller

Withdrawals are taxed as regular income.

The second question is a good one. This scenario is not covered by the ruling. I suppose that all contributions which result in a tax benefit in Germany (because the contributions are  deducted from the taxable income in Germany) will not be deductible from later withdrawals.

Kommentar von Gregor Falke |

Dear Mr Scheller,

Thank you so very much for the quick response and all the wonderful information here. Considering that the German private retirement system (such as Riester etc.) usually comes with high fees, it's really fascinating that American citizens who have an existing IRA can actually benefit from the generally superior US retirement account options (low cost IRA with full control over investments and often zero additional fees). It's amazing that they can then even deduct their retirement contributions from the German taxes (as you explain above), which effectively means their IRA becomes tax-advantaged like Riester, but without all the drawbacks of the German options (high fees, low return, little transparency and no control).

Regarding the applicability of Kapitalertragssteuer:
Why does EStG § 20 (1) 6. (https://www.buzer.de/20_EStG.htm) not apply to an IRA account, according to which "der Unterschiedsbetrag zwischen der Versicherungsleistung und der Summe der auf sie entrichteten Beiträge (Erträge) im Erlebensfall oder bei Rückkauf des Vertrags bei Rentenversicherungen mit Kapitalwahlrecht" falls under the "Einkünften aus Kapitalvermögen"? As it is possible to withdraw a lump sum from an ETF-invested IRA account (or even the whole sum - big advantage compared to Riester or Rürup in terms of flexibility), it appears that in this case the IRA income may be considered Kapitalertrag, so that 25% plus Soli applies (potentially even including Teilfreistellung for ETFs). Or are IRA accounts somehow excluded

Thank you again for your article and all your clarifications!

Antwort von Peter Scheller

§ 20 (1) No. 6 EStG is only applicable on insurance contracts. However, IRAs are in general trust based. Therefore I think that the § 20 (1) No. 6 EStG is not applicable but probably § 20 No. 5 EStG.

Kommentar von Lucas |

This is not really a comment or question, but just a remark/compliment that your fantastic resources are regularly discussed in the US Expat Tax Questions Facebook group with more than 32k members. Most recently here (https://www.facebook.com/groups/usexpattax/posts/5585263181491036/). Just FYI, not for publishing here...

Kommentar von Gregor Falke |

I'm following up on your recent statement that IRAs with ETF investments are taxed according to § 20 No. 5 EStG rather than § 20 (1) No. 6 EStG. I had checked § 20 No. 5 EStG and it distinguishes
a) ist bei lebenslangen Renten sowie bei Berufsunfähigkeits-, Erwerbsminderungs- und Hinterbliebenenrenten Nummer 1 Satz 3 Buchstabe a entsprechend anzuwenden,
b) ist bei Leistungen aus Versicherungsverträgen, Pensionsfonds, Pensionskassen und Direktversicherungen, die nicht solche nach Buchstabe a sind, § 20 Absatz 1 Nummer 6 in der jeweils für den Vertrag geltenden Fassung entsprechend anzuwenden,
c) unterliegt bei anderen Leistungen der Unterschiedsbetrag zwischen der Leistung und der Summe der auf sie entrichteten Beiträge der Besteuerung; § 20 Absatz 1 Nummer 6 Satz 2 gilt entsprechend.

As an IRA with stock investments does not appear to fall under (a) or (b), I assumed that (c) is applicable and thus we end up with § 20 (1) No. 6 EStG. Or would you say that an IRA falls under (b) for some reason? Thank you again for your time.

Kommentar von Ulrich Germann |

Responding to Kommentar von Gregor Falke | 15.03.2022.

Disclaimer: I'm not a tax expert, especially not when it comes to other people's international taxes. What I write here is only an expression of my personal opinion and does not constitute any advice or legal opinion in any way, shape, or form, and comes with absolutely no claim to accuracy (or warranty, or guarantee).

That said, based on https://datenbank.nwb.de/Dokument/449077/?fbclid=IwAR0LB1F7SrGOkPfziU3DLpbTq2k4QCN8N7MqkvNI1TpoWXko-niHD3KmFPY, my hunch would be that anything based on contributions after 2008/01/01 would be taxed as income under EStG § 22 Nr. 5 (as an aside: I'm not aware that EStG § 20 Nr. 5 even exists. That article has only two paragraphs, and EStG § 20 (1) Nr. 5 doesn't make sense here, as it's related to income from real estate). As far as I understand, § 20 Abs. 1 Nr. 6 EStG would only apply to retirement income based on contributions prior to 2008. Anything else appears to fall under § 22 Nr. 5.

I'm a bit puzzled by the distinction that Mr. Sheller appears to draw between traditional IRAs (408(p)) and employer-sponsored plans such as 401(k), 403(a/b), etc. The Protocol to the German-US Double Taxation Agreement (18A, see earlier in this comment section) puts these in the same category. Roth-IRA(s) (401(a); after tax) and Self-directed IRAs (SDIRAs, don't know the relevant US tax code section) are a different matter.

Moreover, another thing to consider here is the implication on health insurance if you decide to retire in Germany. Depending on your health insurance situation (doesn't matter if you are privately insured (fixed premium regardless of income) or "freiwillig gesetzlich versichert" (ALL income counts toward the calculation of your income-based premium), but if you are in the "Krankenversicherung der Rentner", only certain income is considered, and that's where things get messy and you should seek professional advice. Distributions from employer-sponsored plans (such as, 401(k)) are subject to mandatory health insurance contributions (but possibly not the part that you paid into personally after quitting your job; apparently it depends on who is named on the insurance policy; did I mention it's messy?), whereas private pension plans (such as a traditional IRA) are not. I have no idea of tax implications of converting a 401(k) to a traditional IRA in time not to fall under the assumed 10-year payout period assumed for single payouts.

As I said, I'm no expert and look forward to being corrected by Mr. Scheller on all the things I got wrong here ...

Kommentar von D.F. |

Thank you for your incredibly helpful articles and answers.

You've written that contributions to US 401(k)s and IRAs are considered by Germany to be pension plans, and thus are tax deductible (or tax-free if contributed by an employer). What are the contribution limits for 401(k)s/IRAs for US citizens working in Germany for US organizations as a freelancer?

Any specific guidelines or resources you could point to would be much appreciated.

Antwort von Peter Scheller

This depends on various factors.

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