Retirement provision with foundations – enjoying liquidity and security

This is a situation most employees face at some point:

The end of working life is approaching. With current, quite respectable income, it has been possible to pay off the owner-occupied home and meet the children’s education costs. In addition, for the above reasons, there is no high level of cash assets or cash assets that are perceived to be sufficient for old age. The remaining working life for building up such liquidity reserves as a nest egg is shrinking, and at the same time there is a growing preoccupation with questions as to how any care services and care costs that may arise in old age can be solved financially.

In this situation, especially if the family home does not need to be inherited, the contribution of the owner-occupied property to a charitable foundation with the simultaneous reservation of a life-long usufructuary right can be an interesting arrangement and a building block for one’s own old-age security. A donation to a charitable foundation entitles the founder to claim a corresponding special expense deduction in his income tax return. This reduces his taxable income and the income tax burden is reduced. With the Act to Further Strengthen Civic Involvement (Gesetz zur weiteren Stärkung des bürgerlichen Engagements), the legislature has increased the possible maximum special expense amounts for such donations to one million euros per taxpayer since 2007. For married couples, the amount doubles accordingly to two million euros.

Hedging with usufructuary rights

The amount of the contribution and thus of the special expenses deduction corresponds to the value of the property after deduction of an amount for the reserved usufructuary right. Property value is usually determined by an expert appraisal. The usufructuary right to be deducted is made by multiplying the notional local annual rent for the property by a factor reflecting the statistical life expectancy of the person entitled to the usufruct.

This leads to interesting results, especially in metropolitan areas with high real estate prices and low rental yields. If, for example, a property in the Munich area has a market value of one million euros, this compares with a customary annual rent in the region of 40,000 euros. The property is valued at 25 times the annual rent.

Tax advantages

For example, for a 60-year-old woman, a life usufruct is valued for tax purposes at 12.034 times the annual rent and deducted from the property value. After deduction of this burden, a special expenses deduction of 12.966 times the annual rent remains in the example. This amount, equivalent to EUR 518 640, results in income tax savings and additional liquidity of EUR 229 809 at an income tax rate of 44.31 percent (42 percent ESt plus five percent solidarity surcharge).

The prerequisite for this is that the taxable income after making the special deduction is at least 52,160 euros. The special expenses deduction can be distributed freely over a period of ten years from the date of the donation. In addition, the general charitable deduction can be claimed at 20 percent of annual income. Neither gift tax nor inheritance tax is levied by the tax office. There is also the possibility of entering tax allowances on the income tax card or reducing advance income tax payments. Towards the end of a professional career, the highest incomes are regularly achieved with a corresponding income tax burden.

This earned income is taxed progressively, while capital gains are taxed at a flat rate of 25 percent plus a five percent solidarity surcharge as of this year. By skilfully utilising and distributing the special expenses deduction gained over the last few years of work, a considerable amount of liquidity can be created, which can be invested at a low tax rate, if the income is sufficient. A capital investment of the amount of EUR 229 809 mentioned in the example leads, at an interest rate of three percent net after final withholding tax, to cash assets of around EUR 427 000 after 20 years. This amount is then available at around the age of eighty, for example, to cover any nursing home and care costs that may be incurred during the last stage of life. In the meantime, one has spent one’s twilight years unchanged within one’s own four walls and has not had to accept any restriction of one’s quality of life. If a corresponding agreement is made, income from a rental is also available in the event of a necessary move out of the owner-occupied home.

Public interest and asset protection

In the case of foundations, it should be noted that a charitable foundation must fulfil its foundation purpose on an ongoing basis. If only a property with a reserved usufructuary right is transferred, the foundation initially has no liquid funds available to fulfil its purpose. Here, there is the possibility of additionally providing the foundation with a smaller cash amount, which, however, costs parts of the own liquidity that has just been created. Alternatively, however, an endowment and transfer of the property to an already existing foundation can be made, which is equipped in terms of liquidity in such a way that it can fulfil its charitable purpose on an ongoing basis. Foundations can be established in the form of a foundation with legal capacity or also as so-called trust foundations.

The trust foundation is regularly the more suitable form of foundation, as it is more flexible and less bureaucratic in its establishment and handling.

A pleasant side effect of transferring the property to a charitable foundation is the certainty of supporting a charitable purpose of one’s own choice and deemed worthy of support in the event of one’s death. After all, even during one’s lifetime there is the opportunity to support the foundation’s purpose and to find for oneself a fulfilling old-age task oriented towards the common good. The foundation should also be seen as an instrument of asset protection for the founder. Assets such as collections, works of art and patents can be entrusted to your own foundation, which is managed according to the founder’s specifications.

In this way, certain assets can be protected from being broken up by heirs in the event of death or, in principle, from being accessed by third parties. With the established foundation, which can bear the name of the founder, the founder experiences at the same time a piece of immortality: Foundations are basically designed for eternity. They consist of basic capital in the form of special assets that belong to themselves. Married couples and singles without heirs or with distance to relatives can appoint their own charitable foundation as heir. The inheritance to be transferred to the Foundation in the event of death may be used to promote any charitable purpose. It is advisable to set up the foundation during one’s lifetime and to endow it with a small amount of assets.

Solution for company successions

According to calculations by the Institute for Research on Small and Medium-Sized Businesses, more than 300,000 family-owned businesses are facing a change of ownership in the coming years. It is estimated that in about 40 percent of all cases there is no suitable successor from the family circle or no descendants. In this context, the double foundation, which is one of the company-affiliated foundations, represents a contemporary, intelligent building block for solving the problem of succession. For example, the shareholder or managing director of a GmbH (limited liability company) can transfer a large part of the privately held company shares to a charitable foundation without voting rights and in a tax-neutral manner. The remaining GmbH shares, which carry voting and sufficient profit participation rights, are transferred to a family foundation in Germany or abroad.

by Dr. Johannes Fiala and Dr. Uwe Dörnbrack

by courtesy of

www.median-verlag.de (published in Hörakustik 01/2009)

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About the author

Dr. Johannes Fiala
PhD, MBA, MM

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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