The pension promise as a tax trap?
The advantages of a pension commitment are sufficiently known to every tax consultant and GmbH controlling shareholder-managing director. Tax advisors have also recommended this pension plan to their clients in order to reduce taxes and increase liquidity in the company.
However, experts estimate that over 90% of all GmbH managing directors have been promised a pension for retirement that cannot be financed by the GmbH. Most of the reinsurance concepts of the pension commitments have gotten out of hand with predominantly German endowment policies. Since the stock market crash in the years 2001 to 2003, the profit sharing and yield promises of German insurers have practically disappeared into thin air. Of the promised returns of around 7.0 % p.a. originally determined using non-binding sample calculations, only 4.0 % or less p.a. remained for many insurers. This means that many commitments lack the necessary funds for later pension payments: With a term of 20 to 30 years, gaps in coverage of 40 to 50 percent can quickly occur up to retirement age 65.
This is a fatal situation, as the tax authorities are now paying more attention to the financial viability of pension commitments and, if they cannot be financed, are quickly accepting hidden profit distributions. The unfunded pension commitment is discussed at the latest in the event of anticipated succession, the sale of a company or a succession arrangement. What began as a tax saving model can later lead to unavoidable tax burdens and an impending old-age poverty of the managing director. Numerous tax consultants are aware that the majority of their clients have fallen into over-indebtedness due to the pension commitment, for these reasons. Insolvency can thus be pre-programmed, as it were.
Risk of the company buyer and in case of anticipated succession!
A further disadvantage of the pension commitment is above all the fact that when the GmbH is sold, nobody really wants to buy a GmbH with an existing pension commitment. A lifelong obligation to pay an annual old-age pension of 36,000 € to 60,000 € is something that no successor would want to tie himself to his leg. The liquidity of the company is often endangered in the short term with such a high monthly burden, especially if the pension commitment was calculated – as usual – only at the low tax values. The risk of the company buyer is expressed in the fact that often less than half of the assets are available that would be necessary to pay a lifelong pension.
Financial service providers are happy to recommend the formation of additional reserves for classic restructuring – sometimes also referred to as “outsourcing the pension commitment”: Unfortunately, however, this approach hardly changes the liability of the Mittelstands-GmbH, nor does it change the fact that the financial means for further reserve formation are too rarely available.
Capital compensation as a lifeline?
The tax advisor then usually advises a lump-sum settlement of the pension commitment, as the continuation of the commitment with payment of monthly old-age pensions by the GmbH cannot be financed in the long term and ends when the managing director reaches the age of 75 or 80. In the case of a lump-sum settlement at the age of 65, however, it is important that the corresponding agreement is formulated and available in the exact wording of the pension commitment. Many pension commitments are not up to date in terms of text, because important BMF letters have not yet been taken into account. A settlement of the commitment will then often not be possible or will be treated by the tax office as a hidden contribution: The manager will then have to pay tax on the part of the pension he has waived, i.e. tax on non-existent income.
The expert opinion of an actuary on the pension commitment also helps to considerably reduce liability in the event of a tax audit by the tax office. At first glance, it is also bitter for the entrepreneur to realise that long-term contracts, especially when it comes to his own old-age provision, require regular review and adjustment. In the case of the restructuring of pension commitments, it is also advisable to consult advisors who initially do not want to sell “financial products”, but who are rather in a position to show the entrepreneur the most varied ways.
Tax-neutral settlement of the pension commitment
As things stand today, a pension commitment can be settled with the so-called fifth rule or the personal tax rate. However, the current regulation means that although the pension commitment can be removed from the GmbH’s balance sheet in the case of congruent reinsurance, the severance payment is considered a taxable inflow for the managing director in the private sector. However, this presupposes that there are sufficient assets in the GmbH to pay compensation – otherwise there is a risk of partial taxation of unpaid partial pensions due to the managing director’s partial waiver of his claims.
In the case of a complete severance payment of, for example, € 500,000, taxes of € 100,000 to € 200,000 are quickly due and payable immediately in the year of the severance payment. Then there may only be about 350,000 € left for the pension scheme. With a retirement of these 350.000 € the managing director receives then with the German pension insurance just a lifelong old age pension of approx. 17.000 €, thus about only half of the imagined old age pension. With it the beautiful dream of a pension in the amount of 35.000 € is over.
Solution: Settlement of severance pay with special expenses
However, there is an equally elegant and simple solution to all of these problems of a GmbH and its shareholders managing directors, at the latest at the start of retirement at the age of 65.
By deducting special expenses resulting, for example, from payments for donations and extraordinary expenses, the tax on severance pay can be reduced or eliminated.
The establishment of a non-profit trust foundation and the associated endowment of the foundation with assets also leads to special expenditure amounts, which the SME can use to reduce taxes in the private tax return.
According to foundation expert Frank M. Strobelt of the Munich Society for the Promotion of Foundations (GfS), the non-profit foundation, which has received special tax incentives from the German government since 2000, has a whole range of valuable advantages for medium-sized entrepreneurs in addition to tax benefits. For example, it is possible to solve the problem of company succession, inheritance and protection of life’s work by setting up a non-profit trust foundation. Furthermore, the assets transferred to the charitable foundation are exempt from inheritance and gift tax and, from a certain point in time, are protected from creditors and other undesirable groups of people (locusts, greedy relatives). In addition, the trust foundation is to be seen as an ideal PR/marketing instrument due to its charitable orientation; the foundation’s credible public relations work additionally strengthens the company’s core business.
At the beginning of July this year, the German Bundestag passed the “Law to further strengthen civic involvement”. Under the new law, founders will in future be able to deduct EUR 1 million in special expenses (EUR 2 million for married couples) within 10 years in their private tax returns to reduce their tax burden.
Tax advantages due to private assets transferred to the foundation
In the case of private assets of €600,000 (for example: rented real estate, patents, securities, fixed-term deposits, works of art, etc.) which are transferred to the company’s own non-profit trust foundation, special expenses of the same amount arise which can be used freely in the private tax return and thus, under certain circumstances, lead to a tax-neutral treatment of the severance payment. With a private tax rate of 40%, this results in a tax refund of approximately € 240,000 in liquidity inflow over the next 5 to 10 years. Depending on the taxable income, the tax refund may be higher or lower. If one now applies this tax refund or the reduction of tax prepayments for 10 years with e.g. 6%, an additional private wealth of about 350,000 € results in 10 years.
The difficulty in restructuring pension commitments is that the tax-optimised treatment of pension commitments requires the expertise of neutral experts.
Experts who can competently assess this specialist area and work on it independently of insurance or products are rare. In this respect, neutral solutions can only be presented by fee-based consultants who are used to interdisciplinary work.
by Dr. Johannes Fiala and Andreas Michael Bosl
published in MM Maschinenmarkt on 13.08.2007
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About the author
Dr. Johannes FialaPhD, 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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