Pension commitments are popular as an instrument of old-age provision. But because of the poor returns on many life insurance policies, there is a threat of tax problems. The tax trap can be avoided with a well thought-out spin-off from the GmbH.
Johannes Fiala and Andreas M. Bosl
The advantages of a pension commitment are known to every tax consultant and every controlling shareholder-managing director of a GmbH. Many tax advisors have recommended this retirement plan to their clients. This reduces taxes and increases liquidity in the company. However, experts estimate that over 90 percent of all GmbH managing directors have been promised a pension that cannot be financed by the company. Most of the reinsurance concepts for pension commitments are counter-financed with German endowment life insurance policies. Since the stock market crash of 2001 to 2003, however, insurers’ profit sharing and promised returns have virtually vanished into thin air. Of the originally calculated returns of around seven percent per year, often just four percent or less remained. This means that many commitments lack the necessary financial resources for subsequent payment. With a term of 20 to 30 years, coverage gaps of around 50 percent can easily arise by the time people retire.
This is a fatal situation, as the tax authorities are paying increasing attention to the financial viability of pension commitments and are quick to assume a hidden distribution of profits if this is not the case. The unfunded pension commitment comes up at the latest in the case of an anticipated succession, the sale of a company or a succession arrangement. What began as a tax-saving model then easily leads to unexpected tax burdens and old-age poverty for the managing director. In the worst case, to insolvency. Another disadvantage of the pension commitment is that nobody likes to buy a GmbH with an existing pension commitment. No successor will accept the lifelong obligation to pay a high annual pension if he has less than half of the assets that would be necessary to pay a lifelong pension.
In such cases, financial service providers like to recommend building up further reserves for restructuring purposes – in some cases by taking out new life insurance policies. But this approach unfortunately hardly changes anything about the liability of the Mittelstands GmbH. Nor is it due to the fact that the financial resources for further reserves are too rarely available. The tax advisor then usually advises a lump-sum settlement of the pension commitment. In the case of a lump-sum settlement at the age of 65, however, it is important that the corresponding agreement is precisely formulated in the pension commitment. However, many commitments are not up to date. Consequence: A settlement is often not possible or is treated by the tax office as a hidden contribution. The director then has to pay tax on the part of the pension he has waived, i.e. pay tax on non-existent income.
In the case of restructuring pension commitments, it is advisable to consult advisors who do not want to sell financial products. The expert opinion of an actuary also helps to considerably reduce liability in the event of an audit by the tax office. As things stand today, a pension commitment can be settled using the one-fifth rule or the personal tax rate. This means, however, that in the case of congruent reinsurance it can be removed from the balance sheet of the GmbH in a tax-neutral manner. In the case of the managing director, however, it is regarded as a taxable inflow. This also presupposes that there are sufficient assets in the GmbH for compensation. Otherwise, there is a risk of taxation of the partial pension that has not been settled.
In the case of a full settlement of, say, 500,000 euros, 150,000 euros or more in taxes quickly become due – and immediately in the year of the settlement. This would leave only around 350,000 euros for the pension scheme. If the sum is annuitised, the managing director will receive just a lifelong old-age pension of around 17,000 euros from the German pension insurance scheme. However, there is an elegant and simple solution to all these problems. By deducting special expenses, the tax payment on the severance pay can be reduced again at another point or, ideally, not be paid at all. The appropriate means for this is the establishment of a charitable trust foundation. The endowment of the foundation with assets leads to special expense amounts which the middle-class person can claim in his private tax return.
According to foundation expert Frank M. Strobelt of the Munich-based Gesellschaft für Stiftungsförderung (GfS), the charitable foundation, which has received tax incentives from the German government since 2000, has a number of other valuable advantages in addition to tax benefits. Among other things, it is possible to solve the problem of business succession, inheritance and the protection of life’s work by setting up a charitable trust foundation. Furthermore, the assets transferred to the charitable foundation are exempt from inheritance and gift tax and are also protected from creditors after a certain point in time. In addition, the charitable nature of the trust makes it an ideal PR and marketing tool. At the beginning of July, the German Bundestag passed the law to further strengthen civic engagement. According to this, founders will in future be able to use one million euros of special expenses (married couples two million euros) in their private tax returns to reduce taxes within ten years. In the case of private assets of 600,000 euros contributed to one’s own charitable trust foundation, this results in special expenses in the same amount, which can be freely used in one’s private tax return. Thus, they may lead to a tax-neutral treatment of the severance payment. Assuming a private tax rate of 40 percent, this would result in a tax refund of around 240,000 euros over the next five to ten years. Depending on the taxable income, the refund may be higher or lower. If one invests the refunded amount or the sum from the reduction of advance tax payments for ten years, an interest rate of six percent results in additional private assets of around 350,000 euros.
The difficulty in transferring or spinning off pension commitments from a GmbH, however, is that the tax-optimized treatment of the commitments requires the expertise of neutral experts. However, specialists who can competently assess this complex field and work on it independently of insurance and products are rare.
(Markt und Mittelstand 10/2007, 110)
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About the author
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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