The principle of life insurance continues to be a popular instrument for old-age provision for many people, but above all for survivors’ pensions. In Germany there are currently 86.7 million completed life insurance policies. This has been determined by the German Insurance Association in 2016. From a tax perspective, the principle of life insurance is extremely complex and many factors play a role. Because it depends not only on which life insurance you have decided, but also when you have opted for this form of protection. We explain the taxation of life insurance with an example:
Georg, the newly-born father of twins, wants to take out life insurance in 2018 to secure his family. His older brother Heiko already opted for such insurance in 2004. Thus, different rules of taxation apply to the brothers.
Georg is still looking for the right life insurance. In principle, he can choose between two forms – namely term life insurance or endowment life insurance.
Term life insurance
The term life insurance is a pure death protection. This means: If the insured person dies during the term, the insured sum will be paid to the registered person. If the insured person experiences the end of the contract, the insurance expires. The insurer pays no money.
The endowment life insurance serves both the death protection and the old-age provision. This means: in the event of death, the family is covered. In contrast to term life insurance, the insured builds up a capital stock with his contributions. If the insured experiences the end of the contract, the income is paid out – for example, in the form of a monthly pension or a one-off payment.
Tax advantage of term life insurance
If Georg – or any other taxpayer – decides on a term life insurance, the monthly contributions are deductible as a precautionary expense up to a maximum amount of 1,900 euros per year as a special issue.
In the event of death, inheritance tax may apply if the allowances are exceeded. You can avoid this if you and your partner take out cross-term life insurance. In other words: As policyholder, you take out endowment insurance on the life of your partner and vice versa. In the event of death, the sum insured is paid directly to the partner, so there is no inheritance tax.
Taxation of endowment life insurance depending on the year of graduation
A life insurance is paid out at the end of the term. How many taxes you have to pay for your life insurance depends on the time of the contract.
Contract concluded before 2005
Heiko had already completed his insurance in 2004. If he meets the following requirements, he does not have to pay any taxes on the income:
- The contract runs for at least twelve years.
- The first contribution was paid into the life insurance until March 31, 2005 at the latest.
- He has insured contributions for at least five years.
- The expiry service, ie the amount paid out, is paid out in full at once.
If all conditions are fulfilled, the income from his life insurance remains tax-free. Otherwise, the entire income is subject to the final withholding tax.
Contract conclusion from 2005
Georg concludes his life insurance after 1 January 2005. Therefore, he must pay taxes in any case, it takes the downstream taxation. After all, only 50 percent of the income he must tax, if
- the contract has been running for at least twelve years,
- the sum insured is paid out only after expiry of the 60th year of life (for new contracts from 2012 after the end of the 62nd year of life),
- the expiry benefit is fully paid out in one amount and
- the death protection covers at least 50 percent of the contribution sum. However, this last point only applies to contracts concluded after 31 March 2009.
If one of these criteria does not apply, Georg must have his income from the life insurance fully taxed – in this case, then the withholding tax will be due.
For all contracts that were only concluded after March 31, 2009, there are two other points to consider in terms of risk performance – not to be confused with term life insurance:
The risk benefit of the contract must amount to at least 50 percent of the total contributions paid by the end of the term.
In the event of death, the agreed insurance benefit after five years must be at least ten percent above the actuarial reserve or the time value of the policy.
Only if both of these conditions are met does the 50-percent rule apply to contracts after 31 March 2009
Monthly payments must also be taxed
If you do not receive your income from an endowment policy in one sum, but on a monthly basis, you have to pay tax on the so-called revenue share. Unfortunately, it is not possible to say how high the revenue share will be. Because it depends on the age of the policyholder. The earlier you take the monthly pension, the higher the revenue share is usually.
You do not have to worry about calculating the revenue share, your insurer will take care of it for you. The income is then added to your taxable income and taxed at your personal tax rate. By the way, it does not matter when you have completed your contract. In the case of a monthly payment, the income share is always taxed.
Cancel or sell life insurance
If you urgently need money during the contract period, you can cancel or sell your life insurance. It works like this:
You can return the insurance policy to the insurer – this is the so-called buyback. The insurer then pays out a surrender value.
You can sell the insurance policy to a third party – for example, in the so-called secondary market.