Tax-Efficient Wealth Transfer in Germany: Pensionfriend's Solution for Capital Gains & Inheritance Tax Savings

The situation without a tax shield

To fully appreciate the benefits of a tax shield, it is important to understand how taxation applies in Germany when passing your savings to your children. One key tax to consider is the capital gains tax.

In Germany, capital gains are taxed at 26,375 %. While there are some ways to reduce or avoid this tax, they often come with drawbacks.

Capital Gains Tax Exemptions and Limits

Another key tax to consider is the inheritance tax. When transferring wealth to the next generation, you have to pay inheritance tax if the transfer occurs upon your death, whereas a same rate gift tax applies if you transfer the wealth while alive. Inheritance tax rates can be significant for large sums, but they can be minimized—primarily by gifting in tranches, as the substantial exemption resets every 10 years. Also by transferring the wealth at an early age of the recipient the value of the transfer is much higher namely before the accumulation of investment gains.

However, relying on these 10-year exemptions comes with challenges:

• Loss of control – Once transferred, you can no longer access the money if needed or prevent potential misuse by the younger generation.

• Tax burden on the recipient – The recipient may still face taxation, particularly on capital gains.

Inheritance and Gift Tax in Germany

Using a tax shield to transfer wealth

What, then, is the smartest way to transfer wealth to the next generation, particularly wealth you do not immediately need yourself?

The most effective approach we identified is using a specialized version of a Private Pension Plan, our Wealth Transfer Plan. This plan allows for up to two policyholders and two insured individuals, with the oldest insured person permitted to be up to 104 years old. This structure offers several key benefits:

• Minimized Inheritance Taxes Through Seamless Ownership Transfer: Ownership can easily transition from one policyholder (typically older) to the other (typically younger), making it simple to take advantage of substantial tax-free exemption limits to avoid gift and inheritance taxes. For example, every ten years, you can transfer up to 400.000 € to a child tax-free under the gift tax threshold. Additionally, the plan can function as a joint account for spouses, allowing up to 500.000 € to be transferred every ten years free from gift tax.

• Minimizing Capital Gains Taxes: By allowing individuals up to 104 years old to be designated as the insured person, the policy payout can effectively be exempt from capital gains tax when the payout is structured to occur upon their passing—for example, that of a grandparent. In principle, insurance payouts upon death are not subject to capital gains tax, making this an efficient tax-minimization strategy.

• Protection Against Misuse: The plan ensures that gifted assets are safeguarded by requiring approval from both policyholders for any withdrawals. This means that a parent, for instance, can withhold consent if the younger policyholder is deemed not to use the funds for intended purposes—and vice versa. A prudent approach is to outline withdrawal conditions directly in the policy, such as restricting access to funds for specific purposes like education expenses or in case of severe income loss of the older policy holder.

This structured approach offers a tax-efficient, controlled, and secure method for wealth transfer, ensuring financial benefits for future generations while minimizing tax exposure.

It is important to note that larger amounts can be transferred beyond the gift tax exemption. While these may be subject to some inheritance tax, capital gains tax can still be avoided. Additionally, tax authorities may scrutinize potential misuse, so the insured person must have a relevant role and a legitimate connection to the policy. Be sure to consult your tax advisor for guidance on compliance and best practices.

Examples of how it works

Take a parent of 40 and a child of 5. The parent is the insured person. The parent opens an account with 250.000 €. At the start of the account, 100.000 € is gifted tax-free to the child. At child age 15, another 100.000 € is gifted. 

• Case 1 At the age of 21, the child wants to study abroad, and both parent and child agree to the use of the child's assets for study costs. At this time, the account has grown to 600.000 €, of which 400.000 € is owned by the child and 200.000 € is owned by the parent. The child can now take money out of the account capital gains tax-free if the child's income is below the income tax-free threshold. If the amount is higher then capital gains tax is due. 

• Case 2 The child is now 30 and wants to buy a home. His value in the policy is now 400.000 €. The parent and child agree that the value in the account can be used as collateral for buying a home. Their mortgage advisor will find a bank that gives the child much better interest rate conditions due to this collateral value. 

• Case 3 The parent passes away at age 78, while the child is 33. The child now owns 600.000 € of the account and the parent 400.000 €. The child can now take out the 600.000 € without paying any capital gains tax. Whoever inherits the 400.000 € has to pay inheritance tax. Such tax can also be avoided by including a special clause that, for example, allows the other parent (say the mother) to get the policy. 

• Case 4 The parent is 55 and finds herself without a job. The account holds 400.000 € in the name of the child and the parent's share is 300.000 €. The parent would like to use her share to pay some of her bills. In order to do so both policyholders need to agree or to have specified at the start that the parent can take out her share. The parent will have to pay capital gains tax. 

Conditions for Pensionfriend's Wealth Transfer Plan

Fees  

• 0,69 % if the portfolio value is over 50.000 €

• 0,49 % if the portfolio value is over 250.000 €

• A 7,50 € monthly fee is charged as an administration fee no matter the value of the fund

Flexibility

All flexibilities that Pensionfriend's standard PPP allows for are included. No exit fees, no upfront cost. So, withdrawal is possible at any time. 

Investment structure

You can invest in Pensionfriend's portfolios with expected gross returns of 7-8 % but also have a wider choice of in total 349 ETFs.

Taxation

85 % of the gains are subject to capital gains tax of 26,375 %. There is no reduction of 50 % (Halbeinkünfteverfahren) structure.

The big benefit is children can not only inherit different sums tax-free over time, they could also inherit without paying capital tax-free when the insured person (parent) passes away.