How self-employed workers can leverage tax deductions for their retirement

In Germany, becoming self-employed also means taking your retirement planning into your own hands, as freelancers and entrepreneurs often don’t contribute to the state pension system. Retirement advisor app Horizon65 explains how self-employed workers can take action now and use tax advantages to save for their retirement. 

Becoming self-employed is always a big step, and many that take it are aware that they are giving up state benefits in return to be in charge of their own time. In Germany, self-employed individuals are not generally obliged to contribute to the state pension system and, if they do not make voluntary payments, will find themselves without a state pension or with only a meagre income when they reach retirement age. 

Unlike employed people, who are generally reliant on the state pension scheme, the self-employed are expected to arrange for their own retirement - either by making voluntary pension contributions to the state scheme or by setting up a private pension fund. 

Since money is often tight in the early stages of a self-employed career, it can be tempting to hold onto it rather than set it aside for something as far-off and abstract as retirement. Entrepreneurs often therefore have to make major catch-up investments later in life. The disadvantage to this approach, however, is that it does not give their money the same time to grow as if they had started making contributions early on to provide a comfortable retirement. 

Explore tax deductions and save for your retirement using the Horizon65 app

How to leverage tax deductions for your retirement

To encourage people to save for retirement, while recognising that successful self-employed people often make payments to lower their taxable income, the German state created the Rürup pension scheme. This scheme can be used by high-income earners and freelancers to make tax-exempt retirement contributions in a private pension pot.

But this isn’t the only scheme that self-employed workers in Germany can take advantage of to simultaneously reduce their taxable income and start saving for retirement. Let’s take a look at the options available:

1. Voluntary contributions to the state pension scheme

The first option would be the state pension scheme for the self-employed. It is far less popular today than it was in the past, yet voluntary contributions to the German state pension system are still a viable method of saving taxes while building up a retirement fund. 

Every resident of Germany aged 16 years and above is allowed to pay additional money into the national pension scheme. In exchange for these contributions, you will be able to demand a lifelong pension after reaching the retirement age (which will hit 67 by 2031). 

The amount you will get depends almost exclusively on the total sum you paid into the system during your working years. More money invested yields a higher monthly pension later. You can decide on a monthly basis how much to contribute and how much you want to put into the system. Tax-deductible contributions start from 83 euros up to 1.311 euros per month.

The great benefit is that you get access to all benefits and services provided by the state pension system. This kind of retirement fund can also help to support you in the event of a prolonged illness or disability. The money is locked into the system and cannot be claimed in case of bankruptcy (or divorce).

On the other hand, you are directly buying into a pension scheme that is heavily dependent on the contributions of the next generation and the overall health of the German state. Germany, like most countries, finances pensions on a pay-as-you-go basis, meaning that they pay pensions from the government budget and not from an investment fund.

2. A Rürup pension plan

The second option is the Rürup-Rente (Rürup pension), for the self-employed, which has rapidly become the favourite amongst freelancers and entrepreneurs in Germany - and increasingly amongst high-earners - as it allows you to make large tax-deductible contributions and benefit from flexible investment options. 

The underlying principle is very simple. You as a saver make contributions to a private pension. These contributions can be deducted directly from your taxable income, lowering your tax bill. You can decide where your money is invested, and any resulting profits remain inside the pot and are reinvested. 

When the plan matures, you can receive the money how you like, either as a lump sum payment - which could be used, for example, to buy a rental property to secure a stable income - or as a regular payment throughout your retirement. 

The biggest advantage of the Rürup-Rente is that you can pay in very large sums of money all at once. Each year a single person can pay up to 25.787 euros into the scheme (and deduct this from their taxable income), while married couples can deposit up to 51.576 euros. With amounts like these, it is possible to build up a sizable retirement fund in only a short time. 

Of course, the tax savings depend on the overall level of taxation, but for self-employed people in Germany, it is not uncommon to pay up to 30 to 40 percent of their income in taxes. The Rürup pension allows you to save this money. 

Another benefit of the Rürup-Rente is the ability to choose an investment according to your own liking. A stock heavy fund of ETF is possible, but so are fixed interests and savings strategies. 

The downside is of course that, while you save taxes during the investment phase, the complete pension becomes taxable income when you receive it. So, you essentially shift your tax burden from the present to the future. However, given that normally most people have a lower income in their retirement and therefore lower taxes, this is not a huge issue - it just needs to be mentioned. 

A bigger disadvantage is the scheme’s inflexibility when it comes to accessing your money. The German tax authorities only grant you these tax benefits if you actually use the pension pot for your retirement. As a result, any money invested in the Rürup scheme cannot be withdrawn before you reach the age of 62 and cannot be borrowed against or otherwise used for emergency purposes or other investments prior to retirement - although the same can be said of a state pension. 

Horizon65 helps many self-employed expats secure their retirement and adjacent financial questions. They are offering IamExpat readers a free consultation to help them understand what they can expect from the German pension and what their retirement options are.