Starting 2025 German tax law holds some changes in how it will tax distributions from US retirement plans.
Some basic understanding upfront: As laid out in previous articles before, it is currently and up until Dec 31, 2024 possible to frontload all lifetime contributions into a retirement plan and take full credit against any distribution. Essentially, you can burn through all of your contributions first tax-free under German law before the actual “profit” of the plan (excess of distributions over contributions) becomes relevant for German tax purposes – either because it is taxed fully or only considered for tax rate purposes, when it is a TSP.
With the change as of next year, only those contributions will be considered as a credit against your distribution, which have not yet had a tax savings effect on the US side. This means that you and your taxperts need to do a lot more digging as to that. We recommend you try to locate as many previous year-end pay-stubs, LES, W2 and US tax returns as possible so we can determine which contribution has been included in any US tax break, and which has not. The days of where we could just take a look at an annual statement for the total contributions are unfortunately over.
Right here is an important aspect to consider: Those of you who have a retirement plan which was built around the HEART Act should not be affected by this change at all! The HEART Act allows you to turn an SGLI payout into a retirement plan – there has not been any income on the US end or tax break attached thereto!
The same should hold for benefits from Roth components as a Roth can only be paid into from after-tax money.
Also, you need to consider the nature of your retirement plan. A TSP should be considered on the German tax end only for tax break purposes, so not being able to show usable contributions will not come with as steep of a tax effect as payouts from a non-TSP plan.
Given all of the above, we do understand why some of you feel like getting out of their retirement plans for good before 2024 is up. However, we are not sure this is the best way forward. There are a few good reasons which support this stance.
- The law is too new to really know all planning aspects yet.
- Benefits from Roth, HEART Act or TSP plans should still come with little to no tax consequence.
- Many people spent decades building their plan – dissolving it on a whim for fear of unknown tax consequences appears rushed.
- Other mitigation means are still available, such as lowering distributions to the required minimum, switching sources for distributions from regular to Roth or looking into taking paid penalties as deduction against the distribution.
If you are planning to take retirement plan benefits in the future or are already receiving them, please do not hesitate to ask your taxperts what can be done to keep the tax benefits minimal.
