Cancelling a private pension policy and taxes: your guide to optimisation
15.04.25
6
Minutes
Katrin Straub
Managing Director at nextsure
Cancelling a private pension insurance policy can have unexpected tax consequences. Find out how to avoid pitfalls and what alternatives there are to secure your financial future.
The topic in brief and concise terms
When a private pension insurance policy is cancelled, the taxation of the returns depends heavily on the contract conclusion date (before/after 2005).
The half-income method can halve the tax burden for contracts from 2005 onwards if the contract ran for at least twelve years and the payout takes place from age 62/60 onwards.
Cancellation is often associated with financial disadvantages; alternatives such as withdrawal, sale or premium-free status should be considered.
Understanding the tax basics when cancelling a private pension
The decision to terminate a private pension insurance policy is often linked to financial expectations. However, the tax aspects in particular are often underestimated. Since the Retirement Income Act, which came into force on 1 January 2005, the taxation of pensions has changed fundamentally.
In the event of termination, you will usually receive the so-called surrender value. This value can be lower than your contributions paid in, especially in the first years of the contract, due to acquisition and administration costs. Losses are therefore not uncommon in the event of an early termination.
The tax treatment of the proceeds from a terminated private pension insurance policy depends largely on the contract start date. For contracts concluded before 2005, more favourable rules often apply. For newer contracts, the proceeds are generally taxable. A careful review of your contract is therefore essential before you make a decision on payout.
Old contracts (concluded before 2005): make use of tax advantages when cancelling
If you took out your private pension insurance before 1 January 2005, you may be able to benefit from tax exemptions in certain circumstances. A key requirement is often a minimum contract term of twelve years.
In addition, a minimum contribution payment period of five years must often be met. If this and other contract-specific conditions are satisfied, the lump-sum payout upon cancellation can be completely tax-free. This represents a significant advantage over newer contracts.
It is crucial to check the exact terms and conditions of your older policy. Not every contract concluded before 2005 is automatically tax-free on cancellation. In some cases, contributions to these older contracts can still be claimed as special expenses in the tax return. The complexity of these rules makes an individual assessment necessary.
New contracts (concluded from 2005 onwards): Tax liability and structuring options
For private pension insurance policies taken out from 1 January 2005, the tax situation is different. The proceeds from these contracts are generally taxable if they are cancelled.
However, there is an important tax concession: the half-income method. This may apply if the contract has been in force for at least twelve years and the payout only takes place after reaching the age of 62 (for contracts taken out from 2012 onwards, otherwise the age of 60). In this case, only half of the earnings are taxed at the personal income tax rate. This rule can significantly reduce the tax burden.
If these conditions are not met, the entire earnings are subject to withholding tax. This is a flat rate of 25 per cent plus the solidarity surcharge and, where applicable, church tax. Correctly declaring this in the KAP schedule of your tax return is crucial in order to reclaim any tax paid in excess. A unit-linked pension insurance policy is subject to similar tax rules.
Our expert tip: Before cancelling, carefully check whether the requirements for the half-income method are met or can be met in the near future. Delaying cancellation by a few months can save you real money.
Practical examples: Tax calculation when cancelling a private pension insurance policy
To illustrate the tax implications of a cancellation, let us consider two scenarios. Scenario one: a contract from 2008 is cancelled after ten years, and the policyholder is 55 years old. The gains amount to EUR 5,000. Since neither the 12-year term nor the minimum age has been reached, the full EUR 5,000 is taxed at the withholding tax rate (25 per cent), plus the solidarity surcharge and, where applicable, church tax.
Scenario two: a contract from 2006 is cancelled after 15 years, and the policyholder is 63 years old. The gains likewise amount to EUR 5,000. Here, the half-income method applies. Only EUR 2,500 (half of the gains) are taxed at the personal income tax rate. If this is, for example, 30 per cent, the tax burden amounts to EUR 750, significantly less than in the first scenario. Compliance with the deadlines makes a difference of several hundred euros.
The following points are relevant for the calculation:
Date the contract was concluded (before/after 2005)
Term of the contract at the time of cancellation
Age of the policyholder at payout
Amount of gains earned (difference between the payout and contributions paid in)
Personal income tax rate (relevant for the half-income method)
These examples show how important an accurate calculation is. An life insurance tax calculator can provide initial guidance here, but it does not replace individual advice.
Losses on termination: tax treatment and pitfalls
It is not uncommon for the surrender value of a cancelled private pension insurance policy to be lower than the total of the contributions paid in. This means a financial loss for the policyholder. The tax treatment of such losses is complex.
Losses from private disposal transactions can, under certain circumstances, be offset against gains from other capital investments. Whether this is possible in the case of losses from cancelling a pension insurance policy depends on the details of the individual case and current case law. A blanket statement is difficult here.
It is advisable to consult a tax adviser in the event of losses. They can check whether, and how, the losses can be claimed in the tax return. Correct declaration is crucial to avoid tax disadvantages. The question of where insurance policies should be entered in the tax return is of central importance here.
Expert depth: Legal foundations and current rulings
The taxation of private pension insurance is primarily regulated in the Income Tax Act (EStG). In particular, Section 20 EStG (income from capital assets) and Section 22 EStG (other income, including pensions) are relevant. The Old-Age Income Act of 2005 introduced deferred taxation for many retirement provision products and reformed the treatment of capital income.
For the tax relief applicable to existing contracts (concluded before 2005), Section 10(1) No. 2(b) EStG in the 2004 version was decisive. For new contracts (concluded from 2005 onwards), the half-income method is governed by Section 20(1) No. 6 sentence 2 EStG. The final withholding tax is regulated in Section 32d EStG.
Current rulings, for example from the Federal Fiscal Court (BFH), can further clarify the interpretation of these laws. There are repeatedly decisions on the calculation of taxable income or the offsetting of losses. It is important to keep up to date here, as case law can evolve.
Our expert tip: In complex cases, especially when it comes to interpreting rulings or offsetting losses, consulting a specialist lawyer for tax law or a specialised tax adviser is often essential. This also applies to questions relating to insurance and tax in general.
Cancelling is often the most expensive option for exiting a private pension policy. However, there are alternatives that may be more financially advantageous. One option is to revoke the contract. This is possible if the cancellation information was defective, which may be the case for many contracts concluded between 1994 and 2007. If the revocation is successful, you will often receive more than just the surrender value.
Further options are:
Premium holiday: you stop paying contributions, but the contract continues with the capital accumulated to date. The insurance cover remains, albeit reduced.
Selling the policy: on the secondary market for life insurance, you can sell your policy. The sale price is often above the surrender value.
Using the contract as collateral: you can borrow against your policy and receive a loan. The contract remains in force.
Adjusting the contributions: if you are experiencing financial difficulties, it is often possible to agree a reduction in contributions.
Each of these alternatives has its own advantages and disadvantages as well as tax implications. Before taking action, you should carefully review the options. A question about the obligation to have health insurance in relation to a private pension may also become relevant.
Recommendations and conclusion: Making wise decisions when intending to terminate
Cancelling a private pension insurance policy should never be done in haste. The tax consequences can be considerable and significantly reduce the financial return. A careful review of the contract terms and the tax circumstances is essential.
Our recommendations for action for you:
Check the date your policy was taken out (before or after 1 January 2005).
Determine the current surrender value and the contributions paid to date.
Clarify whether the requirements for the half-income method (minimum term of twelve years, payout from age 62/60) are met or will be met soon.
Find out about alternatives to cancellation such as revocation, sale or premium-free status.
If you are unsure, consult an expert (tax adviser, specialised financial adviser).
A well-informed decision protects you from unnecessary losses and tax payments. Bear in mind that the taxation of other pension provision products such as the Riester pension also has specific rules. nextsure will be happy to help you analyse your insurance situation and find the optimal solution for you.
Request an individual risk analysis now: Have your insurance situation reviewed free of charge and receive concrete optimisation suggestions.
More useful links
The Federal Ministry of Finance offers a BMF letter on tax incentives for private pension provision.
The Federal Ministry of Finance provides income tax guidance (EstH) in Annex 22a on private pension provision.
The Consumer Advice Centre assesses private pension insurance critically as a retirement planning option.
The Federal Statistical Office (Destatis) publishes press releases with statistical information.
The German Pension Insurance offers comprehensive statistics and reports.
Wikipedia offers an article on private pension insurance.
Laws on the Internet provides the legal text of the Insurance Contract Act (VVG).
The Federal Agency for Civic Education (bpb) offers an article on the topic of private provision.
The Federal Ministry of Finance provides comprehensive information on pension taxation.
FAQ
Do I have to declare the payout from my cancelled private pension insurance in my tax return?
Yes, income from cancelled private pension insurance policies must be declared in the tax return, typically in Appendix KAP. For pension payments, Appendix R is relevant.
What costs are incurred when cancelling a private pension insurance policy?
When a policy is cancelled, high acquisition and administration costs often arise, which reduce the surrender value and can lead to losses.
Is there a notice period for cancelling my private pension insurance?
The notice periods are contractually agreed and are usually one to three months before the end of the insurance period.
What is the difference between the surrender value and the premiums paid in?
The surrender value is the amount the insurer pays out on cancellation. It may be lower than the sum of the contributions paid in because of charges.
Is it worth cancelling a private pension policy shortly before retirement starts?
Termination shortly before retirement begins is rarely advisable, as the tax advantages of standard annuitisation (taxation of the earnings portion) or the half-income method are often lost. Alternatives should be considered.
How does termination affect my pension provision?
Cancelling reduces your available capital for retirement provision, as losses often arise and the planned pension benefit is lost. This can lead to a pension gap in later life.
