Not every “pension” is a pension

The headline sounds paradoxical, but it reflects how loosely the word “pension” is used in everyday English. Many people call any old-age payment a “pension,” often assuming it is paid for life or at least for a fixed period. For tax analysis in both the United States and Germany, however, you must distinguish between different categories of benefits because the labels, reporting, and tax rules differ.

A company-paid promise (the German Direktzusage) is an unfunded employer promise. There is no separate plan trust; the employer pays benefits directly from its general assets. In U.S. terms, this resembles nonqualified deferred compensation. These payments are best described as a company-paid pension or an unfunded employer promise, not as a plan distribution.

By contrast, qualified employer plans governed by ERISA—such as defined-benefit pensions, 401(k) and profit-sharing plans, 403(b) arrangements, and governmental 457(b) plans—hold assets in trust. Payments from these plans are called plan distributions. If the money is paid as a lifetime stream, those payments are annuity payments; if the participant elects a single payout or a schedule of fixed payments, they are a lump-sum distribution or installment payments.

Individual Retirement Accounts or Annuities (IRAs) are not employer plans. Payments from IRAs are properly called IRA distributions and can be periodic or lump sum. Some IRAs are annuity contracts, but most IRAs are accounts; the distribution label does not change.

Insurance annuities (outside the qualified plan and IRA context) pay annuity payments after annuitization. Before annuitization, owners typically take withdrawals. These should not be conflated with life insurance.

Life insurance pays a death benefit (also called life insurance proceeds) upon the insured’s death. If the policy is surrendered during life, the payout is the cash surrender value (or surrender proceeds). Interest paid under an interest-only settlement is simply interest, not an annuity.

Social Security benefits are a separate category. Payments from the Social Security Administration are called Social Security benefits and follow their own federal tax rules.

Further discussion of tax treatment is available here:

https://scheller-international.com/blog-beitraege/german-income-taxation-of-us-pensions-and-similar-retirement-provisions.html
https://scheller-international.com/blog-beitraege/payouts-from-us-pension-plans-the-new-regulation.html

Author: Peter Scheller, Tax Adviser, Master of International Taxation, Qualified expert for custom duties and excise taxes

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