We have studied the first pillar and Switzerland three pillars system in the previous post in the series. Now, it is time to see the second pillar. The first pillar covers the basic needs of everybody. The second pillar is here to cover a larger part of your salary than the first one. If you never worked, you will never pay anything for this and you will never receive anything from this. It is significantly more complicated than the first pillar.
In this post, I am going to try to give you as much important details as possible on the second pillar. I am also going to try to help understand what you can do to improve it.
The Second Pillar
The second pillar is your work pension. In French, it is called Loi fédérale sur la prévoyance professionnelle vieillesse, survivants et invalidité (LPP). In German, it is Bundesgesetz über die berufliche Alters-, Hinterlassenen- und Invalidenvorsorge (BVG). As you can see, the Swiss government is very good to make short names…
This pillar is a pension for every people who worked in Switzerland and paid into the LPP. Every Swiss employee of at least 24 years and with an annual salary of more than 21’150 CHF contributes to the second pillar. It is directly deducted from your salary and transferred to your pension fund. Interestingly, your employer will at least match your contribution. Some company contributes more than this. If you are an independent, you will have to pay both the employee and employee parts. How much you pay for the second pillar depends on your age:
- 25 to 34 years old: 7%
- 35 to 44 years old: 10%
- 45 to 54 years old: 15%
- 55 to 65 (64 for women) years old: 18%
The percentage deducted from your salary depends on the part your employer is paying. All the contributions to the second pillar are pre-tax. This is very important. You will pay the taxes when you withdraw your second pillar. You may notice that as you get older, you put more and more into your second pillar. This means that the last years matter a lot in the calculations of your second pillar pension. This is a bit dumb because the first years are the one that compounds the most and therefore should be contributed higher.
The first pillar was global insurance. But the second pillar is a physical account, in your pension fund, with your name. And your pension fund is related to your current employer. Each employer chooses its own pension fund. If you change employer, you will need to transfer your existing contributions to the new pension fund. If you lose or quit your job, you will need to transfer the funds into a vested benefits account. This account will be locked until you get a new job (and a new pension fund) or you reach retirement age. Even if it is in your name, there is not a lot you can do with it. You cannot choose how it is invested, you cannot move money in or out.
Mandatory vs Extra Mandatory
Now starts the complicated part about the second pillar. We have to distinguish between the mandatory insured salary and the extra-mandatory salary.
We will only be talking about yearly salary here. The mandatory insured salary is the salary between MIN and MAX. MIN is defined as 7/8 of the maximum of the first pillar, which is 24’675 CHF. MAX is defined as three times the maximum of the first pillar, which is 84’600. If your salary is between 21’151 CHF and 28’200 CHF, your mandatory insured salary will be 3’525 CHF. Everything higher than MAX is the extra-mandatory salary. So, the maximum mandatory insured salary is 59’925 CHF (MAX-MIN).
Let’s see a few examples with different annual salaries:
- 20’000 CHF: Not eligible to the second pillar (less than 21’150 CHF)
- 25’000 CHF: Mandatory insured salary of 3’525 CHF (less than 28’200)
- 30’000 CHF: Mandatory insured salary of 5’325 CHF
- 50’000 CHF: Mandatory insured salary of 25’325 CHF
- 84’600 CHF: Mandatory insured salary of 59’925 CHF
- 100’000 CHF: Mandatory insured salary of 59’925 CHF and Extra-mandatory salary of 15’400.
So what is the difference between these two parts?
I mentioned before the contribution rate for the second pillar. These were the contributions for the mandatory part. The contributions for the extra-mandatory part depends on your pension fund and on your company.
Another difference is the interest. The law sets a minimum interest rate of 1% on your mandatory contributions. But there is no minimum for the extra-mandatory portion. Your pension fund can offer better (or worse) interest on it. It is generally a bit better on the extra-mandatory portion. This interest is the only way your second pillar account money will grow. It is not really great interest rate. But there is nothing you can do about it. It still beats Swiss banks currently.
The last difference is the conversion rate. This will define how much pension can you get out of the capital. The law sets a minimum conversion rate of 6.8% for the mandatory portion of your capital. Again, no minimum is set for the extra-mandatory portion. Your pension fund will set the conversion rate. Generally, it is worse than the conversion rate on the mandatory part.
How much will I get?
Once you reach retirement age (65 for men, 64 for women), you can get your second pillar. You have three options:
- An annuity
- A lump sum
- A lump and an annuity
Here is where the conversion rate is important. The annuity will be computed using the conversion rate. If you are converting 200’000 CHF with a conversion rate of 6.8%, you will get 13’200 CHF pension each year. If you take a lump sum, you will pay capital taxes and if you take an annuity you will pay income tax on top of it. For the extra-mandatory part, the conversion rate will depend on your pension fund.
Should I take an annuity or a lump sum?
There no definite answer on this. It will depend on the conversion rate at the age of your retirement. And how much you expect to get out of the capital each year if you were managing it yourself. Generally, if you were to invest the amount into stocks, you would do, on average, better than the current conversion rates. However, there is a risk with stocks, whereas the conversion rate is guaranteed. In the end, you will have to do the math yourself depending on your situation.
Optimize your second pillar
Compared to the first pillar, there are a few things you can do to optimize your second pillar.
Just as it was the case for the first pillar, you can have holes in your second pillar. This can happen in several cases. For instance, if you started to contribute late due to your studies or if you were unemployed for some years. If you left Switzerland, you will stop contributing too. Finally, it generally happens simply because your salary is higher now than before. Therefore, you could contribute more now because your current salary would have allowed you to contribute more.
You can fill these holes (or contribution gaps) by voluntary contributions (or buy ins). These contributions are pre-tax too, so this will reduce your taxes. However, they are not matched by your employer. Moreover, buy ins are always extra-mandatory. Finally, they are locked for three years. It means there is no way to withdraw them before. You can ask your pension fund how much you are able to contribute to fill the gaps. There is an annual limit on how much you can contribute. They will also give you directions on how to perform these voluntary contributions.
If you have the means to do it, I think it is a good way to increase your pension and to lower your taxes. However, you need to be sure whether you should contribute to your second pillar or not. Be sure of what you are doing, because this money will be locked for years. This is also money that will not return a lot of interest. But it is a safe investment. You can think of it as a long-term bond investment.
Another thing you can do is choose a company with a better pension fund. Of course, this is not practical and the pension fund should probably not be the main argument for choosing a company over another. But this could make a large difference in your retirement. You can also ask your company if there is an option for investing more in the second pillar. Indeed, at some company, they give you the choice of how much to invest in it.
As for the first pillar, increasing your salary will increase your contributions to the second pillar. Then, it will increase your final pension. Do not forget that contributions to the second pillar are pre-tax. But of course, increasing the salary is not always possible or even what you want. And increasing your salary is an obvious choice if you can do it in good conditions.
If you want more details on the subject, you can read whether you should contribute to your second pillar or not.
Withdraw before retirement
You can withdraw money from your second pillar before retirement (early withdrawal).
The main reason for early withdrawal is to buy a house. Indeed, you can withdraw your second pillar money to build or buy a house. This will reduce your pension accordingly, but can greatly help you to have the funds for your house. The same applies if you want to start your own company. You can also withdraw the money if you are leaving Switzerland. The other reason is early retirement. You can withdraw your second pillar five years before retirement age.
The cast of leaving Switzerland is the most complicated, it will depend on where you are going to. If you leave for an EU country, you will only be able to withdraw the extra-mandatory part of your second pillar. But that will actually depend on exactly the country where you are going.
There are some limitations and rules to these early withdrawals. The minimum withdrawal is 20’000 CHF. If you sell the house you bought with the second pillar, you have to repay what you withdrew. Contributions into your second pillar after early withdrawal will not be tax-free. After you have reached the same amount before the withdrawal, they will be tax-free again. Be careful that after 50 years old, you are limited in what you can withdraw. After age 50, you can only withdraw the amount that was available when you were 50 or half of what is available. The limit is the maximum of these two numbers. Finally, withdrawals are only possible every five years.
Every year, you should receive a report from your pension fund telling you a lot of things. It will give you information about how much you contributed, the mandatory part, the extra-mandatory part, … It also makes prediction on how much you will have by retirement. You should not bother too much about the predictions. But it is interesting nonetheless.
This report is different from each pension fund, but most of the information will be the same. For instance, here is my redacted report from last year:
As you can, there are tons of numbers here. It will also cover things like death or pension in case of handicaps. If you are married or divorced, you will have more information than me.
If you are lucky, you will receive reports more often. And if you are very lucky, your pension fund will have a portal where you can see this information online. It will depend on your pension fund. My new second pillar company (at Pied Piper) updates its online portal monthly. I can track it much better now.
You should always keep these reports if you receive them on the mail (I scan them). They contain important information for your financial future.
If you are tracking your net worth (and you should!), you may consider the second pillar inside it. Personally, I integrate my second pillar in my net worth and count it as bonds. Since it’s a very safe and conservative investment, counting as bond in my net worth make sense. Adding your second pillar into your net worth will give you a better picture of your entire assets. This is really useful.
If you want to track your net worth monthly, you have two choices. You can either extrapolate yearly information from the report. Or you can use the amount of contributions you do each month from your salary. Personally, I use the “Prestation de sortie effective au 31.12.XXXX “ metric from the report. Then, I extrapolate monthly values. If you want more details on this, you can read my article about second pillar and my net worth.
The second pillar is the second part of the retirement system in Switzerland. It will cover a larger part of your salary in retirement than the first pillar. While the first pillar was for everybody, the second pillar is only for employed people. How much you get at retirement will mostly depend on your salary. With your first and second pillars together, you should gain a pension of about 70 to 80 percent of your salary. If you want to complete this, you will have to use the third pillar. I will cover the third pillar in the next post of this series. It is an optional part of the retirement system but has many advantages.
What do you think about the second pillar? Do you have tips to optimize it? Do you have any question regarding the second pillar?