Should You Contribute to Your Second Pillar in 2021?

Mr. The Poor Swiss | Updated: | Investing, Financial Independence, Retirement, Switzerland
Should You Contribute to Your Second Pillar?

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In Switzerland, you can make a voluntary contribution to your second pillar. These contributions come with some tax advantages since you can deduct that from your income. Therefore, you have a return equal to your marginal tax rate. And this return is almost instant.

However, the money is then blocked into the second pillar. And the returns on that blocked money have been very low in recent years. Finally, you can only withdraw the money from your second pillar if you retire, buy a house, or start a company.

Many people ask whether they should contribute money to their second pillar or continue investing in stocks.

In this article, I am going to answer this question.

Second pillar contribution

So how does a voluntary contribution to the second pillar works?

Usually, you pay each month some amount of your salary to the second pillar. And this is matched by your company. You do not have a say in this. So there is no way to optimize that.

However, you can contribute some amount yourself to cover the holes in your second pillar. If you had a low salary when you started, you are sure to have holes in your contributions. When you contribute, you can deduct it from your taxes, just like the third pillar.

How much of a reduction in taxes this will realize is challenging to calculate correctly. It depends on your marginal tax rate. The amount will depend on your income, your wealth, and where you pay your taxes. In most cases, this will be between 30% and 40%. That means that the immediate rate of return of this contribution will be 30% to 40%. We can view voluntary contributions as a form of investment.

Now, the invested money will be blocked until you can take it. In the second pillar article, we have seen only four cases when you can take this money out: building a house, starting a company, retiring, or leaving Switzerland. In those cases, you will lose out a part of the second pillar as taxes. But this is not as much as your marginal tax rate. And voluntary contributions are always locked for three years.

As long as it is inside the second pillar, your money will get some interest. Unfortunately, the interest is currently extremely low now. You can expect about 1% interest in most pension funds in Switzerland. Nevertheless, it is a safe interest for now. It cannot go down. So, you can consider the second pillar as a place to have your bond allocation.

There is a second tax advantage to the second pillar. You do not have to pay taxes on the second pillar assets. So, if you have a large net worth, you will not have to pay wealth tax on your second pillar assets.

But this is a smaller advantage than the first one. It will still reduce your taxes a little further, but where the first tax advantage can be up to 40%, the second advantage is about 1% in the best case. Nevertheless, it is still important to know that you do not pay any wealth tax on your second pillar.

Scenarios

The obvious alternative is to invest in stocks. We can check how the same sum behaves if invested in stocks or contributed to the second pillar. First of all, let’s run some scenarios to see how that works.

Let’s start with a return per year of 3% for the stocks. This is a very conservative estimate. For the second pillar, we will consider 30%, 35%, and 40% marginal rates. The current interest rate on most second pillars is 1%. So we will take that as the reference. Here are the results for twenty years.

Second pillar vs Stocks (3% per year)
Second pillar vs Stocks (3% per year)

As you can see, it takes 13 years for the stocks to catch with even the lowest marginal rate. And it takes about 17 years to catch with the largest marginal rate. In that case, a 3% return per year on the stock market is slow to catch up with a substantial interest as a tax deduction.

But generally, stocks are returning more than 3% per year. So let’s see what happens with a 5% return per year.

Second pillar vs Stocks (5% per year)
Second pillar vs Stocks (5% per year)

This time, it takes less than ten years for the stocks to go up as much as the second pillar. And they are ending up much higher. This exponential growth is the power of compounding. Even 5% per year can return a lot in the long term. 5% per year is what I expect from the stock market.

Obviously, in practice, you will not get 5% per year. You may get 10% one year and -20% the next year. But this is how the stock market works, and I am prepared for this. You can only expect average returns over the long term.

Now, some people are counting on about 7% of return per year. So, let’s see how that will go:

Second Pillar vs Stocks (7% per year)
Second Pillar vs Stocks (7% per year)

With 7% of stock returns per year, the return on the second pillar contributions is dwarfed. Compounding gets stronger and stronger as the returns increase. After twenty years, your stocks will be worth more than twice your second pillar contribution.

Based on this uniquely, one should probably not invest in the second pillar.

However, there are other considerations. First of all, it will depend on the term of your investing. If you are investing in the long term, it is probably better to stick with stocks. But if you are to get access to your second pillar soon, it may be a solid investment. It could be a good investment if you are going to retire soon or if you are going to build a house or start a company in the medium-term.

But, do not forget that voluntary contributions are locked for three years. So if you intend to buy a house in the next three years, you should not invest in it.

Another thing you need to take into account is whether you have a great second pillar account or not. If you have a good second pillar account invested in stocks, it will become more interesting to invest in it! But the great majority of people in Switzerland will not have access to a good second pillar.

The other consideration is whether you need bonds in your net worth or not.

Your bond allocation

Due to its safe nature and the guaranteed interest rate, I consider my second pillar as bonds. I integrate my second pillar into my net worth as bonds.

So another reason to buy into the second pillar is depending on your allocation. If your bond allocation is too low for your current allocation, you can make a voluntary contribution to increasing it. Given that it also has a nice tax advantage when you purchase, it is probably better than bonds. Especially, it is better than Swiss bonds that have a negative interest rate. If I need to buy bonds, I will contribute to my second pillar.

For instance, here is the allocation of my net worth at the start of 2021:

Our Net Worth Allocation as of March 2021
Our Net Worth Allocation as of March 2021

We currently have too few bonds in our portfolio. We aim for our bonds to be 10%, and it is currently 5.2%. So, it shows that we should contribute a little to our second pillar. Unfortunately, it is not a good time for us, as we will see in the next section.

Proper Timing

There are some cases where it becomes very interesting to make such contributions.

  • When you know, you will retire or buy a house in the medium-term (but further than three years). Since they are a short-term investment, it is good to use them as such.
  • When you know you are going to leave your company and switch to a vested benefits account. This could be the case when you are retiring early or leaving Switzerland. These accounts are often much better than second pillar funds. So it could be interesting to max out your contributions to have them invested properly.

On the other hand, there is one case where you should not contribute to your second pillar: when you do not get any tax advantage. When you withdraw money early from the second pillar (for a house or business), you will not get any tax advantage until you have paid back the withdrawn money. So as soon as you withdraw money from the second pillar, it becomes pretty much useless to put more money into it.

This is the case for us. We just withdrew money from our second pillar and cannot get any tax advantage until we contribute at least 50’000 CHF into it. So, without the tax advantages, it does not make sense for us to invest in the second pillar.

These examples show that timing is important for second pillar contributions.

Conclusion

It is clear from the different scenarios from an investment point of view that contributions to the second pillar are not as good as it seems. Even though they have a substantial initial return on investment, they have very little returns per year after that.

Nevertheless, money in a second pillar is an excellent alternative to bonds. They have a guaranteed (at least for now) interest and offer an excellent tax reduction. These tax reductions are something that would be quite interesting to do as one is nearing retirement. But keep in mind that you can only contribute to your second pillar if you have a salary or have your own company.

But it is not necessarily the best investment at all times. Like every other investment, it will depend on your context and your situation. You should consider every element before you decide on any investment. And never make any rash decisions!

Since our marginal tax rate is getting higher and higher, I wish I could contribute a little to the second pillar. Unfortunately, we just withdrew 50’000 CHF from it. So, we would need to contribute 50’000 CHF back without tax advantages before we could get tax advantages. So, we will not contribute to our second pillar. The only reason for us to contribute would be if Mrs. The Poor Swiss gets a job, and then we could contribute to hers to save money on taxes.

What do you think about this? Are you contributing to your second pillar?

Mr. The Poor Swiss is the author behind thepoorswiss.com. In 2017, he realized that he was falling into the trap of lifestyle inflation. He decided to cut on his expenses and increase his income. This blog is relating his story and findings. In 2019, he is saving more than 50% of his income. He made it a goal to reach Financial Independence. You can send Mr. The Poor Swiss a message here.

69 thoughts on “Should You Contribute to Your Second Pillar in 2021?”

  1. Hi Mr. The poor Swiss,

    Another great article from you, may you explain a little bit how the initial numbers at year 0 came from from each graph. How you do pick this number as the start point in year 0. Thanks a lot in advance.

    Blue ~10500
    Red ~12750
    Yellow ~ 13750
    Green~14000

    1. Hi,

      It’s actually the returns of each of the investments after 1 year
      * With stocks, you made 5% each year
      * With the second pillar, you make an instant return (tax saving) of your marginal tax rate (30%, 35%, 40%) and 1% on the second pillar itself, and then in the following years, you can invest the tax saving in the stock market.

      Does that make sense?

  2. Good article.

    Not so sure about your calculations though.
    I’m assuming that you are using CHF 10k as amount to invest in stocks when not contributing to your second pillar.

    With 30% marginal tax rate the amount to contribute to the second pillar would be CHF 10k/0.7=14285.71. Which means the graphs show incorrect representations for the contribution cases.

    With 15 years left that would mean a required return on the stocks of 3.43% to break even. Not to mention the risk difference between the two options.

    1. Hi capmac,
      ¨
      I am using 10K in both cases. In the case of the second pillar, this brings in extra returns based on your marginal tax rate. These extra returns are invested in the stock as for the 10K for stocks.
      In the case of stocks, 10K is invested in stocks.
      The marginal tax rate does not give you more to invest in the second pillar, it gives you more to invest in stocks. By investing X int the second pillar, you are saving X*marginal tax rate. And then you can invest this amount in stocks.

      Thanks for stopping by!

      1. Hmm, I think this is a similar problem as with your third pillar calculations. Applied maths is always affected by perspective and can be biased.

        My view is that in both cases you don’t get additional money to invest.
        In case of stocks you even have e.g. 30% (the marginal tax rate) less to start with than with the second pillar case. So starting with 10k in both cases is already an issue.

        I did contribute to my second pillar in 2018 and the expected tax reduction I received was exactly the marginal tax rate applied to the lump sum I paid in. But I don’t understand that as a return as that reduction basically ended up in my 2nd pillar.
        Also I have roughly 15 years max left in the 2nd pillar and the interest rates are more around 2% in my case. So the stocks option is not really competitive in my case.

    1. Hi papuu,

      There is, but it depends on each situation. It will depend on your contribution gap. So you will have to ask your second pillar provider to know the limit you can contribute.
      It will depend on how much you have contributed, how much your income increased over the years, how many years you did not contribute.

      Thanks for stopping by!

  3. Hi Mr. The Poor Swiss

    Have you thought of including wealth tax into your calculation? If you prepare for your retirement by investing into stocks, you probably will reach the limit, where you start to pay wealth taxes. This will somehow reduce the return of your stocks by having to pay more taxes.

    1. Hi RetirementDreamer,

      By my calculator, you mean the graphs on this article or the calculator on the website about retirement?
      For the first case, I don’ think it matters much. Either for the second pillar or stocks, it will grow your wealth tax. And for your stocks, they should compensate for the growing wealth tax by returning more than the second pillar.
      For the second case, you can include the estimated wealth tax in your expenses and the simulation should be accurate enough. Of course, we could add a wealth tax on top of that based on the current value. But I do not think this would add enough value to make it more complicated.

      Thanks for stopping by!

      1. Thank you for your response!

        I do mean for the graphs in this article. As far as I understand, you will not have to pay wealth taxes on your second pillar, whereas you do have to pay them, if you invest yourself. This could have an impact on your decision to pay into your second pillar or not. It is different for each canton, but it looks like, that the wealth tax is in the range of per mill and not percent. So it will probably have a negligible impact on your decision.
        It was just a thought to try to be as thorough as possible.

        1. Hi,

          Ok, I understand then :)
          It’s a good point! You do not pay wealth taxes on the second pillar until retirement age. And then, you will pay a wealth tax. But you are right that this especially matters during accumulation. So this could be a good way to avoid some wealth taxes by having more money in the second pillar.
          I will add try to do this once I update this article!

          Thanks for the suggestion!

  4. I feel like topping-up the second pillar is something for your 40s and up in my case. Right now, my marginal tax rate decreases significantly with my 3a (with VIAC) but wouldn’t decrease much more with 2nd pillar contributions. The more I earn, the more likely I’ll be able to decrease the tax rate by investing in 3a and 2nd pillar. Am I wrong?

    1. Hi retireby50,

      No, you are not wrong. You can do large contributions to the second pillar. This could help with a large salary to reduce your tax rate.
      For really young people, this is not great since it’s a very short-term investment. But for people that are getting closer to retirement, it starts to make more sense.

      Thanks for stopping by!

  5. Dear Mr. Poor Swiss,
    Topping-up the second pillar is an excellent tool to reduce taxes. There are also ways to pay no taxes on withdrawals (e.g. relocate to a foreign location that doesn’t tax capital payouts and has a double-tax treaty with Switzerland). I fully agree with your post that putting money into a second pillar is a lousy investment per se. However, it can be a powerful tool used strategically for paying less income taxes and plan the withdrawal well! Cheers, Matt

    1. Hi Matt,

      Yes, you are right that if you can avoid the taxes at withdrawal, it becomes more interesting.
      It is also very interesting for the short-term for instance 4-5 years before buying a house.

      I plan to retire in Switzerland, so I will pay taxes on withdrawal. Therefore, it’s not that efficient for me.

      Thanks for stopping by!

  6. Thanks for the great post.
    Should we consider the combined investment?
    If I pay 30kCHF in second pillar, and get 30 to 40% back on day 1 (let’s say 12kCHF at 40%), basically I can combine the two investing the 12kCHF.
    With a total ‘cash out’ of 30 kCHF I would have:
    30kCHF in second pillar 3%
    plus 12kCHF invested at 3 to 7% in stock
    Maurizio

    1. Hi Maurizio,

      This is a nice way to think to it. Especially since the extra money you get back from investing in the second pillar is not in the second pillar. I didn’t consider it like this, but it seems more correct.

      You are not going to get 30% back since this will be money that you are going to save on your taxes bills, not something you are getting back. But it’s true that by the end of the year, you will have extra money to invest.

      I have run a few calculations and it is indeed significantly better! It’s still not as good as stocks, especially with a high % returns, but it gets closer.

      Thanks for pointing that out! I will have to redo my calculations once I get some time :)

  7. Hi
    Thanks for these calculation. Do your charts take into account the tax on payout? (Kapitalauszahlungssteuern)

    Afterall it takes away about 5% of the FINAL value.

    1. Hi,

      No; my charts do not take into account. The final number for the second pillar will be even smaller. Unfortunately, it is difficult to compute how much taxes will be paid on the second pillar.

      But you are right that I should account for that! I will try to update the post to make that more clear

      Thanks for stopping by :)

  8. My question is if you are only allowed to invest in very low yielding debt instruments in your second pillar, tax-advantages account? Do you not have an opportunity to invest in stocks, mutual funds, ETFs through that account? If you can, tax-advantages stock returns are better than after-tax stock returns, assuming your ultimate goal is a secure retirement. If you’re looking for liquidity and have a more pressing purchase in mind, after-tax is the way to go.

    1. Hello Young (YATI? YI? :) )

      That is a very good question.

      If we could choose the allocation of our second pillar, it would make sense to invest as much money as possible into it. Unfortunately, Swiss second pillars are much worse than 401(k) from the United States. The pension Funds companies are allowed to invest the money as they wish but they only give you very little (1% per year currently) of the returns. This really sucks. But there is nothing we can do.

      We cannot choose what our second pillar money will be invested into. Therefore, it’s not as good an investment as it seems.

      I hope that makes sense

      Thanks for stopping by

        1. I agree, it stinks. There is still the advantage of the initial tax advantage. So I am going to use it if I want more bonds. But for now, my second pillar is already quite big compared to my stocks.

          Thanks for stopping by YATI ;)

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