Should You Contribute to Your Second Pillar in 2023?| Updated: |
(Disclosure: Some of the links below may be affiliate links)
In Switzerland, you can make a voluntary contribution to your second pillar. These contributions come with 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 ask whether they should contribute money to their second pillar or continue investing in stocks. In this article, I answer this important 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 to cover the holes in your second pillar. If you had a low salary when you started, you will surely have holes in your contributions. When you contribute, you can deduct it from your taxes, just like the third pillar. The second and third pillars are among the best tax deductions.
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 on a part of the second pillar as taxes. But this is not as much as your marginal tax rate. And voluntary contributions are always blocked for three years.
As long as it is inside the second pillar, your money will get some interest rate. Unfortunately, the interest rate is currently extremely low now. You can expect about a 1% interest rate in most pension funds in Switzerland. Nevertheless, it is a safe interest rate 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.
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.
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 rate 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.
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:
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 will retire soon or build a house or start a company in the medium term.
But do not forget that voluntary contributions are blocked for three years. So if you intend to buy a house in the next three years, you should not invest in the second pillar. If you plan to buy a house without the second pillar, then you can continue your contributions if you have enough cash for the downpayment.
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 most people in Switzerland will not have access to a good second pillar.
The other consideration is whether you need bonds in your net worth.
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.
At the start of 2021, we had 5.2% allocated bonds in our net worth. Since we aim for 10% bonds. 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.
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 short-term investments, it is good to use them as such.
- When you know you will leave your company and switch to 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.
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 increasing, 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 first put that 50K back into the pension fund before having benefits.
If you are interested in saving money from taxes, you can read my article about the best tax deductions in Switzerland.
What do you think about this? Are you contributing to your second pillar?
Download this e-book and optimize your finances and save money by using the best financial services available in Switzerland!Download The FREE e-book
95 thoughts on “Should You Contribute to Your Second Pillar in 2023?”
There is another, albeit small additional benefit I think is missing here. If you contribute and save taxes, that saved money could be invested into stocks.
In my case, it’s a bit different. I am moving back to Switzerland starting again with zero in my 2nd pillar. It’s a bit more interesting to catch up now with the money I originally pulled out years ago.
Hi, do you get taxed when you do an early withdrawal of the Pilar 2 say, o buy a house? At which rate are the withdrawals taxed? Same as normal income?
Yes, you get taxed, but at a significantly lower rate than income tax rate. This rate is different for each canton. And this rate is generally progressive by tier.
I asked my second pillar provider and they confirmed that although you cannot withdraw the 22nd pillar contribution for three years to buy a home, you can still pledge it to buy a home. So I think that having the intention to buy a home in the next three years should not be a reason not to contribute to your 2nd pillar.
Am I missing something here you think?
Thanks a lot for your blog
You are correct. If you plan to pledge the money, you should be fine since pledging is long-term and you have no 3 years limit. In that specific case, it’s not a reason not to contribute.
I think this article is missing an important point: The returns on the 2nd pillar during retirement.
On the mandatory part of the pension, it’s 6.8% and on the extra mandatory (if that’s where you contribution lands), it depends, but it’s common to get over 5%.
So when you combine the tax advantages with the returns which are higher than an often targeted 4% during retirement, then it looks like an attractive proposition, except for the fact that the money is more difficult to get to prior to retirement.
That article assumes you are getting a lump sum for your second pillar.
Contributions all lands in the extra mandatory part. So, you usually get about 5% pension.
4% is not target return, but withdrawal rate, which are different. I expect at least 5% annually returns, so 5% on the second pillar is in check with what I expect from my own portfolio.
Hi IB, I have been lurking around your blog with so many questions. Sorry and thank you. You are so great!!! As I’m leaving Switzerland and about to transfer my Pillar 2 into finpension vested benefits account, I’m considering making the buy back contribution of around 30K to get more benefits from tax deduction. Is this falling into the scenario “When you know you will 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”
I’m quite unsure about the locking 3 years rule for the buy back. I’m leaving in a next few months and will make the buy back now. Is the transfer from Pension Fund to finpension considered an early withdrawal that violates this 3 years rule.
I found this on finpension website,
“The blocking period is three years. It begins on the day of purchase and ends three years later to the day. Both the advance withdrawals (WEF, self-employment, emigration) and the lump-sum withdrawal on retirement are affected by the blocking period.”
Normally, buyins should be locked for withdrawals, not for transfer. You should be able to do contributions and move all the money to another pension fund or vested benefits accounts without issue.
You can ask finpension to be sure, but I am pretty sure it would not cause an issue.
Hi, since my one year employment contract ends in August i was wondering if i am allowed to contribute to second pillar too? The idea would be to transfer the money after the contract end to a vested benefit account like finpension or viac (99% stock allocation possible). So i would benefit from tax savings and still be invested in stocks until my retirement. i am currently 37.
I like your blog a lot (i sometimes disagree with some things, while at the same time agree with many other things); i think that your blog stimulates us a lot to think about how exactly we provide for own future – and this is very important. Thank you so much indeed for sharing so much with us. I think that yours: “So, you can consider the second pillar as a place to have your bond allocation.” (i.e. to use pillar 2 instead of bonds, as swiss bonds yield negatvely) – is a terrific thought! i honestly never thought of the 2nd pillar this way; it is very wise and gives plenty of food for thought.
Don’t hesitate to let me know in the comments when you disagree :)
I am glad some of my articles are stimulating people to think more about their future!
And the second pillar is a good way to balance an asset allocation!