In our Three Pillars of Retirement of Switzerland series, we already talked about the first and second pillar. We now have to cover the most important of the three pillars: The Third Pillar.
The third pillar is the only one that is not mandatory. Everybody is free to choose to invest in the third pillar or not. It is simpler than the second pillar. But there are much more choices than you can make. You can optimize a lot of things for your third pillar. I believe it is very important to optimize the investment of the third pillar as much as possible. Once you reach retirement, your second pillar should still be larger than your third pillar. But there is not a lot of things you can do with your second pillar.
In this post, you will find all the details you need to invest in a third pillar. And also, what you can do to optimize your use of this last pillar.
Types of third pillar
The third pillar is your private pension. This time, there is no complicated name associated with it. It is known everywhere as the third pillar. There is just a slight twist. There are two different third pillars:
- Pillar 3a (restricted pension): Locked and tax-advantaged
- Pillar 3b (unrestricted pension): Not locked but much fewer tax-advantages
In this post, I will mainly talk about the first one, Pillar 3a. For information about the 3b, you can read the Section Pillar 3b. Otherwise, when I talk about the third pillar, I will be talking about the Pillar 3a.
If we focus on the Pillar 3a, there are still two ways to invest in a third pillar. You can invest either in the form of a bank account or as insurance. We are going to cover both of them in details in the next two sections. It is important to know that not everybody can open a third pillar account. Indeed, you need to have a salary and pay for the first pillar. If you do not satisfy both requirements, you cannot open a third pillar account.
In both cases, contributions to your third pillar are tax-advantaged. Each year, you can deduct up to 6768 CHF (as of 2018) from your salary. The exact amount removed from your taxes will depend on your income. Generally, you can easily save 2000 CHF per year by contributing the maximum to your third pillar. Contrary to popular belief, you can put more money into your account than the yearly maximum. But this is not tax-advantaged and thus not useful. Some banks will actually prevent you from doing that. So, never put more than 6768 CHF per year into your third pillar. You will receive a certificate with your contributions at the end of each year. You can use this to fill your taxes.
What you will get in retirement will depend on whether you have a third pillar in a bank or with an insurance company.
The third pillar in a bank
The simplest third pillar is a bank account. It is a normal bank account except that it is locked. You cannot withdraw anything until you reached retirement. You can directly deposit money into this locked account. Pretty much every bank has one or several third pillar accounts. The only thing that is different between these accounts is the (small) interest. It is generally higher than the interest on your savings account. But today, it is ridiculously low.
More interestingly, you can also deposit this money in Third Pillar funds. For instance, my bank (PostFinance) has three different retirement funds. One with 25% stocks, one with 45% stocks and one with 75% stocks. You are investing this money for the long-term. It is better to invest it in stocks rather than let it grow very slowly with current interest rates.
You will be able to withdraw the money at most 5 years before retirement age and at most 5 years after retirement age. You cannot do a partial withdraw, you have to withdraw the entire amount.
How to choose a third pillar account?
Which third pillar account should I choose?
I cannot recommend any specific account since I have not done full research on it. You should pay attention to the following points when you search for a third pillar account:
- Interests. If you are not using a fund, you should worry about the interest rate of the account. Be aware that currently, it is pretty bad. The best interest rate I have found is 0.75% (with Bancastato)
- Choice of funds. If you plan in investing in a fund, you should check the funds proposed by the bank. Some banks have a large panel while some others have a poor choice.
- Allocation to stocks. You do not have a lot of choice in what the retirement fund will be investing in. But you can decide how much investment in stock you want. You can be very high based on the provider you choose. The highest investment in stocks is 100% (with VIAC), currently invested at 97%. Be careful in your asset allocation before you choose your fund.
- Total Expense Ratio (TER). When you are comparing third pillar funds, you should pay attention to the TER of the fund. This is the amount of fees that you are going to pay. The TER is removed from your returns each year. The fees are generally high on these funds. The lowest fee I know of is 0.5% (with VIAC). Even the lowest fee is still high in my opinion.
- Diversification. Another important point is to see how the stocks (and bonds) are invested in the fund. Almost all the retirement funds are only investing in Swiss stacks and Swiss bonds. But some of them are more diversified. For instance, VIAC offers one fund with 60% world and 40% Switzerland.
You should do your research well and think about what you want from your third pillar. And do not worry if you already have a third pillar account, you can have as many as you want.
In the past, before I did the full research on third pillar accounts, I had a PostFinance third pillar account. It was invested a pension fund, PostFinance Pension 75, with 75% allocated in stocks. It is a good option since the allocation to stock is higher than the average in Switzerland. But the TER was too high and the international allocation was too low.
So, I did a full comparison of the options for third pillar accounts. After this, I found out that VIAC is the best third pillar available in Switzerland. It has very low fees and you can invest almost 100% in stocks which is great for the long-term. If you are interested, you can find out how to open a VIAC account in a few minutes.
The third pillar with an insurance
The other option is to have a third pillar in the form of life insurance. You will pay a certain amount each month that will go into your insurance. Once you reach retirement age, you get a certain amount of money plus some interests. The amount of money that you will get at the end is guaranteed. But, the interests you will get are not guaranteed.
If you are unable to pay any more (if you are handicapped for instance), it is still guaranteed. This is only the case for some stated reasons in your contract. You cannot stop paying simply because you want to. If you die before the terms of the contract, your spouse will get the guaranteed amount. If you break the contract or stop paying, you will lose a lot of the money you invested. The amount your life insurance is worth will increase faster and faster over time. The first two years, it will not even be worth anything. If you think you may break the contract or stop paying, never contracts life insurance! Never stops a life insurance contract!
A lot of people will tell you not to use this kind of insurance. And a lot of insurance people will tell you that everyone should have one.
Who to believe? Should I take such insurance?
Again, it depends on your situation. There are advantages and disadvantages. First, it is true that you will not get back the entire amount you paid, contrary to a third pillar bank account. However, this amount is guaranteed. If your third pillar in a bank has done poorly because of a bear market, you can end up losing money. With third pillar insurance, you will get at least the guaranteed amount. The interests will vary of course. And generally, they are quite optimistic with the interests they are predicting.
Most importantly, it is a life insurance. If you are not in a couple and do not plan to be, you probably will not need a life insurance. It may still be useful for the case when you are incapacitated, but much less interesting. If you are in a couple and your spouse does not work and you do not have much savings. It is a great way to insure her/his quality of life. If you are both working with good salaries and you have good savings, you do not need such a life insurance. A problem with a life insurance is that you do not choose how much you put each month. It is yet another bill to pay every month.
Personally, I do have a life insurance third pillar. I did it because in case I am incapacitated, it will still fill up. Also, my future wife will have no salary at the beginning and if I die, it will be much easier with the life insurance money. However, I did not do much research for this, so it may not be so great.
Which third pillar life insurance should I choose?
Again, I do not know which life insurance is the best one. Here are some things you should pay attention when you research a life insurance:
- The amount per month: You should pay an amount per month that you are comfortable with. You will pay this for many years. This will set the guaranteed amount in the end. I would not recommend more than 300 CHF. You should keep some to invest in a third pillar bank account.
- The guaranteed amount in the end: The most important number is how much you will get in the end. The insurance guy will try to make you look at projections. I would advise you to care mostly about the guaranteed amount. Nobody can predict interest rates over 30 years or more. You should consider the interests as a bonus.
- The investment of your funds: Each insurance will invest your money differently. They will probably propose you different asset allocation or investing strategies. You should pick the one your are the most comfortable with.
You should your research well. Do not take any rash decisions.
Optimize your third pillar
There are a few things you can do to use the third pillar in the most optimized way. First, always try to contribute the maximum each year into your third pillar. If you can! Do not get into a bad financial situation just to max out your third pillar.
If you have it in a bank account, you should consider using a retirement fund. You should consider a fund with an asset allocation that you are comfortable with. You should consider for how many years you will invest and how much risk you want to take.
Now, a slight twist. When you will withdraw your third pillar, you will pay taxes on the amount. This amount is taxed as several levels and it depends on which state you are in. For instance, in Geneva, for up to 25’000 CHF, you will pay 250 CHF in taxes (0 CHF for a married couple). For up to 50’000 CHF, you will pay 1’500 CHF (500 CHF for a married couple). If we take the state I am living in (Fribourg), it is different. There is a 2% tax on the first 40’000 CHF. Then a 3% tax for the next 40’000 CHF and it keeps increasing until it reaches 6% tax. You may have already seen the problem here. The taxes are more expensive the more money you will get. And it is quickly getting worse if you withdraw even more.
You can withdraw your third pillar money up to five years before and five after the official retirement age. Thus, you can work around these taxes by having several third pillar accounts and only withdrawing one each year. For Geneva, you should try to have less than 25’000 CHF on each account before withdrawal. Below 50’000 CHF, the taxes are still fair. So you may keep your accounts below 50’000 as well. But you should not go higher. For Fribourg, you should stay below 40’000 CHF. You have to check the exact taxes for your current state.
Now, there are two tricky things with this. First, there is no way to know how much will be on your third pillar account if you have a retirement fund. The returns will depend on the market. If you think your investment will double before retirement, you should stop contributing at 12’500 CHF. The difference between a 24999 and 25001 will result in 1500 CHF of taxes! This is absolutely insane in my opinion.
Now comes the second tricky issue. Some states in Switzerland are considering this as tax evasion! For instance, the state of Vaud allows you to have two different accounts. The state of Neuchâtel forbids you to do this. My state (Fribourg) does not currently prevent this. But this may change. So, you should be careful with this technique. You should check with your state before you try to do this. Just to be clear, it is never a problem to have several third pillars. The problem arises when you optimize the withdraw over several years. Thus, I advise you to create several smaller third pillar accounts. But only spread out the withdrawals over several years if your state allows it!
Withdraw before retirement
You can withdraw money from your third pillar before retirement (early withdrawal). The rules are the same as early withdrawal for the second pillar. You can withdraw to buy a house, start your own company or leave Switzerland.
There is another case when you can withdraw money from the third pillar. In fact, you can withdraw money from the third pillar to contribute to your second pillar. I am not sure there is a lot of value in doing that. You will not be able to deduct this contribution to the second pillar from your taxes. So that you will not be able to deduct it twice.
Accounting for the Third Pillar
Accounting of the third pillar in your net worth is fairly easy. For a third pillar bank account, you can simply account for it like all your other accounts. It is money you owned, it is just locked until retirement age.
For a life insurance third pillar, it is a bit more complicated. Your insurance should give you a guaranteed amount year by year. Using this, you can extrapolate the monthly values to see how much you currently have. You can have a look at how I accounted for my life insurance in my net worth.
The pillar 3b is a bit more obscure and is less known. First, you do not have the choice between a bank account and insurance. A pillar 3b is always life insurance. There is no way around it. But, it is much more flexible than a life insurance 3a. You can choose any term. Most insurances have a minimum term of 5 or 10 years. Another interesting thing is that you can do insurance for a couple. This is generally cheaper than two individual insurances.
Some people will tell you that there is no tax-advantage, but that is not true. A pillar 3b has some tax-advantages. First, the capital you will get at the term will not be taxed. That means that the interests accumulated over the years are not taxed. Then, some states have some more advantages. For instance, my state (Fribourg) allows a married couple to deduct up to 1500 CHF each year. Geneva is even better and you can have deductions per children. You should consult your local state to see if you can have advantages.
To choose a life insurance 3b, you can follow the same criterion as for a 3a life insurance. The other thing that you have to choose is the term of the insurance.
The third pillar is the last part of Switzerland retirement system. It will help you cover what is missing from the first and second pillar. Contrary to the previous two pillars, it is an optional part of the system. It is entirely up to you to invest in it. Since it is tax-advantaged, you should invest in the third pillar. At retirement age, you will get the capital back and pay some taxes on it.
If you have not yet read about the first pillar or the second pillar, I encourage you to do so now. In the next and final post, I summarize Switzerland’s retirement system. I also talk about early retirement in this context.
What do you think about the third pillar? What is your preferred account? Do you have tips to optimize it? Do you have any question regarding this pillar?