This article deals with the Swiss specificities of pension funds and is not useful in its entirety to all readers who may skim the first part. The last section on “Considering occupational pensions as part of your wealth” may however provide useful information to anyone wishing to integrate the impact of their occupational pension into comprehensive wealth management.
Who is insured under the occupational pension plan: contributions and benefits
The occupational pension plan (BVG or second pillar) is compulsory for employees who are already subject to the state pension plan (AHV) and earn currently more than CHF 21,510.
The second pillar is based on individual savings. The savings start when the insured reaches the age of 25 and stop when he/she reaches retirement age. The capital accumulated by the insured person in his or her account over the years of insurance is used to finance the retirement pension. The accumulated capital is then converted into an annual retirement pension using the current conversion rate of 6.8% for men and women.
According to the Law on Occupational Pensions (LPP) and as in the 1st pillar, the retirement benefit can be received before reaching the normal retirement age. However, the insured may only take early retirement if the institution’s regulations expressly provide for this possibility. The minimum age for early retirement is 58. In the event of early retirement, the retirement benefits are reduced: as the theoretical retirement savings are not fully built up, a lower conversion rate is applied to the calculation of the retirement pension (see section “Pension, conversion rate, and forecasts”).
The capital built up for retirement benefits is called retirement savings capital. This capital is made up of the annual retirement credits, on which an interest rate of at least 1% (since 2017) is applied. This rate has been steadily decreasing in recent years (1.25% in 2016 and 1.75% in 2015).
It should also be noted that the decline in the technical interest rates of the pension funds should have reached its bottom. The technical interest rate is used to discount future benefits and must be chosen so that it can be financed by the return on assets. Achieving an annual return of 1.5 or 1.75% on investments should be possible in the long term, even in Switzerland, and this technical rate should not fall any further.
The situation of pension funds
Performance of pension funds
Pension funds have weathered the pandemic crisis well. The capital markets were in a “state of confusion” during the Coronavirus crisis, with the effect of expansionary fiscal and monetary policies. Former ECB President Mario Draghi had indeed set the tone in 2012 with his “Whatever it takes” statement and opened the floodgates for unprecedented unaccountable money creation in Europe, which Switzerland could not resist.
In such an environment, equity investments have risen sharply in value and like many of us, pension funds have benefited in proportion to their exposure to the stock markets. The influx of money from central banks has driven up stock prices and real estate prices – and Swiss pension funds have benefited as well. But let’s not forget that you can also lose money with stocks in the long run. The Nikkei 225 index peaked at more than 38,000 points in 1989 and never reached that level again with significant losses, even for long-term equity investors.
Many pension funds also hold a high proportion of government bonds in their portfolios. These assets help stabilize the fund but lead to poor performance during these bull markets. These bonds imply virtually guaranteed losses until maturity, a situation dictated by ultra-low interest rates. This will undoubtedly impact the performance of pension funds in the future, as will the very large real estate holdings in the periphery (for which finding enough tenants may prove difficult) by pension funds.
In 2021, the lower house of the Swiss parliament (National Council) passed a motion to give pension funds more investment flexibility. In return, the motion calls for more financial expertise on the part of pension fund boards of trustees to better manage the risks of these more volatile investments.
Supervision of pension funds
Pension fund consolidation is a long-term trend and is expected to continue. In 1987, there were still more than 4,000 registered pension funds with the active insured. Today there are less than 1500, and by the end of the decade, there could be less than 1000. This is reflected in the investment volume: small funds account for only a good 2% of management, while the largest pension funds with assets of more than one billion Swiss francs account for more than 80% of assets under management.
Today, the vast majority of pension funds have an occupational pension plan with a collective foundation or a community pension fund through their employer. This consolidation can increase efficiency in certain circumstances and certainly compensates for the loss of the pension institution’s proximity to “their” companies.
In 1976, Peter Drucker predicted that pension funds would one day become the majority owners of the world’s means of production, i.e. companies. A professionalization and a better organization of these funds are therefore necessary to make the most of the power obtained by pension funds. Thus, any good pension fund should follow the following precepts
- Autonomous pension organization with clear missions ;
- Strong fiduciary governance functions;
- Access to the resources they need to succeed.
To date, it is clear that small funds are far from this ideal and still have glaring shortcomings: pension fund boards of trustees work part-time and often have to acquire professional competence themselves!
Occupational pension provision is compulsory and very important, but the law does not impose any formal requirements on pension fund managers. Education and training are indeed required by the pension law and there are many training offers, but the fulfillment of this mandate remains at the discretion of each individual. For example, pension expertise and investment know-how are not required, despite the great responsibility and consequences. For example, foundation boards have unlimited personal liability under the law for damage caused to the pension fund intentionally or through negligence.
Fortunately, pension fund accounts must be reviewed by independent auditors and pension obligations must be accounted for under the recommendations and actuarial calculations of the certified pension fund expert. Actuarial experts are commissioned by each pension fund and their calculations take into account the life expectancy of the insured and the number of retirees and employees.
In addition to actuaries and auditors, the supervisory authority ensures that non-professional bodies stay on track, but this supervision remains limited: When setting up a pension fund or replacing the members of the foundation board of a pension fund, the supervisory authorities require documents on the appointed members of the foundation board, such as professional experience and current extracts from the criminal and prosecution records. Only in the case of obvious circumstances will the supervisory authority examine the situation and the individuals more closely, but rarely intervene.
Pension, conversion rate, and forecasts
In 2021, the average forecast for the future conversion rate was 5.2%. This means that if you have CHF 500,000 in your occupational pension plan when you retire, you will receive an annual pension of CHF 26,000 with this conversion rate. The reason for these expectation is the negative interest rates as well as the demographic development. Since the last survey reported by the NZZ, expected conversion rates have not decreased further and have stagnated at an average of about 5.2% (instead of the current 6.8% for the mandatory portion and 5.5% on average). The projected retirement pensions have thus stopped their negative trend after a long decline. Conversion rates below 5% would make the second pillar very unattractive and unless the system is coercively overhauled to prohibit capital outflows from the second pillar, this is the lower limit that should not be exceeded.
A few words on the 1st plan
Pillar 1e is technically part of the second pillar, i.e. the occupational pension plan. Apart from the compulsory benefits of the occupational pension plan, the extra-compulsory benefits, of which Plan 1e is a part, allow you to choose your investment strategy for the part of your salary that exceeds CHF 127,980, i.e. for salaried or self-employed individuals with a comfortable income. However, employees cannot choose to invest in a 1e pension plan, even if their salary is above this limit. As it is up to your employer to provide a 1e plan to his employees or not, find out if you have access to it.
1st pillar plans are offered by pension funds that exclusively insure this part of the salary by proposing different investment strategies according to the individual risk profile and the financial situation of the insured. Companies offering these plans benefit from the following advantages: they can offer attractive pension solutions for their executives and limit their risks to the pension funds (no need to compensate for any under-coverage or to build up fluctuation reserves for the pension fund).
The success of this form of pension provision indicates that confidence in the second pillar remains (perhaps more so than in pillar 3a with its limited amounts). However, Plan 1e is a foreign body in the second pillar and a sign of the individualization of pension provision (and for some a sign of a lack of solidarity): it is thus vehemently attacked by the left as a privilege reserved for executives of large companies.
Consideration of the occupational pension as part of your assets
Given the stalled reforms and the increase in life expectancy, further reductions in occupational pensions can be expected in the years to come. It is convenient to have a good fixed pension in the form of the first and second pillars. But as their level of inflation will probably be lower than today, it is better to contribute partially to the 2nd pillar to have a minimum basic pension (e.g. with 28’000 from the first and 50’000 from the second pillar). As an example, this would correspond to a capital of about CHF 700’000 accumulated in the second pillar. The two pillars will thus form an annuity that protects you against the risk of longevity (i.e. you will avoid using up all your resources before leaving this world); on the other hand, your heirs will not receive a cent in the event of your death and you cannot dispose of this capital freely. So don’t overload your second pillar or fill it up to the maximum, but use part of it for your house and invest it to build up your assets (if your situation allows it, also consider the possibilities of the 1e plans). You may be sandwiched between not being able to access the high-income 1e plan and still being too high income to qualify for other benefits (not rich enough, not too poor), like many middle-class individuals. For you, a real estate investment and a portfolio progressively accumulated according to the approach of this site is the solution of choice when faced with the challenges of retirement.
Sources: Trend der sinkenden Renten gestoppt, 27.10.2021, Neue Zürcher Zeitung https://www.ch.ch