When should you buy into a pension fund in Switzerland?

Retirement planning is essential, especially in Switzerland, where living costs are high. The Swiss pension system, with its three pillars, provides a solid foundation, but may not always suffice for a comfortable retirement. In this article, we will focus on the second pillar—your occupational pension—and the strategy of pension fund buy-ins. We'll explain what a pension fund buy-in is, why you should consider it, and the best times to do so. You will see that one of the main benefits is: You can fully deduct your buy-in amount from your taxes. But that doesn’t mean you should always do it.. Read on to understand why!

 Table of contents

• The Swiss Pension System: Quick Recap
• 7 things you need to know about Pension Funds
• What is a Pension Fund Buy In?
• What benefits come from buying into the pension fund?
• When should you consider buying into the pension fund?
• What should you consider when buying into a pension fund?

The Swiss Pension System: Quick Recap

Switzerland's pension system is renowned for its stability and comprehensive coverage, designed to provide financial security in retirement. It is structured around three pillars, each serving a unique purpose and collectively ensuring that retirees maintain a reasonable standard of living. However, with increasing costs of living and society growing older and older, the three pillars might not be enough for your comfortable retirement. But that is a story for another article…

For now, you need to now that the Swiss Pension System consists of three pillars:

First Pillar (State Pension - AHV)

The first pillar, known as AHV (=Alters- und Hinterlassenenversicherung= Old age and dependents insurance), is designed to cover basic living expenses. It is a mandatory scheme funded through payroll taxes shared by employees and employers. It offers benefits not only to retirees but also to their dependents, including widows, widowers, and orphans. Further, it provides you pensions in case you become disabled - be it through an accident or sickness. You contribute to the first pillar with every paycheck – it is automatically deducted from your salary. The amount of the pension you’ll receive depends on the number of years you’ve contributed and the average income over those years. Thus, it’s so crucial to close gaps if you have any.

Second Pillar (Occupational Pension - BVG)

The second pillar, known as BVG (Berufliche Vorsorge = Occupational Preventions) or “Pensionskasse” (=Pension Fund), is aimed at maintaining one's “standard” of living during retirement. This occupational pension scheme is mandatory for all employees and complements the first pillar. It provides benefits in cases of retirement, disability, and death. Both employers and employees contribute to this fund. The contributions are based on your salary and age, with higher savings contributions as you get older.

Third Pillar (Private Pension - 3a/3b)

The third pillar consists of voluntary private savings and is designed to fill any gaps left by the first and second pillars. It offers flexibility and tax advantages. Flexibility because it can be used to save for various life events, such as retirement, home purchase, or starting a business (single company). You can choose to save through bank accounts, insurance policies, or investment funds. The 3a scheme offers tax deductions up to CHF 7’056.- per year (2024), while the 3b scheme is more flexible and lets you invest as much as you’d like. You will not have tax advantages while you pay into the 3b, however, you will not have to pay taxes when you withdraw your capital.

7 things you need to know about Pension Funds

In this article, we will dive into the 2nd pillar: Your occupational pension.

You should know that:

1. Everyone over the age of 21 with a minimum salary of CHF 22’050.- per year must pay into the 2nd pillar.
2. If you are self-employed, you are not obligated to participate, but can choose to do so voluntarily.
3. You don’t get to choose your pension fund. It is determined by your employer unless you’re employing yourself via your own GmbH or AG.
4. You can cash in your 2nd pillar savings early to buy a home for yourself, start a business (Einzelfirma) or upon leaving Switzerland for good.
5. You can close contribution gaps in your 2nd pillar (e.g. from having a child or studying) by making voluntary contributions. But this is not a must. Read on for more information on this.
6. Voluntary contributions are fully tax-deductible, just as the 3a contributions are.
7. Important: Making voluntary contributions will block your entire pension money for 3 years. You won’t receive anything until the 3 years have lapsed.

What is a Pension Fund Buy In?

A pension fund buy-in means that you invest a certain amount of money – surplus to what you and your employer pay into it on your recurring monthly income – to close contribution gaps in your 2nd pillar. This will help you get more pension later in life as the pension fund will decide your final retirement pensions based on how much you and your employer contributed to your pension funds. If you have taken time off to study, to have a child, worked part-time or have taken a sabbatical, you’ll have gaps to close. Those gaps in your record can be closed by making voluntary payments.

Before you run away to close your contribution gaps right away: Continue reading first, there’s a caveat!

The maximum amount that you can buy-in can be found in your personal pension fund extract (= “Pensionskassenausweis”). Don’t hesitate to give the pension fund a call to ask for more information such as the minimum amount required to make a voluntary contribution.

Where do contribution gaps come from?

There are three main reasons for 2nd pillar contributions gaps:

1. Part-time employment: You earn less, you pay less into your pension fund. It’s logical. But the consequences can be severe for your financial security. If you can, limit part-time employment to a couple of years or find a solution with your partner to balance out your contribution gaps until you can work full-time again.
2. Missing contribution years: There are certain phases in life where you might not have worked, maybe due to childbirth or a sabbatical. Those are phases where you didn’t pay into your pension fund and thus creating a contribution gap.
3. Higher salary now then what you used to have.

I’m not here to say: Don’t start a family or don’t take that trip to Australia. But I am here to tell you: There is an impact on your retirement that you should be aware of and plan accordingly especially if you’re having children within a concubinage!

What benefits come from buying into the pension fund?

There are a couple of benefits associated with buying into the pension fund. The obvious one being: Closing contribution gaps to maximize your pension.

One of the main benefits is: You can fully deduct your buy-in amount from your taxes. But that doesn’t mean you should always do it.. hear me out!

When should you consider buying into the pension fund?

If you have maxed out your 3a pillar, you can make use of the tax benefits that come with buying into the 2nd pillar. However, you need to be strategic about it. It  makes most sense to buy into a pension fund when you are close to the extraction, be it due to age or due to wanting to buy a property for yourself in 5-6 years. Thus, if you’re planning on taking out capital upon retirement at 65, you might not want to pay in any later than 61 (being your last pay in) or maybe even 60, because you never know when you’ll be sent into early retirement - unless you're employing yourself. Please, please, please, be smarter than most, and do never forget about the 3 year capital blockage period! 

Also, the tax authorities don’t like to see you “exploiting” (their words, not mine) the system. So if you’re seen to just buy in to “only” harvest the tax benefits they might get annoyed and pull your tax benefits.

If you are planning on using your 2nd pillar funds to buy a house to live in yourself (you can’t use it to buy a house that you are renting out), then a buy-in when you are younger can make sense, but that house purchase better happen. If you’re uncertain about whether or not you’re going to purchase - better not buy in. Don’t forget: You can’t touch any of the pension money for 3 years starting on the day of the buy-in. Thus, if you are buying a house earlier, don’t buy into your pension fund, because you will block your entire funds and won’t be able to buy anything at all for the time being. Get in touch with me if you are unsure about your personal situation! 

On the flipside, I wouldn’t recommend buying in when:

• You’re around 61 years old (so close to retirement age) and you’re not sure if you’re going to pull out the capital from your 2nd pillar upon retirement. My reasoning is that you never know for sure until what age you will be able to work. Should your current employer decide to retire you early and you can’t find another job, then you will be forced into retirement and your buy-in will be blocked for 3 years, thus you’ll be forced to take pensions instead of having the choice of having monthly pension payments of a lump-sum capital pay-out.

What should you consider when buying into a pension fund?

Personally, I believe there are two main tasks that you should tackle before buying into a pension fund:

1. Decide whether you want to buy into the “ordinary” 2nd pillar or the 1e 2nd pillar - or as I like to call it 2c pillar. The yield on your investment will be very different; the ordinary 2nd pillar has a limit on how much of your money can be invested in stocks (higher yield, higher risk); on the 1e (2c) pillar you have full flexibility on your investment. It works similar to a 3a, which means that you can select your investment strategy yourself and are able to allocate a significant amount to stocks and equity to increase your yield. That wouldn’t be possible in the 2a pillar.

The infographic below will make it clearer:

• Within the 2nd pillar, there are three options: 2a / 2b / 1e (which I refer to as 2c)
• Employees with a salary of over 132’300.- can pay into the 2c pillar, which allows you to choose a personalized investment strategy
• This means, you can opt for a more equity-intense portfolio just like the 3a pillar allows you to
• Personally, I believe that you should always take advantage of 2c, if you can!

2. Find out if the pension fund is solid and stable:

1. Have a look at the foundation’s annual report and find out more about their financial situation.
2. How is the current funding ratio? The higher, the more stable the fund. It should be over 100%, otherwise the pension fund is underfunded. If it is, find out whether that is a current situation (wait with buy in until it’s resolved) or a long-term trend.
3. How is the ratio between retirees and active payers? The lower the number of retirees, the better.
4. Have well-known companies joined the pension fund? That is usually a good indicator for a trust-worthy fund.
5. How are the yearly investment returns the past 3 to 5 years? What was the market's performance in the same time frame?

3. Determine how much you are going to buy-in: Many people make the mistake of buying in the full gap in their 2nd pillar in one go. Don’t be those people! That will prevent you from getting the full tax benefits. If it were me, I would pay a maximum of 3 times the amount that I paid in taxes last year (assuming that my situation hasn’t changed much since). And then repeat next year until my gap is closed. Essentially, it’s a staggered buy-in approach. Always keep the 3 year block in mind! Scroll back, if you’ve forgotten about it.

Conclusion

In conclusion, buying into a pension fund in Switzerland can be a strategic move to maximize your retirement savings and benefit from tax deductions. It's particularly beneficial to consider buy-ins around the age of 55 to 60 (when thinking of extracting capital at 65) or 60-65 (if you’re wanting to receive pensions only) or 4-5 year prior to purchasing a home. However, the decision should be based on your individual financial situation, considering factors such as contribution gaps, tax benefits, and your retirement timeline. Always conduct thorough calculations! Should you want to discuss your personal situation with an expert, you can schedule a call with me here.