Most of us could potentially make an optional buy-in into our 2nd pillar. But should we? Let’s run the numbers!

For those who need a refresher: The 2nd pillar (Pensionskasse) is one of three pillars of the Swiss pension system. Money is paid into this pillar throughout our working careers, both by us, the employee, and by the employer. There are only a few certain scenarios when we are allowed to withdraw the money before retirement, namely self-employment, home ownership, or emigration.

## Case Study

There is a line in your “Pensionskassenausweis” that states how large your buy-in could be. Given a typical example of Heinz, we see that he could make a voluntary contribution of 62’580 CHF (No. 11 in the image below).

Heinz knows that there are some benefits of doing so!

- Contributions can be deducted from the taxable income which means that he pays less in taxes.
- The contribution earns interest which in turn results in a higher pension annuity (Altersrente – No. 5)

On the other hand, the money that is about to get merged with the pension fund could also be invested otherwise. However, this would then neglect the possible tax deduction! And kaboom! We have a nice little math problem to solve.

Let’s have a closer look at two scenarios.

- In scenario A, Heinz has the full amount of 62’580 CHF at his disposal and wants to know if he should be investing this lump sum into his pension fund as a buy-in or if he should be investing it otherwise. He plans to retire with 65 and does not touch the money until that date.
- In scenario B we assume that Heinz plans to take out his pension fund earlier for fun stuff like buying a house or building his own business.

### Scenario A – Pension vs. Traditional Investment

Before we can dive into the calculation, we have to set up a couple of assumptions and boundaries:

- The persona Heinz
- Lives in Zurich
- Goes to church every Sunday
- Is married to a lovely catholic wife

- Marginal tax rate (Grenzsteuersatz): 25.54%
- For every 100 CHF he reduces his taxable income, he saves 25.54 CHF in taxes

- Interest rate Pensionskasse: 1.5%
- See number 4 on the “Pensionskassenausweis”. Note that this number varies drastically among Swiss pension funds!

- “Kapitalbezugssteuer”: Approx. 9%
- Taking out all the money at once in 16 years. Note that we neglect the option of pension annuity for simplicity.

- Interest rate of the alternative Investment: 6%
- Let’s deduct 1% from the popular assumption of 7%, in order to cover wealth taxes, fees, and some conservative assumptions.

Okay. Here we go. First we look at the case where he puts all his money into the pension fund. We ignore he money that is already in the 2nd pillar in order to make both cases comparable. First, we look at the equation that derives from placing 100% of the money into the 2nd pillar:

Wealth after 16 years = (Starting Capital * (1 + Interest Rate)^(Years))

* (1 - Kapitalbezugssteuersatz)

= (62'580 * (1 + 0.015)^16) * (1-0.08)

= 73'060

His decision will leave him with 73’060 CHF at the point of his planned pension age (65). How does this compare to the decision to invest his money into a more traditional form of investment? Below the equation which deducts the potential tax savings compared to the other option:

Wealth after 16 years = (Starting Capital * (1 + Interest Rate)^(Years))

- (Marginal Tax Rate * Starting Capital)

= (62'580 * (1 + 0.06)^16) - (0.2554 * 62'580)

= 142'992

He will end up with almost double the amount if he invests his lump sum into the alternative investment vehicle, namely 142k CHF instead of 73k CHF. I personally did not suspect the difference to be that drastic! Wow! Another quite extreme example of the effect of compound interest.

### Scenario B – Parking the Money

But wait – There must be some way to benefit from the tax deduction effect, right? Yes, there is. Below a graph to compare different percentages of buy-ins vs. traditional investments over time. At time = 16 years, we find the numbers from Scenario A.

Two observations are jumping right at us:

- The tax deduction effect for Heinz’ case study holds up for about 3.5 years. After that, the higher interest rate of the traditional investment option kicks in and makes the traditional investment the clearly better option. So if Heinz plans to take out the money within that time frame he would actually be better of to “park” his money in the pension fund and take it out when needed. That being said, there is a rule against taking out the money within the first three years of the buy-in.
- There is no benefit in a partly buy-in. The cross-over point does not move with different percentages of allocation.

## Conclusion

Due to the results above and all the shady non-transparencies of the Swiss 2nd pillar system, I decided for myself to avoid the additional buy-ins into the 2nd pillar. What about you, have you run the numbers with your current situation? Do you arrive at the same conclusion? Let me know in the comments below.

*Disclaimer: I am not in any kind or form a professional financial expert. This article reflects my personal views on the world and should not be blindly followed when making financial decisions.*

Hi Mr. Lean Life

I very much appreciate your thoughts. I agree with your considerations. I have parked part of my 2nd pillar in a vested (50% stock) account since 2004. Current situation: Bank earned 52’500 in commission during the last 15 years. I earned 80’000 (=2,43% p.a) in the same period with more volatility than my other investments. And I still have to deduct capital withdrawal tax which currently would account to another 23’000. So Bank earned 52’500 and I earned 57’000 or 1,95% p.a. Nice business.

Hi Mehti

Many thanks for sharing your experience! Much appreciated! It saddens me to see that pension funds are shamelessly exploiting their monopoly to push their overprized investment products. 1.70% of commissions are simply outrageous and have a large effect over longer time periods. Unfortunately I don’t think there is a possibility at the moment for employees to choose a pension fund for themselves.