The 2nd pillar: its importance as an occupational pension scheme in Switzerland

The Swiss economy changes from year to year due to increasing inflation and demographic change. It is increasingly difficult to balance the cost of living and income, let alone the burden of taxation. In this context, the planning a retreat early becomes imperative for all workers. After retirement, maintaining a healthy, worry-free life requires adequate savings during the years you are professionally active.  

To ensure a good standard of living even after retirement, the Swiss social security system offers a solution of 2^e pillar to all workers, in addition to the AVS.

But,

• What is 2^and pillar?
• How does this system work?
• Who can benefit from this pension measure?
• How important is it for employees?

In this blog post, the experienced pension advisors at Impact Financial Engineering (IFE) explain everything about this occupational pension instrument by addressing the questions above.

Before getting to the heart of the matter, it is appropriate to briefly review all the social security instruments proposed by Swiss legislation.

The Swiss social security system is based on 3 pillars:

1^er pillar : AVS (Old Age Insurance, Survivors) / AI (Disability Insurance): compulsory public insurance for all inhabitants of Switzerland. To find out more, read our last article.

2^e pillar: professional pension provision, compulsory private insurance for all employees in Switzerland.

3^e pillar: individual pension provision, optional and also benefiting from tax advantages

What is 2^e pillar?

The 2^e pillar helps protect against drops in income linked to the risks of retirement, death and disability and aims to maintain a decent life even after retirement. The 2^e pillar is also called occupational pension (LPP), pension fund or company pension. This system, governed by the federal law on old age, survivors and disability insurance, operates in addition to the benefits of 1^er pillar (AVS/AI). The LPP can be supplemented by 3^e pillar (individual foresight).

How does this system work?

In this occupational pension scheme, insurance benefits are financed jointly by employers and employees. This is a system of monthly contributions at a legal minimum rate which requires that the employee and the employer each contribute equally. It is the employer's responsibility to provide appropriate insurance coverage with a pension institution chosen from occupational pension plans and to link it to a pension fund.

The bonus is deducted directly from your salary by your employer. The minimum contribution rate is applied to your base salary to obtain the monthly LPP bonus. The employer, for his part, pays his contribution directly.  According to the law, the employer must contribute at least half of the minimum contributions set by law.  There is room for maneuver to set higher contributions and to modify the employer/employee proportion for contributions.

Minimum requirements are set by federal law. Companies can therefore opt for a higher contribution rate and offer several plans to choose from, which can open up great benefits for their employees. In general, higher savings contributions (up to 25% for both parties) are paid by employees.

The current minimum contribution rates, established by federal law, are as follows:

• 7% for 25 to 34 year olds
• 10% for 35 to 44 year olds
• 15% for 45 to 54 year olds
• 18% for those aged 55 to 65

To enjoy your retirement years with peace of mind, structuring your entire assets as early as possible is crucial. However, the majority of policyholders are unaware of the numerous possibilities offered by their pension plan to improve their retirement situation. Impact FE advises policyholders to implement an appropriate retirement savings and investment strategy from the start of their career, to compensate for the expected drop in your income once they retire.

Who can be insured under this system?

You benefit from the LPP if:            

• you are at least 17 years old (you can start contributing to the pension fund from the age of 18).  
• you are insured under 1^er pillar (AVS);
• you are an employee and you receive at least CHF 21,510 per year (one which corresponds to 3/4 of the maximum old-age pension paid by the AVS).

Employees already subject to AVS, receiving an annual income of at least CHF 21,510, are compulsorily insured under the LPP. Initially, contributions only cover the risks of death and disability. From the age of 25, you also contribute to old age provision. For the self-employed, professional pension provision is optional.

Compulsory occupational pension insurance begins at the same time as the employment relationship. For the unemployed, compulsory insurance is limited to risks and begins on the day they first benefit from daily unemployment insurance compensation.

Compulsory insurance from 2^e pillar ends:

• at retirement age (at 64 for women 65 for men);
• if you earn less than CHF 21,510 per year (you do not reach the LPP entry threshold); Or  
• if your employment contract has ended.

Entrusting your retirement planning to professional advisors like Impact FE will allow you to optimize your return on capital by 2^e pillar and free passage. We have a dedicated team of specialists in this field.

How important is 2^e pillar?

Given the complementarity of the 3 pillars of the Swiss pension system, it is obvious that the 2^e pillar or professional pension provision is an essential element for building your retirement savings. However, the importance of LPP is often underestimated and under-exploited by employees and business leaders.

Initially, the LPP supplements the AVS and aims to combine the two annuities. In itself, the AVS pension from the 1st pillar only covers a subsistence minimum. The combined pension (LPP+AVS) created thanks to contributions throughout your career should make it possible to reach around 60% of the final salary, but in reality this coverage rate is often lower.

Saving for your retirement with the LPP gives you a great degree of flexibility. Your contributions to the LPP are your savings accumulated until retirement (in the majority system of contribution primacies) and do not depend on public funds.

The LPP offers you the possibility of receiving payments from the age of 58 at the earliest. You can receive it as capital, an annuity, or a combination of both. Under certain conditions, you can also withdraw all or part of your retirement capital earlier, in the form of a cash payment, if you plan to:

• to create your own business or independent activity
• to leave Switzerland,
• to acquire a main home, or
• if your exit benefit is lower than your annual contribution.

If you leave, change jobs or start a new activity, your employer's pension fund ends at the same time and your pension assets are in principle transferred to your new employer's fund. Under certain conditions, you can deposit these savings into a vested benefits account with a bank, a financial institution or a privileged vested benefits institution, whose management profile you will define yourself. If you do not start another salaried job or open a vested benefits account, your 2^e pillar will be automatically deposited with the National Provident Foundation – LPP supplementary institution.

It is also possible to buy back years of contributions if you have contribution gaps. The redemption amount is calculated by your fund and depends, essentially, on your salary level, your age and your employer's contribution plan. If you leave the pension fund, you are entitled to your entire old-age capital available at the time of your departure.

It should be noted that the annual salary insured by the LPP includes a part insured in the compulsory scheme and a part insured in the non-compulsory scheme. The insured annual salary which is included in the supplementary plan is subject to additional benefits from the provident institution concerned. Finally, people who wish to build up a supplementary pension can invest in an appropriate individual pension product (3^e pillar).

A poorly chosen management profile can lead to extremely low returns, with a very negative impact on your pension capital in retirement. The vast majority of policyholders are unaware of the effect of a rate of return that is too low over long periods and thus shorten the means available to them in retirement. This is especially true if your funds are managed by the Supplementary Foundation, as the return can often be as low as 0.1% per year. On the other hand, opening your vested benefits account with private institutions can bring you higher returns (of the order of 4 to 6% per year), but it must be remembered that the insured then bears the full risks of the financial markets

Although the Swiss pension system is remarkable and advantageous in many ways, it is often difficult to pin down. For all professionally active people, retirement issues can represent a real challenge, both in terms of building up retirement savings and in terms of taxation. It is always a good idea to entrust this analysis to a professional retirement advisor. Impact FE can help you meet the challenges of preparing for retirement in a tax-optimized way. We also provide advice to companies in the field of occupational pensions, so that they can offer the ideal services to their employees.

Would you like to know more? Contact now one of our specialist pension advisors.