When are we faced with a “good” pension fund?

Switzerland has no shortage of good pension experts. The latter generally approach the problem from the angle of the needs of the fund and the pension plan that an employer is required to put in place.

At Impact Financial Engineering, we see ourselves above all as pension specialists from the perspective of the opportunities it can offer its policyholders.

This is the subject we address in this letter. It applies both to companies wishing to strengthen their attractiveness as an employer, and to individuals wishing to better exploit the opportunities offered by foresight. For the latter you can also find out by consulting the blog at travail-en-suisse.ch/podcast

We are regularly surprised in our practice to note the relatively passive behavior of policyholders in relation to their pension foundation. Unlike what happens for the AVS, in the LPP policyholders do not simply have to “suffer” social security contributions, they can use the opportunities offered by their plan to improve their situation during employment and retirement, while lowering, sometimes massively, their tax base.

What questions should you ask (yourself)?

What is the insured salary? A seemingly trivial question, but important for both small and high earners.

For "small" salaries, typically in the case of part-time employees, too large a coordination deduction will significantly reduce savings contributions dedicated to retirement. On the surface, the insured and the employer will benefit from lower social charges but in reality it is pension savings which will be seriously reduced, with serious consequences at retirement age.

For higher salaries, we sometimes observe a limitation on the maximum insured salary. This makes it possible (here also) to limit the social charges paid by the employer and the employee, but this approach drastically reduces any possibility of tax optimization, directly by reducing ordinary contributions, and indirectly by (massively) reducing the possibilities of redemptions, both of which are tax deductible. This is how employers deprive their executives of tax savings possibilities which can amount to several hundred thousand francs, depending on the case.

Are there multiple plans to choose from ? This point is often neglected, even though the long-term impacts can be very significant. We can mention the following few key dimensions:

• Enveloping plan or basic and extra-mandatory plans ? The second approach makes it possible to propose more advanced solutions, generally for company executives and to eliminate the problem of subsidizing “small annuities” (due to the excessively high conversion rate demanded by the political world on the compulsory part).
• Several plans with different contribution rates : employers who offer this solution generally allow the possibility of changing plans once a year. It allows you to increase your tax-deductible savings contributions and therefore improve your retirement capital. Important point: a change to a higher contribution plan also makes it possible to improve the calculation of redemptions, because the fund then uses the new annual contribution rates to estimate the amount of the gap. And the impact can be very substantial, especially for high salaries.
• Plans with several investment strategies : Rather reserved for non-mandatory plans, the choice of risk profile is often insufficiently analyzed in the banking world. However, it is decisive for the expectation of long-term return. And the public generally underestimates the effect of compound interest rates over long periods: this is how capital invested at 2% for 15 years will increase by some 34.6%. The same capital invested at 5% will have doubled over the same period!

The choice of a risk profile, even within a pension plan, is very individual and depends on a multitude of parameters, which is why we attach particular importance to it in the context of the analyzes carried out for our clients.

• Insurance benefits : LPP contributions are broken down between a savings contribution and a risk premium. The latter covers non-life and disability risks and can vary greatly from one fund to another. The multiplicity of existing plans is such that we will not develop the subject in this letter. However, it is appropriate to check that any insurance taken out privately does not duplicate the services covered by the fund's plan.

Regarding the robustness of a pension fund how to judge?

Conversion rate : it applies to the pension capital projected upon retirement and thus makes it possible to calculate the amount of the pension which will be paid ad vitam. A low conversion rate may reflect a fragile fund, which thus seeks to limit the amount of its future commitments beyond simple mortality tables. To this is sometimes added an upper limit to the amounts that can be taken as an annuity, which allows the fund to transfer part of the longevity risk to its (future) retirees. At the end of 2021, the average conversion rate in Switzerland was around 5.5% at 65. Note that some funds practice very different conversion rates between the base plan and the framework plan, if the latter exists.

The coverage rate : a key element in getting an idea of the solidity of a fund, the coverage rate is the ratio between the fund's assets and its future commitments. A low coverage rate means a more fragile fund. The consequences are a risk of reorganization measures, generally financed by the employer and active policyholders. A less visible, but equally devastating, element is that a fund with a low coverage rate will only distribute low returns to its policyholders, due to its need to replenish reserves of fluctuating values. It will be remembered here that the return on investments on the capital markets depends on their evolution and that the return distributed to policyholders is a decision of the Foundation Board (and the Federal Council for the mandatory part).

The returns offered to policyholders : As we saw above: the more fragile a fund is, the lower the returns paid to policyholders will be. The public seems to have gotten used to returns of 1% but this is not inevitable! With an average coverage rate close to 120% on Swiss average at the end of 2021, there is no real reason why distribution should not be better. Do not hesitate to apply an interest rate differential on your pension capital for the number of years that will lead you to retirement. The effect in francs is generally very substantial!

The technical rate : this is a discount rate used to calculate the current value of the fund's future commitments, i.e. the annuities that will be paid to future retirees. The higher this rate, the lower the value of future commitments today. Be wary of funds that use a technical rate that is too high, because this amounts to artificially “inflating” the coverage rate.

The demographics of the provident fund : It is interesting to get an idea of the proportion of retirees/workers in a fund as well as the average age of policyholders. Thus, the younger the population of a fund, the more robust the fund will be. We will remember that to date, retirees benefit from a “fixed” conversion rate and that the latter is often too high compared to the reality of the life expectancy of those concerned. Therefore, certain funds “subsidize” their annuitants by distributing lower returns to their active policyholders.

As we can see, there are multiple sliders to optimize your situation and their movement must be adapted to each person's situation. This is also one of the essential elements of our approach with our clients, whether they are Businesses or Individuals.