In the spotlight: occupational pensions
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Leading Partner, Corporate Support Services
Leading Partner, Corporate Support Services
Dr. Marcel Widrig
Partner, Tax and Legal Services
Dr. Marcel Widrig
Partner, Tax and Legal Services
The three-pillar benefits system in Switzerland is designed to give people financial security in their old age and cover them for the risks of accident, illness and death. The first pillar is the federal old-age and survivors’ insurance scheme (AHV/AVS). This also includes disability insurance (IV/AI), income compensation during military and civilian service (EO/APG) and maternity, and unemployment insurance (ALV/AC). All first-pillar social security is mandatory, and is designed to ensure a minimum subsistence level. The second pillar, occupational benefits (pensions), is based on the Swiss Federal Law on Occupational Retirement, Survivors’ and Disability Pension Plans (BVG/LPP). It is also mandatory. The second pillar covers the risk of death and disability, and beyond this allows people to accumulate retirement savings so that they can maintain their accustomed standard of living following retirement. The third pillar has two components: tax-advantaged, voluntary retirement savings, and individual savings without any tax advantages.
The three-pillar model ensures a high level of social security and facilitates peaceful industrial relations. But it is expensive by international standards. Countries in Southeast Asia and South America have no or only very limited social security systems. The only countries to offer their citizens a similarly high level of social security as Switzerland are the majority of western and northern European nations plus countries such as Canada and Australia that are part of the British Commonwealth.
The AHV/AVS was introduced in 1948, the IV/AI in 1960. At that time Europe was rebuilding after World War II. Many people had vivid memories of their terrible experience of totalitarian political movements in the period between the world wars. The concept of a social market economy where free competition coexisted with social security found broad acceptance.
The AHV/AVS system is funded by employee and employer contributions, together accounting for more than 10 per cent of a working person’s gross pay. Employers bear a slightly greater burden than employees, having to cover the administrative costs themselves (the costs billed vary depending on the social security authority). Employers must also pay contributions to the funds for family allowances paid to families with children. Here too the contributions vary depending on the canton and the authority.
Most people in Switzerland still see the AHV/AVS pension as a well-earned reward for the work they have done. The basic principles behind the first pillar also include solidarity and guaranteeing a minimum level of subsistence. In the past this has led to repeated expansion of the system. If pensions and other income are not sufficient to cover the minimum cost of living, people are legally entitled to supplementary benefits.
The AHV/AVS system requires solidarity on two levels. First, the active generation finances the pensions paid to the older generation and trusts that subsequent generations will do the same. Second, higher earners support employees in a less fortunate position by paying considerably more into the AHV/AVS than would be needed to fund their own pension.
Here nothing is likely to change in the near future. However, if in the years to come the digital revolution erodes the service industries to the same extent that manufacturing has been eroded in past decades, the current rates for AHV/AVS contributions will no longer suffice. Maintaining current pension levels will mean either raising the retirement age and contributions, or reducing benefits.
As a result of structural changes, in time the AHV/AVS could take on the character of a minimum income. If this actually happens it’s likely to put pressure on solidarity. The rates for AHV/AVS contributions are the same regardless of pay. Currently the maximum AHV/AVS pension for unmarried people is CHF 28,200 a year, and CHF 42,300 a year for married couples. Many high earners – including, notably, foreigners who are only working temporarily in Switzerland – already view the first pillar as an additional income tax.
The second pillar, occupational pensions, is designed to supplement the basic cover provided by the AHV/AVS and IS/AI. The goal is to enable people to preserve their accustomed standard of living in their old age or in the event of illness, disability or the death of the family’s main breadwinner.
Occupational pensions are financed on an individual contribution basis. Employees with annual pay of between CHF 21,150 and CHF 84,600 who exceeded age 17 but have not yet reached retirement age have to be covered by second-pillar (BVG/LPP) insurance. People who earn more than CHF 84,600 a year can take out extra-mandatory cover if their employer offers such insurance (see Room for manoeuvre despite regulation).
In most cases employers and employees contribute equally to the mandatory pension fund. The rate of these contributions increases in four stages over the course of the person’s working life. In combination with the first pillar, second-pillar benefits cover up to 60 per cent of the final salary for single people and up to 75 per cent for married people.
Since they became compulsory in 1985, occupational pensions have become a very significant economic factor. The amount of money accumulated in the second pillar is many times greater than in the first pillar. Nowadays pension funds are among the investors with the greatest financial clout in the country.
In 1993 the Swiss parliament filled what had been a gaping hole in occupational benefits by adding the Vested Benefits Act to the BVG/LPP legislation. Since then employees have been able to take all their benefits with them if they change jobs, transferring their retirement assets to the new employer’s pension fund without any financial penalty. The law on vesting removed the ‘golden handcuffs’ that had kept many employees tied to a particular employer. Prior to the new legislation, an employee leaving a company would have had access to only part of the money they had paid in, or none at all, depending on how long they had worked for the company and the set-up of the pension plan.
Younger employees, many of whom don’t yet earn so much, are often sceptical about occupational pensions. They have doubts as to whether the mandatory contributions are invested in their retirement profitably, or at least well enough to preserve the value of their capital. These concerns are magnified in the current environment of low interest rates. The BVG/LPP provides leeway for the set-up to be adapted on an individual basis, especially on the extra-mandatory side. For example employers can choose to offer their employees a less comprehensive BVG/LPP solution but cover risks such as illness, accident, disability and death via supplementary insurance. Many different models are used in practice. Depending on the age and income structure of the workforce or the corporate philosophy, an employer might cover the additional costs fully, partly, or not at all.
The second pillar can be very attractive for people with extra-mandatory cover. As their income increases, people have more money available to contribute to their pension fund. And these contributions can be deducted in their entirety from income and wealth tax. Absolute top-earners can put aside several million francs over the course of their career. If the contributions were deductible at a tax rate of 40 per cent and the pension or lump sum benefit is taxed at a lower rate at the moment it is paid out, considerable tax savings are possible over a person’s full working life.
The BVG/LPP allows employers with gaps in their second pillar cover to buy into the pension fund tax-free. Such gaps can arise, for example, if an employee had a low income early in their career and now earns a lot, or if an employee didn’t pay into the occupational pension scheme for a time because they were abroad or had interrupted their career. Anyone considering the tax benefits of buying in voluntarily should also remember that as things stand any cash they pay in will be tied up.
The third pillar has two components: 3a and 3b. Pillar 3a is tax-advantaged provided contributions are paid into a recognised form of pension or benefits set-up. The annual tax-free amounts are adjusted in line with increases in maximum AHV/AVS pensions. Employees with a second-pillar plan are entitled to pay in CHF 6,768 and deduct it from their direct taxes. Self-employed people who don’t belong to a pension fund can pay in a maximum of five times this amount tax-free. In concrete terms this is CHF 33,840, although the actual amount paid in may not exceed 20 per cent of their net income. Money saved in pillar 3a is paid out in accordance with the rules that apply to the second pillar.
Many sole traders don’t have full cover for their retirement, taking the view that their business constitutes their pension fund. Since 2011, Corporate Tax Reform II has enabled business assets to be liquidated at tax-advantaged terms. Before 2011 the liquidation of business assets incurred taxes of well over 50 per cent. Now this is subject to tax at around the same rate as a payment of capital from a second pillar plan.
Pillar 3a savings are unattractive for self-employed professionals such as lawyers and doctors who don’t have substantial investments. But in most cases they have the option of joining a benefits scheme offered by their professional body and thus enjoying the same tax advantages as people who work on an employed basis.
Pillar 3b covers individual savings in the form of cash, equities and other assets. It is free and individual, doesn’t enjoy any tax advantages, and can be liquidated at any time.
The three pillar system helps ensure the cohesion of the social partners in the Swiss employment market. But it comes at a price: mandatory contributions to the first and second pillar make up between around 20 and 30 per cent of gross pay. These high ancillary wage costs reduce companies’ competitiveness and are an incentive to automate and cut jobs – a trend that is likely to become even more pronounced as digitisation sweeps the tertiary sector.
The costs of administrating the first and second pillars are high. Employers have to evaluate suitable benefits solutions for their employees, record joining, leaving and absences correctly, settle contributions and handle employee benefits. Accounting for first-pillar benefits may seem straightforward at first glance. But things can get more complex, especially when employees work part-time or on a flexible basis. With the BVG/LPP offering a wide range of individual alternatives, it becomes even more complicated when it comes to the second pillar. Many companies have difficulty determining the pay used as the basis for calculating social security contributions.
But the benefits of the three-pillar system outweigh the disadvantages: the Swiss old-age and risk insurance set-up helps create a level of social security unmatched in most other countries. The system ensures peaceful industrial relations in this country, and can be adapted flexibly to individual needs. For this reason we should take good care of it.