Pension Funds in Switzerland
Since 1972 retirement provision in Switzerland has been organized in accordance with the so-called 3-pillar principle which is enshrined in the Federal Constitution. Financial provision for the period after retirement, financial loss in the event of death, as well as the risk of a disability-related incapacity to work is covered by the three pillars. The 1st pillar is compulsory for all. Employees starting from a certain minimum income are required to join the 2nd pillar - also called pension fund. The third pillar is voluntary.
For many people, the capital in the pension fund is the key element in their provision and the largest source of income after retirement. For every employee earning an income of at least 21'060 Swiss francs, insurance under the second pillar is a mandatory requirement. Depending on the situation, the pension fund can serve not only as an instrument of retirement provision but also offers numerous opportunities for optimization of their tax.
Aim and purpose of the occupational pension
As the second pillar, alongside the AHV/IV/EL as the 1st pillar, the task of the occupational pension is to enable the insured to continue his/her previous standard of living in an appropriate manner. In this context, in conjunction with the first pillar, it endeavors to achieve the aim of generating a retirement income of around 60 per cent of the final salary. The mandatory insurance commences when the employee starts work but no earlier than when he/she reaches the age of 17. Initially, until the employee reaches the age of 24, the contributions only cover the risks of death and disability. From the age of 25 the employee also makes savings contributions towards his/her retirement pension. Various groups of people are not subject to the mandatory insurance: for example, the self-employed, employees with a temporary contract of employment not exceeding three months, family members working on their own farm or persons who are at least 70 percent disabled within the meaning of the IV (Invalidity Insurance Scheme).
What types of pension institutions are there?
In Switzerland there are over 2'000 pension funds, with approx. CHF 600 billion under management. They all have different conditions and benefits. In addition to the federal, cantonal and municipal administrations, there are also many medium and large private companies which have established autonomous pension schemes for their employees. However, many companies prefer to utilize the services and take advantage of the guarantees of pension plans from life insurance companies, banks or professional associations. These are divided into group and community plans.
How does a pension fund work?
A distinction is basically drawn between defined contribution and defined benefit scheme. In the defined contribution scheme, the level of contributions is defined according to a benchmark (e.g. qualifying salary) by a set of rules from which the amount of the benefit is determined. However, in the defined benefit scheme, the contributions are determined on the basis of the defined benefit. The employee contributions are then deducted from the gross salary by the employer on a monthly basis in accordance with the contribution rules of the pension fund. The Swiss pension fund system operates on the funding principle – in contrast to other Swiss social security schemes. The degree of funding indicates the percentage of the fund’s liabilities which are covered by assets.
The conversion rate is used by pension institutions to calculate an insured’s pension based on the pension capital savings. The higher the conversion rate higher the higher an insured’s pension – irrespective of the pension capital savings. The conversion rate - or better still the minimum conversion rate – is a fixed minimum percentage rate for the calculation of the annual pension based on the pension capital savings saved by an insured person in the 2nd pillar. When the Federal Law on Compulsory Occupational Retirement, Survivor’s and Disability Pensions (BVG) came into force in 1985 the conversion rate was set by the Federal Council at 7.2 percent. Existing pension capital savings are currently converted at a conversion factor of 6.80 per cent for men and women (as at 2014). A conversion rate of 6.8 per cent means that someone who has 100,000 Swiss francs in pension capital savings through his/her pension fund will receive an annual pension of at least 6'800 Swiss francs after retirement.
The conversion rate is determined primarily by two factors: one is the so-called technical interest rate. It is intended to give information on the anticipated future return on investment of retirement savings and currently stands at 3 to 4 percent. A second factor is the anticipated, average life expectancy of the pension recipients. Empirical statistical values are used to calculate the life expectancy. In this context however, allowance must be made for people’s increasing life expectancy. By contrast, the future development of interest rates is hard to predict and can at best only be estimated. The minimum conversion rate only applies to the compulsory BVG part, in other words for insured persons with a gross annual salary of between 21,060 and 84,240 Swiss francs. Minimum contribution rates and a minimum interest rate fixed by the Federal Council each year, currently 1.75 percent (2014), also apply in this area.