Purchase and withdrawal of funds from the pension fund

1 Prerequisite: Contribution gap

Purchases into the pension fund are considered for employed persons if they have a contribution gap in the pension fund. The contribution gap is calculated from the difference between the retirement assets saved to date and the maximum possible savings capital according to pension fund regulations. The basis for the calculation of the maximum possible savings capital is the current insured annual salary and the tariff specified in the regulations at the corresponding age. Employees can find the contribution gaps that have arisen over the years in the pension fund certificate. There are many reasons for a contribution gap: it can arise due to salary increases, higher education, a break to look after children, a longer stay abroad, a divorce or a change of job.

Two basic restrictions must be observed when buying into the pension fund: Firstly, voluntary purchases may only be made once any previous advance withdrawals for residential property have been repaid in full. Secondly, within a blocking period of three years since a purchase, the resulting credit balances may in principle not be paid out again in the form of a capital benefit. If a lump-sum payment is made within the three-year blocking period, the taxes saved thanks to the purchase must be taxed retrospectively as income. An exception to this applies in the case of divorce or the judicial dissolution of a registered partnership. This is intended to restore the previous level of insurance cover in terms of pension law and tax. Cf. in this regard our blog post from 15.09.2016.

Buying into the pension fund voluntarily can be fully deducted for tax purposes. This means that purchases are also deductible in excess of the taxable earned income. However, a purchase may not be carried forward for tax purposes into the next year. It is therefore always advisable to stagger purchases over several years up to a maximum of the taxable annual income.

2 Annuity or capital?

The pension assets can be withdrawn in the form of a pension and/or a lump sum. The law provides that retirement benefits are generally paid out as a pension, whereby a quarter of the compulsory retirement assets can be paid out as a one-off lump sum. A further lump-sum payment is only possible if and to the extent provided for in the pension fund regulations.

When deciding whether the pension should be drawn as pension and/or a lump sum, the following questions or considerations are of particular importance to you:

1. are you more of a security-oriented person who appreciates predictability and a secure income in retirement or do you want to have flexible access to your capital?

2. do you have experience in dealing with the investment of assets or are you completely inexperienced?

3) What is your health situation and would you like to be able to bequeath the pension assets you have saved over the years?

 A great advantage of the pension is that it provides security for the insured person. The pension represents a secure life-long income in retirement. The amount of the pension depends on the conversion rate, which is currently 6.8 per cent for the BVG minimum. 100,000 Swiss francs of pension assets are thus converted into an annual pension of 6,800 Swiss francs. In the non-compulsory sector, the conversion rates are significantly lower. Another advantage of the pension is that the insured person does not have to manage their pension assets themselves and invest them on the capital market. In addition, the widow or widower receives a lifelong pension upon the death of the insured person.

A major disadvantage of the pension is that it cannot be inherited by descendants. In the event of the death of the insured person, the entire pension assets go to the pension fund. When deciding whether to take an pension or a lump sum, the insured person should therefore always consider his or her health situation. From a tax perspective, drawing a pension can also be disadvantageous, as the pension from the occupational benefit scheme is fully taxable as income.

A great advantage of the lump-sum payment is the flexibility. As already mentioned, when deciding whether to take a pension and/or a lump sum, the health situation must always be taken into account. For example, if someone has a pension fund with 1 million Swiss francs, but is in poor health with little prospect of a high life expectancy, it may make sense to withdraw the pension assets as a lump sum. This also applies with regard to the heirs: if the pension money is not used up, it goes to the heirs and not to the pension fund. Another advantage of lump-sum withdrawals can be their tax treatment: lump-sum benefits from pension provision are taxed separately from other income at a fraction of the ordinary rate. A major disadvantage of lump-sum withdrawals is that in the event of death - unlike with pensions - no benefits are paid to surviving dependants. 

3 Tax treatment of the pension: ordinary taxation

Pension benefits from the pension fund are subject to the ordinary income tax rate.

For the above-mentioned reasons, assessing whether a pension withdrawal is worhtwihile includes more than just the tax aspects. However, since taxes are regularly one of the decisive factors that speak for or against a pension withdrawal or a lump-sum withdrawal, the following calculation example is intended to show how high the tax burden is when a pension is withdrawn:

3.1 Initial situation

Assume that a person insured under the occupational benefit scheme, resident in the city of Lucerne, has saved up retirement assets of CHF 500,000 in the course of his employment and wishes to draw this exclusively as a pension. The statistical life expectancy of the insured person is 85 years. Apart from the retirement assets, there are no significant assets. At a conversion rate of 5 per cent, this results in an annual pension of CHF 25,000. In addition, the taxpayer receives the maximum AHV old-age pension for single persons of CHF 2,390 per month.

3.2 Tax treatment

In this case, the taxpayer receives pensions (AHV and occupational pension) totalling CHF 53,680 per year. This results in an annual tax burden of approximately CHF 6,500. If the pension is drawn for 20 years, total taxes of approximately CHF 130,000 are incurred.

4 Tax treatment of the capital benefit: privileged taxation

The taxation of lump-sum benefits from pension schemes is regulated differently at federal and cantonal level and can be broken down as follows:

4.1 Different systems

4.1.1 Proportionate to the tax rate for income

Confederation, LU, NW, OW, ZG, AG, AI, SH, SO, VD and GE: The capital payment tax is a fraction of the ordinary rate that would have been paid on a corresponding income. In the canton of Lucerne, for example, the privileged tax is one-third of the tax that would have been payable on an income equal to the capital payment, but at least 0.5 per cent per tax unit. In the case of direct federal tax, the privileged tax rate is one fifth of the ordinary rate;

4.1.2 Taxation according to the pension rate system

ZH, SZ, TI, VS and GR: This model is somewhat more complicated than taxation at a fraction of the ordinary rate. First, it is looked at how high the pension would be if the pension assets were drawn as a pension. On the basis of the calculated annual pension, the tax rate is determined using the income tax rate. The tax rate determined in this way is then multiplied by the total capital withdrawal;

4.1.3 Own tax rate for capital benefits

BE,BL, BS, JU, AR: A separate tax rate - also known as a graduated rate - applies specifically to capital withdrawals, which is not dependent on the income tax rate and is listed separately in the tax law;

4.1.4 Fixed percentage for capital benefits

GL, UR, SG, TG: Some cantons apply a fixed tax rate that is due on the entire capital benefit. Regardless of the amount paid out, the tax rate is always exactly the same. In the canton of Thurgau, for example, the privileged tax rate is 2 per cent for married persons in an unseparated marriage and 2.4 per cent for other taxpayers.

The lump-sum pension benefit is assessed separately from the other income, which means that the pension assets are assessed gross and thus without deductions.

Here, too, the tax burden in the case of a lump-sum withdrawal is shown below on the basis of a calculation example:

4.2 Initial situation

Assume that a person insured under the occupational benefit scheme, resident in the city of Lucerne, has saved up retirement assets of CHF 500,000 in the course of his employment and wishes to withdraw these exclusively in the form of a lump sum. The statistical life expectancy of the insured person is again 85 years. Apart from the retirement assets, there are again no significant assets. In addition, the taxpayer receives the maximum AHV retirement pension of CHF 2,390 per month.

4.3 Tax treatment

When the pension assets of CHF 500,000 are paid out, CHF 42,000 in taxes are immediately due. In the following years, however, the income tax may be lower than in the case of a pension withdrawal, since only the AHV retirement pension and any income earned on the pension capital are subject to income tax. It is assumed that an annual income of 5% is generated on the pension capital (i.e. CHF 25,000), which is also subject to ordinary income tax. In this case, taxes (income and wealth taxes) amounting to approximately CHF 7,800 are due annually. Over a period of 20 years, the tax burden thus amounts to a total of CHF 198,000.

However, if it is assumed that the pension capital is invested in such a way that only tax-free private capital gains are realised, taxes of only CHF 3,100 are incurred annually. The total tax burden over 20 years is then approximately CHF 104,000 and is thus lower than with a pure pension withdrawal.

5 Conclusion

Tax savings through reduction of taxable income, higher pension, better risk protection - a purchase is a good thing in many respects. From a tax perspective, buying into occupational pension schemes can be deducted from taxable income (even beyond the annual income). In this regard, it is always advisable to pay attention to how high the annual income is so that the progression can be reduced as optimally as possible. Purchases in excess of the annual income do not make sense from a tax perspective, as these cannot be carried forward to the next year.

When deciding whether the pension assets should be drawn as a pension and/or a lump sum, tax aspects are sometimes of great importance. Pension benefits from the pension fund are subject to the ordinary income tax rate. In contrast, lump-sum benefits from pension schemes are taxed at a privileged rate at the federal and cantonal level.

The simplified calculation example shows that a lump-sum withdrawal is not always more attractive from a tax perspective than a pension withdrawal, as is often believed. In particular, the capital gains on the invested pension capital that are subject to income tax increase the tax burden after retirement. When making a lump-sum withdrawal, one should therefore always ensure that the pension capital is invested in such a way that only a small amount of taxable income is generated or that tax-free private capital gains can be realised. If the pension capital is invested as optimally as possible from a tax perspective, the lump-sum withdrawal is also more attractive from a tax perspective than the pension withdrawal. However, in view of the complexity of tax planning issues in connection with pension benefits, it is always advisable to consult a tax advisor.