Pension planning: Ten technical terms explained simply

The investment strategy determines how a pension fund invests its members’ money in the financial market. Legal requirements and guidelines must be adhered to when doing so. These are stipulated in Ordinance 2 on Occupational Pensions (BVV 2) in particular. The art lies in investing the money prudently under these conditions and, at the same time, maximizing returns. A pension fund’s investment strategy is therefore decisive for the returns that can be achieved with the pension fund assets and thus has influence on the retirement assets of individual insured persons. Ultimately, it is the level of returns achieved and the pension fund’s financial situation that determine the retirement provision assets’ interest rate.

Retirement assets in the occupational pension plan (pension fund) can be compared to a cake: The conversion rate determines the size of the slices of cake that we may cut each year following retirement. The lower the conversion rate, the smaller the slices. And with smaller slices, the cake will last correspondingly longer. As an example, with retirement assets of 100,000 CHF and a conversion rate of 6.8%, you will receive an annual pension of 6,800 CHF.
6.8 percent – that is the current legal conversion rate for the compulsory BVG component. This means that the cake will be divided into 15 pieces or – without interest – that it will all be eaten up after around 15 years. For a long time, this calculation worked out well, since 15 years was the average life expectancy after retirement. But the picture today is rather different: A man in 1960 could expect to enjoy his retirement for 13 years, but today it is already 19 years. With higher interest rates, additional slices of cake can be placed on the plate, but if interest rates are as low as they are currently this will always be difficult. Furthermore, there are also other factors that influence the size of the cake slices: for example, the age structure of those insured in the pension fund and the return that can be expected from the retirement provision assets. And here we come full circle again: With high conversion rates there is not much investment wiggle room, the return will be correspondingly lower and the cake smaller, as will the pension payments. With lower conversion rates, the pension funds have more room to maneuver in order to invest the money and the insured persons can ultimately benefit from larger slices of cake – i.e. higher pension payments.

The cover ratio from a pension fund is always determined on an effective date and indicates the ratio of the effectively available capital with respect to the obligations. With a cover ratio of 100 percent the pension fund has sufficient financial means to meet all entitlements to benefits at the current time. If the cover ratio exceeds 100 percent and there is more capital than obligations, then this involves “unrestricted assets”. With a coverage deficiency (cover ratio under 100 percent), the current and future obligations – for example, the future payment of pensions – are no longer fully covered by the amount of capital, should the pension fund need to meet all promised obligations simultaneously. This scenario is, however, very unlikely, since not all insured persons change their employer at once or all retire on the same day. A coverage shortfall does not automatically mean that the pension fund will struggle to meet all currently applicable obligations. However, the pension fund would come into payment difficulties over the long haul, which is why it needs to introduce remedial measures (e.g. higher contributions, scrapping inflation compensations etc.) in order to once again reach a cover ratio of at least 100 percent.
The cover ratio of various pension funds is often erroneously used in public discourse as a comparison or evaluation criterion, to determine whether it is a “good” or “bad” fund. However, various assumptions need to be made when calculating the cover ratio. These are individually determined by each pension fund. Precisely because of this, the cover ratio is not an objective criterion. The foundation board decides which assumptions are to be made at the same time as it determines the cover ratio. For example, the future interest rate applied to the retirement assets for the retirement pension is assumed. It is therefore not merely the obligations and available capital that are relevant, but much more the assumptions that are made. Furthermore, the age structure and risk tolerance of a pension fund is also relevant in order to properly interpret the cover ratio. The direct comparison of cover ratios of two pension funds thus produces a distorted picture, because the assumptions for the accounting are mostly unknown and one can vary markedly from another.

Many people have contribution gaps in their retirement provision – because they studied a long time, lived abroad or took a maternity break. They are often not even aware of this. Even a salary increase also has the potential to adjust the insurance benefit to the new salary retrospectively. Those who voluntarily pay in additional money can compensate for their contribution gaps, improve the retirement benefit and at the same time reduce their tax burden. This is because the purchase sum can be deducted directly from the taxable income in your tax declaration. Staggering your purchases over a number of years may be advantageous from a tax burden perspective. Your financial planner or insurance adviser will support you in your comprehensive planning.

There is a so-called entry threshold for the occupational pension scheme – this means you need to earn at least 22,050 Swiss francs to be able to pay contributions into the pension fund. If your annual salary only just exceeds this threshold, then an insured salary of 3,585 Swiss francs shall apply to you. This affects, for example, a person who earns 22,000 Swiss francs per year part-time. The Swiss National Council also recommended reducing the entry threshold here in December 2021, as it did for the coordination deduction.

 Vested termination benefit – can you draw upon this money freely? Eventually yes. But not today: The vested termination benefit refers to the retirement assets you have accumulated in the pension fund up to the current time. Contributions deducted directly from your salary are paid directly into your personal pension account in the occupational pension scheme. Your employer additionally pays in at least the same amount again, the so-called equal financing. Perhaps you have voluntarily paid in extra money (“buy-in”) or brought in other money from previous employers (“rollover”). Furthermore, your savings earn interest in the pension fund. Should a job change be on the cards, you will take this money with you and the balance rolled over to the new employer’s pension provider. Anyone who becomes unemployed or who is temporarily between jobs parks their money in a vested termination benefit account. You can open one of these at a bank, insurance company or a substitute occupational benefit institution. But capital can be paid out prior to retirement only in exceptional cases: For example, if you become self-employed or finance a residential property in which you live. Otherwise, you need to wait until you reach retirement age.

The coordination deduction determines the benefits from the state and occupational pensions. A part of your annual salary is already secured in the first pillar (AHV, state provision). To ensure you do not double insure this part, it is deducted from your gross annual salary – and you only pay contributions on top of the rest in the second pillar (occupational provision). This deduction is called the coordination deduction and currently amounts to 25,095 Swiss francs. The coordinated or insured loan is also your gross annual salary minus the coordination deduction. If the full coordination deduction is claimed for part time work or a low income, this results in the old age retirement benefits dropping at a greater than average level. The Swiss National Council therefore recommended a reduction in the coordination deduction in December 2021, to ensure better safeguards for persons with a low income or in part-time employment.

The occupational pension consists of two components, the share of savings and the share of risk. With risk, the solidarity principle applies because everyone pays in, but only a few draw benefits (so-called assessment system). This solidarity idea makes sense for chronic illnesses and premature deaths. Conversely, with the savings component the funded system applies: Everyone saves for himself or herself in order to ensure a good living standard following retirement. The law does not provide for redistribution in this case: Everyone pursues their own goals and is then able to enjoy them. However, in the meantime, redistribution within the savings component is becoming ever stronger: My retirement cake is not growing as originally anticipated and is staying smaller than it should be. On the one hand, this is due to demographics – people are getting older, but at the same time there are far fewer children. On the other hand, the existing payment guarantees and conversion rates no longer correspond to reality because they are based on a shorter life expectancy and higher interest rates than those that apply to today’s reality.
In this situation, a financing gap emerges in the pension funds. Part of the investment income from those of working age must be shifted to redistribute to the pensioners in order to keep payment promises that cannot be financed by their respective pension funds. Collective foundations are therefore also forced to reduce the conversion rates for the supplementary retirement assets. As a result, companies with high salaries and generous retirement benefits also finance other companies with lower salary levels and offer their own insured persons only the bare minimum in terms of benefits.

According to the applicable laws, salaries are only insured up to a maximum of 86,040 Swiss francs. A precisely defined portion of this sum is paid into the pension fund, partly by the employee and partly by the employer, but the good news is: Depending on the pension plan, insuring higher incomes is also possible. We then speak of “supplementary” benefits. A pension fund that covers both obligatory and supplementary benefits is known as a “comprehensive fund”.

Today’s retirees are usually astonishingly fit. Every sedentary office worker knows this when, during a hike on a sunny fall afternoon, he or she is quickly overtaken by a spry 75 year old on the trail. Since today’s older people are extremely fit, they are living significantly longer than their ancestors. For individuals, this longevity is exceedingly welcome. However, for the insurance collective it is proving to be a financial challenge as old age also means a longer period in which pensions must be paid. Since individuals are unable to reliably predict their personal life expectancy, the occupational pension scheme covers this risk of longevity via an insurance solution. The risks of disability and death are also covered by the pension fund. This means: If you become unable to work or even die prior to retirement age, benefits will be paid from the pension fund, for example a disability pension or a widow’s pension. However, certain requirements must be fulfilled so that this can be paid out, otherwise there may be only a one-off lump sum payment.