Providing for your retirement Pillar 2 must be developed further

After the adoption of the OASI 21 reform in fall 2022 in a popular vote, the next reform to the Swiss pension scheme is now on the agenda: the reform of the Federal Law on Occupational Old Age, Survivors' and Disability Pensions (BVG), i.e., the foundation of the occupational pension scheme or the pension fund. As with almost every pension proposal, a referendum was launched regarding the BVG reform. Signatures must be submitted by 6 June 2023 and the popular vote is not likely to take place before 2024.

Switzerland has an established three-pillar system for retirement provision: pillar 1 is the old-age and survivors’ insurance, usually known as OASI or AHV. This is a state pension scheme. Pillar 2 is an occupational pension scheme, also known as the pension fund or BVG. It is obligatory for all workers, with the exception of those on a very low annual income and self-employed workers. In theory, the first two pillars should cover around 60 percent of your final salary after retirement. Pillar 3 is a private pension scheme which is voluntary, but important if you want to maintain your accustomed standard of living. Pillar 3a (= restricted pension) is incentivized by tax breaks.

Almost 2.5 million people receive an OASI pension (Federal Social Insurance Office, 2021). This amounts to CHF 1,876 per month on average. A little under 900,000 people receive a pension fund pension, which is on average CHF 2,356 a month. For pensioners who previously worked and made obligatory BVG contributions, pillar 2 is usually more financially significant than pillar 1.

Whereas in pillar 1, current workers pay for the pensions of retired people (pay-as-you-go system), in pillar 2, each person saves their own retirement assets according to the originally determined principle (funded system).

Cross-financing outside the system

Increasing life expectancy in Switzerland has caused problems for the obligatory portion of pillar 2Anchor-Link to FAQ, as the system lacks a mechanism for automatically reacting to demographic changes. Mathematically speaking, the calculation is simple: if the capital saved for retirement has to last longer, the monthly pension must be reduced. However, the conversion rate (UWS), which determines the size of the monthly pension, is anchored in the law. It is currently 6.8 percent. This means that saved capital of CHF 1 million will result in an annual pension of CHF 68,000.

6.8 percent is too high, not just for demographic reasons. Such a value requires an interest rate guarantee of 4.8 percent – which must be achieved accordingly as an investment return. To cover the losses, pension funds have sharply reduced the conversion rate on extra-mandatory capital. Funds which have a lot of employees with low salaries, who only have mandatory insurance, have required a cross-financing of pensions by the working population, i.e., a redistribution, which is not intended within pillar 2 system.

Exclusion of part-time workers with low salaries

The contribution obligation only applies after a certain level of income is reached: an amount referred to as the coordination offset is deducted from the annual income. This is currently equal to seven-eighths of the maximum OASI pension, i.e. CHF 25,725 (2024). The coordination offset is intended to prevent contributions from being deducted for both pillars 1 and 2 from the same portion of a person’s salary. There is also an entry threshold for pillar 2, which is currently three-quarters of the maximum OASI pension, i.e. CHF 22,050 (2024).

The coordination offset and threshold value also mean that people in low-wage or part-time employment often do not have a pillar 2 – and additionally often do not have a pillar 3. This will cause them problems in old age. For most people, the OASI pension is insufficient to cover living costs, making supplementary benefits necessary. The vast majority of people in low-wage sectors with part-time pensions are single mothers. Until now, in many cases they have therefore been excluded from occupational pension schemes.

Increased cost for older workers

The retirement credit is the amount that is added to a person’s retirement capital annually. The rates are set as a percentage of the (coordinated) annual salary and are staggered according to age. The current statutory staggering means that the last increase from 15 to 18 percent takes place at age 55, which makes employees from this age even more expensive in terms of wages – which can lead to disadvantages on the labor market.

Pension supplements are planned for the first 15 cohorts retiring after the reform comes into force. However, this does not depend on whether a person is affected by the reform or not, but on their accumulated pension fund assets and the time of retirement. As a result, the reform will cost the younger generations significantly more than if only those people who would have suffered a pension reduction were compensated for it.

Across the 15 years, the pension supplements amount to around CHF 800 million per year, while the reduction in the conversion rate only reduces the burden on younger generations by around CHF 400 million per year. These costs are financed by workers, employers and pension funds. The supplements for pensioners are cross-financed from outside the system by those who are currently employed.

Pension supplements are guaranteed for life. The Federal Social Insurance Office assumes that around 25 percent of insured persons in each of the transitional years fall into the first two pension asset categories and that around 50 percent of insured persons have saved more than CHF 441,000 in pension assets.

Some of the measures agreed in the BVG 21 reform are a step in the right direction. One indication of this is that the vast majority of pension funds have already reduced the conversion rate and the coordination offset below the level provided for in the reform. However the additional parameters are debatable: couldn't a 20-year-old already pay into a pension fund? Wouldn’t an automatic conversion rate have been a better option? Do the pension supplements make sense? Be that as it may, the package was adopted in parliament, and the referendum is likely to take place. The question arises as to whether placing new burdens on the younger generations is justified when the reform measures have already been implemented by the vast majority of pension funds without an additional burden.