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Capital vs. pension: another point of view
Lombard Odier & Co AG Zürich
Published in Schweizer Personalvorsorge / Prévoyance Professionelle Suisse in June 2023
A great deal has already been written about choosing between regular pension income from an annuity and a lump-sum capital withdrawal. Nevertheless, this question remains central to anyone’s pension arrangements. your plans for the future and an individual needs analysis based on these are critical, in addition to your canton of residence. A holistic approach is needed to arrive at the right solution.
A tax analysis is clearly important
For many people, the first priority is to assess the possible tax implications. All pension income from an annuity is taxable. In particular, this means that a conversion rate that initially looks attractive may be significantly reduced once tax is taken into account. You should therefore always establish what conversion rate is achievable after tax so you can gauge how attractive a pension withdrawal would be from a tax perspective. Lump-sum capital withdrawals are taxed at a reduced rate, separately from other income. Depending on your canton, this may be at a much more favourable rate than for normal income.
Example: Tax payable on an annual pension of CHF 60,000
Illustrative example with the following assumptions: married, no religious affiliation, taxable income including pension annuity of CHF 100,000, all figures rounded 1
The tax implications for your pension income will depend on the canton you live in. If you also have other forms of taxable income, the impact may be even greater where progressive tax rates apply. Your tax burden can also vary greatly from one municipality to another within the same canton.
The map and table above illustrate the degree of divergence between cantons.
Example: Tax payable on a capital withdrawal of CHF 1.5 million
Illustrative example with the following assumptions: married, no religious affiliation, all figures rounded 2
Here again, the tax implications vary according to your canton of residence. This gap widens further depending on the amount of capital taken. Progressive tax rates may also apply. It is therefore advisable not to take multiple capital sums from pension savings (Pillars 2 and 3a) in the same tax year. Rather, we recommend adopting a staggered approach. Once again, it is important to bear in mind the differences between municipalities.
The map and table above illustrate the degree of divergence between cantons.
Read also: How to boost your pension with equity investments
But tax is not the whole story
As explained above, the impact of taxation on pensions and capital withdrawals should not be underestimated. In particular, a pension conversion rate that looks attractive at first sight might turn out to be considerably lower once tax enters into the equation.
Of course, the essential premise of drawing a pension is that it protects you financially if you enjoy a long retirement. All the same, the specific needs you will have after you retire are also relevant.
The key question is essentially what your needs will be in retirement and how they will be met. You should take into consideration all other expected income streams, whether taxable or not.
For this reason, the choice between a pension, capital withdrawal or a combination of the two is dependent on each individual’s particular circumstances. The solution is therefore rarely obvious from the outset. A broader evaluation is needed, rather than relying solely on an assessment of your tax position.
A personalised needs analysis as part of an individual financial plan
Everyone’s pension arrangements will depend on their own starting position and needs. Taxes must of course feed into your considerations, but they are just one factor. The specific life circumstances and plans of each prospective pensioner are what count. It is only when you know how much you will need to fund these going forward that you can make the right call: pension, capital withdrawal or a combination of the two. A detailed financial plan is best suited to prepare a needs analysis of this kind. This takes some effort, particularly in pulling together all the necessary documentation. But it is well worth it given the importance and irreversible nature of the decision on what to do with your pension assets. A financial plan is also valuable in gaining an overview of your individual income and asset position, and in better understanding your risk capacity. It is moreover useful in implementing any investment strategy that may be required for your withdrawn capital.
Read also: Estate planning: why make a will?
A financial plan – the foundation for a needs-based investment concept
A financial plan produces a clear picture of the inflows of cash that will be required to pay for future needs. These are broken down into short-term, medium-term and long-term requirements. The number of years that each of these phases translates into will depend on your individual preferences. However, the traditional approach is to treat the first five years as the short term. The next five to ten years constitute the medium term. Anything from 15 to 20 years hence would be the long term.
Determining the capital that will be required in each of these life phases means that an individual investment strategy can be devised for you. This strategy takes your individual risk appetite and investment horizon into account.
The cover achieved in this way is virtually the same as with a pension fund. After all, pension funds must also make provisions for short and medium-term pension payments. At the same time, with the remaining assets, they need to make further capital market purchases to ensure long-term commitments can be met. In other words, an investment concept based on an individual financial plan functions much like your own private pension fund solution.
A holistic approach
An investment concept that behaves like a pension fund in this way requires an all-encompassing approach. It is crucial to get an overview of all the available assets, any income that can be expected from them and the associated costs. An assessment of any taxes payable in the future is also required. Of course, the one-off taxes on any capital withdrawal from the pension fund must be factored in too. Such a stock-taking is necessary to judge whether there is any actual need to draw a pension in order to cover regular liquidity requirements. It also considers the tax implications – both in the short term if withdrawing capital and in the long term if opting for a pension.
As such, taxes are just one piece of a wider evaluation. Such an evaluation will enable the right choice to be made between a pension, capital withdrawal and a combination of the two.
1 Tax calculations performed using the TaxWare tool from TaxWare AG
2 Tax calculations performed using the TaxWare tool from TaxWare AG
Important information
This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.
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