The FINANCIAL -- Retirement benefits from occupational pension plans will be lower for future pension recipients. Accordingly, it is becoming increasingly important to consider the best way for employees to withdraw their retirement assets – whether as a lump sum or as an annuity.
A study published today by Credit Suisse describes the various options, which are affected by factors such as conversion rates, yield environment, life expectancy and the individual's tax burden. The irrevocable choice of a one-time payment or an annuity can have a considerable impact on a retiree's income, depending on place of residence and tax situation, according to Credit-suisse.
A comprehensive reform of the pension system is not yet on the horizon. Accordingly, pension funds are taking advantage of the available options in non-regulated business areas to accommodate the new reality of low interest rates and an aging population. Conversion rates and guaranteed interest rates in the extra-mandatory part of the occupational pension fund system are dropping. Pension funds are increasingly passing investment and longevity risks on to the insured by requiring the withdrawal of at least some of their retirement assets in a lump sum. Some are stipulating that at the time of retirement, assets accumulated for higher salary components must be paid out entirely as a lump sum.
Just under a third of insured individuals withdraw all of their retirement assets as a lump sum
Most people still receive their retirement assets in the form of a monthly pension. In 2016, according to the Swiss Federal Statistical Office, approximately half of all insured individuals chose this option – women somewhat more frequently than men. Roughly 31 percent chose to withdraw all of their retirement assets in a single lump sum, while another 18 percent chose a combination of the two options. The average amount paid out by employee benefits insurance at the time of retirement – including both employees who chose to receive a single lump sum and those who chose a combination of a lump sum and a retirement pension – is CHF 173,892, with men receiving more than twice as much as women (CHF 225,509 relative to CHF 100,689). The likelihood that individuals will opt for a lump-sum payment generally increases with higher levels of education (cf. Figure 1). Lump-sum withdrawals are also more common among Swiss citizens (38%) than foreigners (30%).
So far there is no discernible trend toward more lump-sum payments; however, the average amount paid out to each recipient has increased. In the past, the frequency of such lump-sum payments has risen during certain periods, which seem to coincide with years in which the stock market has done well. We are currently seeing a similar trend. With conversion rates continuing to decline, and with "1e" pension plans becoming more common, it is likely that the number of lump-sum withdrawals will increase still further.
Lump sum vs. annuity: The income of retirees differs considerably from region to region
Economists at Credit Suisse offer scenarios to illustrate the effect this decision has on the amount of money people have available to them in retirement. To that end, they estimated the net post-tax income from AHV pensions, retirement pensions and lump-sum withdrawals for all communities in Switzerland, broken down by whether individuals chose to have all of their retirement assets from the 2nd pillar converted into an annuity, to withdraw them in a single lump sum, or a mixture of the two options (cf. Figure 2).
Because of regional differences in income taxes, taxes on lump-sum withdrawals and wealth taxes, net income also depends on a person's place of residence. In the scenarios, annual net income varies by up to CHF 12,000 (cf. Figure 3). It is also important to note that the appeal of a given location, in terms of tax treatment, can change when people retire, since income is usually much lower during retirement. Geneva, for example, is generally much more attractive for people with a low income than a high income.
Owing to such differences in taxation, decisions about whether to choose a lump sum or an annuity will differ from place to place. The choice of a single lump-sum payment can substantially lower a person's tax burden, and while this will trigger higher wealth taxes, in most cases the increase is more than offset by a reduction in income taxes. In any event, people with considerable retirement assets should consider their tax burden when opting for a lump sum or an annuity, particularly in regions where income taxes are high. In the city of Zurich – which, in terms of taxation, is more attractive than the average location in Switzerland – drawing a pension at a conversion rate of 5.0 percent, a duration of 25 years and an expected return of 2 percent is roughly as attractive, financially, as a receiving a lump-sum payment. In a region with a higher tax burden, such as Neuchâtel, annual net income may be several thousand francs higher, under the same conditions, if one receives a lump-sum payment rather than an annuity. It is also important to consider a person's family, health and residential situations, as well as the relevant aspects of inheritance law.
New working arrangements lead to pension gaps
Societal changes, such as the current increase in part-time work and other flexible working arrangements, including temporary employment contracts and freelancing, are putting the pension system to the test. Such changes can lead to pension gaps for the affected workers, since income below the minimum of CHF 21,150 required for enrollment in mandatory employee benefits insurance is not insured; in addition, the coordination deduction lowers the wages covered by insurance.
The Credit Suisse analysis shows that a six-year delay in entering the workforce, caused for instance by a longer period of education, results in a roughly 8- to 10-percent drop in the retirement assets of the income groups examined (CHF 50,000–200,000) at the time of retirement. Dropping out of the workforce for the same period of time to raise a family has a similar impact. Because BVG contributions increase from 7 percent at age 25 to as much as 18 percent at age 55, the financial penalty for leaving the workforce is greater at a later stage in one's career. Retiring six years earlier than the standard age reduces retirement assets by nearly 30 percent.