As the third of a three-part series, this article will dive into the first pillar of the Swiss pension system. See Pillar 1 and Pillar 2.
Pillar 3: Private Pension
Most similar to the concept of a Traditional IRA, the third pillar of the Swiss Pension System is comprised of two parts:
1. Tied Pension – Pillar 3a
As the name suggests, contributions to Pillar 3a are “tied” to the retirement account and can only be withdrawn under certain conditions. Contributions to this account have tax advantages in Switzerland.
2. Flexible Pension – Pillar 3b
As the name suggests, contributions to Pillar 3b are flexible (or non-tied) to the retirement account and can be freely withdrawn. Contributions to this account have fewer tax advantages in Switzerland than Pillar 3a.
Contributions
Pillar 3 consists of private pensions in which contributions are voluntary. This pillar incentivizes individuals to save for retirement by offering additional tax savings in the year of contribution, similar to a Traditional IRA in the US. However, the US does not recognize Pillar 3 as a Traditional IRA, but as a regular brokerage account.
Annual Contributions Limits:
Pillar 3a - CHF 6,883 (employed individuals) and 20% of earned income up to CHF 34,416 (self-employed individuals) (2022)
Pillar 3b - Unlimited
Taxation During Contribution Years
In Switzerland, taxation differs depending on the type of plan.
For Pillar 3a accounts, contributions can be deducted from your taxable income, therefore decreasing your overall tax balance. Any interest or gains on the account are tax-exempt until withdrawn.
For Pillar 3b accounts, there is a limited deduction available if you purchase an insurance product. The surrender value (aka amount received if the life insurance plan is ended prematurely) is subject to wealth tax.
In the US, Pillar 3 is not considered a “qualified retirement plan” for tax purposes, as is the case with a Traditional IRA. Due to this, contributions cannot be deducted from your taxable income, therefore increasing your overall tax balance. Any interest or gains on the account should be reported and are taxable each year. See Pillar 3a example below:
In the above example, you can begin to see the difference in calculating your taxable compensation in Switzerland and the US. Switzerland reduces your taxable income by your Pillar 3 contributions and defers any account growth until you receive distributions. The US adds your Pillar 3 contributions to your taxable income and taxes account growth yearly. While your initial taxable income is the same, there is a 15,766 difference in taxable income.
Taxation During Distribution Years
In Switzerland, taxation differs depending on the type of plan.
For Pillar 3a accounts, you can withdrawal your benefits up to 5 years before the full retirement age, or if you relocate outside of Switzerland, become self-employed, or purchase a home. Early withdrawal preferential tax rates may apply, dependent on the reason for early withdrawal and your Cantonal location.
For Pillar 3b accounts, you can withdrawal your benefits at any time. These withdrawals generally do not result in additional taxable income but are still subject to wealth tax.
In the US, there is no tax benefit for Pillar 3a nor 3b. Any distributions in excess of your tax basis (aka total prior contributions) will be fully taxable. Any interest or yearly capital gains should be taxable in the year received, but any excess will be taxable when distributed. See Pillar 3a example below:
In the above example, you can begin to see the difference in calculating your taxable compensation in Switzerland and the US. Switzerland taxes your full contributions and account growth at the time of distribution. The US already taxed your contributions and account growth yearly, so there is no additional tax at the time of distribution (unless there is excess growth not previously reported).
Due to the lack of tax benefits, Pillar 3 pensions are not recommended for those who are subject to US taxation. Most of the plans offered under Pillar 3a face punitive taxes in the US and are often actively managed, meaning they have high fees and high risk regulation (resulting in low returns). There are numerous product types, including life insurance, savings accounts, investment accounts, etc., which all have different implications when it comes to your US taxes.
US Tax Reporting – Important Points
If you choose to invest in a Pillar 3 pension, keep in mind it will lead to additional US tax reporting requirements. Among others, these can include:
PFIC - Form 8621: Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
Foreign Trust - Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
FBAR - Report of Foreign Bank and Financial Accounts
Summary
As the US does not treat Pillar 3 as a “qualified retirement plan,” contributing to these accounts will lead to a bigger imbalance between your US and Swiss tax reporting. In addition, it will trigger additional yearly taxable income and filing requirements on your US tax return.
If you currently have a Pillar 3 account, make sure to speak with your financial planner and US tax advisor, as optimization revolves around your unique experiences.
Meet the Author
Arielle Tucker is a Certified Financial Planner™ and IRS Enrolled Agent with Connected Financial Planning. She’s spent over a decade working with US expats on US tax and financial planning issues. She is passionate about working with US expats and their families to help secure their financial future reflective of their core values. Arielle grew up in New York and has lived throughout the US, Germany and Switzerland.
Resources/References:
IRS - US-Switzerland Tax Treaty Documents:
https://www.irs.gov/businesses/international-businesses/switzerland-tax-treaty-documents
AXA - Pillar 3:
https://www.axa.ch/en/pension/pillar-3.html
ch.ch - 3rd Pillar:
https://www.ch.ch/en/work/old-age-pension/3rd-pillar/
UBS – Reduce taxes by staggering pay-outs:
https://www.ubs.com/ch/en/private/pension/information/magazine/2018/reduce-taxes-by-staggering-pay-outs.html
KPMG - US Tax Implications:
https://pensionskassen-novartis.ch/fileadmin/pkn/Praesentationen/2019/Steuerevent_KPMG_21.05.2019_UPDATE_17.05.2019_17.pdf