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By Luigi Galante, Founder of Elite Office SA and the Elite Fondations pension institutions
Over the next six months, I will publish a series of six episodes devoted to the risks and opportunities associated with early or deferred retirement through occupational pension provision.
The aim is to highlight, progressively, the main questions to consider within the framework of the second pillar, rather than to address every aspect of ideal financial and tax planning for retirement, which would also involve analysing third-pillar arrangements, life insurance policies, mortgages, investments, gifts, real estate, companies and inheritance agreements. This series is independent of the type of pension institution. Its purpose is simply to explain, with nuance, the various mechanisms offered by occupational pension provision. However, one fundamental rule must always be borne in mind: the pension regulations are decisive in all cases.
It is important from the outset to distinguish between the reference age under the OASI system and the regulatory reference age under occupational pension provision. The former corresponds to the ordinary retirement age under OASI. The latter refers to the age at which, under the pension regulations, retirement benefits generally become payable. These two concepts do not necessarily coincide. Thus, when reference is generally made to the gradual alignment of women's retirement age with that of men, this concerns the OASI reference age. Under the second pillar, however, it is the pension regulations that determine the regulatory reference age, as well as the conditions governing early or deferred retirement.
Before considering early or deferred retirement, it is important to recall a few fundamental concepts. Occupational pension law generally allows early retirement from the age of 58 at the earliest. However, this does not mean that all pension institutions offer this possibility to their insured members. Some set a higher early retirement age, for example 60 or 62. Others only allow early retirement from the age of 63, which is the minimum age required under the BVG/LPP. At the same time, the OASI reference age is gradually being aligned at 65 for both women and men. Under the second pillar, however, the determining age always remains the age defined in the pension regulations as the regulatory reference age. This determines the date from which retirement benefits may be paid and the conditions under which they may be taken early or deferred.
Retirement benefits may take different forms depending on the applicable pension regulations. They may be received as a retirement pension, a lump-sum payment or a combination of both. Pension institutions offering retirement benefits exclusively in the form of a pension are becoming increasingly rare. However, this development does not remove the need to carefully examine the applicable pension regulations. Such an examination is particularly essential where an individual has several pension arrangements, for example when they are insured not only with an institution providing mandatory occupational pension coverage but also with an institution providing supplementary occupational pension coverage. In such cases, each pension institution applies its own regulations, which must be consulted, as rights, restrictions and tax consequences may vary.
The choice between a pension and a lump sum is often presented in pension regulations in a factual manner, without any real consideration of the insured member's individual circumstances. In reality, it depends on a range of personal, financial and tax-related criteria. Several factors may favour a retirement pension, including excellent health, a long life expectancy, a low appetite for investment risk in financial markets, the need for a stable and regular lifelong income, no particular wish to favour legal heirs, a low marginal income tax rate, a high marginal wealth tax rate, a favourable conversion rate, a period of low or even zero inflation, and a high level of confidence in the second-pillar system.
Conversely, other criteria may favour taking retirement benefits as a lump sum, particularly health concerns, a shorter life expectancy, sound investment knowledge, the ability to plan income and expenditure over a long period, the desire to have greater freedom over the use of capital, particularly to benefit heirs during one's lifetime, the wish to preserve accumulated capital for the family in the event of death, a high marginal income tax rate, a low marginal wealth tax rate, a low conversion rate, a period of high inflation, and a more limited level of confidence in the second-pillar system.
Finally, certain solutions offer greater flexibility, generally with a lower conversion rate. In particular, they may provide a retirement pension without survivor benefits for the surviving spouse, an arrangement that is relatively uncommon on the market but may be relevant in certain circumstances. Other solutions, by contrast, provide for the continuation of the retirement pension to the surviving spouse, most commonly at a rate of 60%, while sometimes allowing a different percentage to be selected, potentially up to 100%. These solutions may also offer the possibility of adding an option to return any unused capital to beneficiaries in the event of the death of one or both spouses.
The right choice therefore always depends on the insured member's profile and how they intend to use their pension benefits upon retirement. It is not necessarily a matter of choosing only one option, as a combination of both is possible in most cases.
Whether the insured member favours a lump-sum approach or opts for a retirement pension, voluntary pension buy-ins can be a valuable tool, although their benefits differ depending on the chosen approach. In the case of a lump sum, they increase the capital available upon retirement. In the case of a pension, they enhance future benefits and can help increase the amount of the pension paid.
If the insured member has already made all the buy-ins corresponding to previous years, they may, depending on the applicable pension regulations, be able to make additional buy-ins to finance early retirement. These make it possible to close the pension gap resulting from the difference between the actual retirement age and the regulatory reference age, which may be as high as 65 in this context. For example, if an insured member intends to retire at 60 while the regulatory reference age under their pension plan is 65, they will need to cover a five-year pension gap. Buy-ins for early retirement are specifically intended to finance this difference. On the one hand, these buy-ins are deductible from taxable income and reduce taxable wealth and, on the other hand, they improve future pension benefits. Some pension institutions also allow members to purchase an OASI bridging pension. Discussions may also be held with the employer to improve the pension plan, for example by increasing the insured salary, savings credits or insurance period, or by reducing or eliminating the coordination deduction.
However, this opportunity must be approached with care. A buy-in is not merely a tax deduction tool; it is also part of a pension provision strategy that requires compliance with a three-year blocking period in the event of a lump-sum withdrawal. If this period is not respected, the tax authority may retrospectively revoke the tax benefit previously obtained. During the blocking period, the pension institution may pay retirement benefits to the insured member in the form of a retirement pension or a lump sum without tax consequences, except in the case of recent buy-ins, which will be paid in the form of a retirement pension and become subject to taxation again. In other words, the capital may, to a certain extent, remain accessible, but the portion corresponding to recent buy-ins will not be available under preferential tax conditions. It is therefore essential to bear the blocking period in mind before making buy-ins when a lump-sum payment of retirement benefits is being considered.
The situation requires further clarification where the insured member participates in a pension arrangement that does not provide retirement benefits in the form of a pension, as may be the case with certain vested benefits arrangements or 1e pension plans. In such circumstances, the amount of the buy-in remains blocked until the end of the three-year period, while the remaining capital may be paid out by the pension institution, although the retrospective taxation of the buy-in is certain. Finally, it should be recalled that when benefits become payable under the pension regulations, the pension institution is required to pay them. This obligation takes precedence over the blocking period.
Furthermore, the situation is the same where an insured member has several pension plans. Having multiple plans does not make it possible to artificially isolate the consequences of a lump-sum withdrawal. Indeed, the tax authority maintains a consolidated view even when an insured member is affiliated with several pension institutions. In other words, an insured member cannot expect to preserve the tax benefit of a recent buy-in by first withdrawing retirement capital from a plan in which the blocking period has been respected, or in which no buy-in has been made, and only subsequently withdrawing capital from the plan in which a buy-in was made less than three years earlier. Similarly, the payment of retirement benefits (pension or lump sum) from the mandatory occupational pension plan results in retirement (pension or lump sum) under the supplementary occupational pension plan. This is because the latter is intrinsically linked to the mandatory occupational pension arrangement.
Finally, consideration must be given to the situation in which the insured member ultimately decides not to take early retirement. Where buy-ins have been made to finance earlier retirement, continuing gainful employment and paying further contributions may result in the maximum permissible retirement capital being exceeded. In such cases, if the retirement capital exceeds the maximum permitted at retirement by more than 5%, the excess amount is forfeited by the insured member and remains with the pension institution. To limit this risk, the pension regulations may provide for various measures, including the suspension of savings contributions when the insured member decides against early retirement. Although the system allows early retirement to be planned, it does not permit this mechanism to be used subsequently to accumulate unlimited excess retirement savings.
In conclusion to this episode, devoted to the initial questions raised by early retirement, it is essential first and foremost to refer to the pension regulations in order to distinguish between the OASI reference age and the regulatory reference age, and to determine the conditions applicable to the payment of retirement benefits, whether in the form of a pension, a lump sum or a combination of both. Particular attention must also be paid to the use of voluntary pension buy-ins, their impact on future benefits and their tax consequences. There are numerous opportunities, but they can only be fully realised by those who respect the underlying principles of occupational pension law while remaining aware of the potential tax implications.
In reality, the transition from gainful employment to retirement often takes place gradually rather than abruptly. Between continuing full-time employment and retiring completely, there are intermediate solutions whose effects on pension provision are often poorly understood. It is precisely this transitional phase that will be addressed in the next episode.