Conversion rate: What does it mean for your pension?

Employees in Switzerland pay monthly contributions to their pension fund alongside their employer as part of the mandatory 2nd pillar. These contributions are saved as retirement assets and earn interest from the pension plan. On retirement, this accumulated capital is converted into a pension using the conversion rate. The conversion rate determines what percentage of the capital saved is paid out as a pension each year. 

The Federal Council sets the statutory minimum conversion rate for mandatory retirement assets. The conversion rate for the super-mandatory part is determined by the pension fund or the highest governing body of a pension fund. Pension funds have two options: With the enveloping principle, which is the predominant model today, the same conversion rate applies to all capital. With the split conversion rate – also known as the splitting model – the statutory minimum conversion rate is used for mandatory retirement assets, while a different conversion rate applies to the super-mandatory part. 

The minimum conversion rate for mandatory retirement provision is 6.8% and is based on an interest promise of 4.5% to 5% per annum. This means that pension plans must achieve an annual return of 4.5% to 5% in order to finance this rate. Employees and employers can voluntarily make higher contributions to ensure better retirement provision. 

Example:

The level of the conversion rate is based on various factors that are decisive for the calculation of the pension amount:

1. Life expectancy: The longer people nowadays live, the longer the pension capital saved during their working life will have to suffice to guarantee financial security in old age.
2. Guaranteed minimum interest rate: The guaranteed minimum interest rate is the assumed interest rate on the pension capital during the pension phase, which is used to calculate the guaranteed benefits. It takes into account future returns on the capital market and serves as the basis for the interest promise in the conversion rate.
3. Prospective benefits: Additional benefits such as a spouse's or child's pension influence the conversion rate as they mean additional costs for the pension fund.
4. Returns and investment strategy: The returns on the investments in which the pension fund money is invested also have an impact on the conversion rate.
5. Regulatory requirements: The Federal Law on Occupational Retirement Provision (BVG) sets the minimum conversion rate that applies to mandatory retirement assets.

The conversion rate is coming under increasing pressure: On the one hand, due to increasing life expectancy, and on the other hand, due to falling investment returns. Nevertheless, the statutory minimum conversion rate was gradually reduced between 2006 and 2014 with the BVG revision (2005) from its original level of 7.2% to the current 6.8%.

However, what is often overlooked is that a lower conversion rate does not automatically lead to lower pensions. A reduction in the conversion rate minimizes the redistribution from active insured persons to pension recipients and thus creates more scope for higher returns on pension capital. At Vita Invest, four additional retirement pensions could be paid out with a conversion rate of 4.3%. It is therefore important to consider the conversion rate in the overall context of pension benefits and investments in order to ensure stable and sustainable pensions in the long term.

Employees and employers can take various measures to ensure adequate retirement provision:

1. Pay in additional contributions: Employees can make voluntary contributions to the pension fund (purchases) to increase their retirement assets, safeguard their pension and save tax at the same time.
2. Use private retirement provision: Supplementing the pension fund with private pension products such as pillar 3a can help to close income gaps in old age.
3. Work longer: Later retirement can have a positive effect on the pension, as the capital earns interest for longer and the conversion rate is higher when retirement is later.

The topic is also relevant for employers. They are not only responsible for selecting the pension fund, but also for informing and supporting their employees. Employers should ensure that their employees are well informed about the effects of the investment strategy, the interest rate and conversion rates on retirement provision. Here are a few tips:

• Transparent communication: Reduce uncertainty among employees with regular information events or individual consultations.
• Additional support: Offer your employees assistance in optimizing their private retirement provision.