A comprehensive guide to help you avoid the mistakes I made and grow your wealth

Growing wealth through your pension pillar 3a is like hiking up a mountain, choose the right path, and stick to it long term, it will lead you to the peak.

In my other article <Simple Explanation of the Pension Fund in Switzerland>, I gave you an overview of the Swiss pension fund system. In this article, we will look at the third pillar- voluntary contribution pillar- 3a. How you can optimize it to create wealth and avoid common mistakes.

For employed persons in Switzerland, you can contribute a maximum of CHF6,826 to pillar 3a. Of course, you can also choose to contribute any amount up to CHF6,826 per year, in a frequency that you want. This contribution is not compulsory, but it has a great tax benefit. That is why I encourage everyone to open a pillar 3a account unless you have other financial obligations for your cash.

Tax Benefits in 2 Folds

Since pillar 3a contribution is tax-deductible, the amount you put into your 3a account is exempted from income tax. How much tax benefits can you enjoy?

Let’s take a single person with a yearly income of CHF100,000, living in Zurich for example (without other tax deductibles for simplicity reasons) The yearly tax is CHF15,172.

With pillar 3a contribution of CHF6,826, the income tax is CHF13,356. The difference is CHF1,816. It is obvious that in a higher tax area or with higher household income, you can even save more from income tax.

Another tax benefit is from your investment in the US-domiciled products. It could a US company’s shares, an ETF consists of US companies ( total US market or S&P500), a REIT which consists of US real estate properties, and so on. Thanks to the US/Swiss treaty, swiss residents will not pay any withholding tax from the profits earned from US-domiciled products. Usual US withholding tax is 30%. When a US company distributes $10 in dividends, you only receive $7. $3 goes to the tax. From the treaty, the withholding tax is 0% for Switzerland. You will receive $10 dividends -> 30% increase. Not every country has a treaty with the US or this kind of agreement. So it is a piece of good news for those who invest and receive US-sourced income. Here is the source of PWC’s article <Update on the US/Swiss Double Tax Treaty> and my article <Simple Explanation of Swiss/US Tax Treaty and Its Impact on Your Investment>.

Grow Wealth through 3a

Besides the tax benefits pillar 3a offers, you can also invest your money into equities and grow your investment over time. There are 3 ways to use your pillar3a money, they are not mutually exclusive, you can slice your deposit amount and put them in different brackets.

1. Deposit in an account and enjoy a fixed interest rate.

2. Invest in financial products and enjoy the return in the long-term but also bear the fluctuations.

3. Buy insurance.

Let’s go through them one by one.

1. Deposit in an account.

It functions similar to a savings account. You open a pillar 3a account with a bank at your choice and put the money there. Then you enjoy an interest gain. It is safe to deposit with a swiss bank, but it is sadly offering an extremely low-interest rate. Post Finance offers 0.15%, UBS offers 0.1%, Zug Canonalbank offers 0.1%, and so on. The interest rate slightly differs from bank to bank, but they are all extremely low. You don’t lose your money, but you also don’t grow it. There are both advantages and disadvantages:

Advantages:

• Security. You have as much as you deposit plus a bit of interest.

• Flexibility. You can stop depositing whenever you want.

• Tax benefits.

Disadvantages:

• Low return compared to some investments.

• Not obvious indirect amortization for your apartment purchase compared to invest in insurance, but it is possible. You should talk to your bank. Maybe you can get indirect amortization through the same bank as you deposit your 3a.

2. Invest in financial products

With a 3a account, you can choose a banking solution with investments. It is similar to the last option, instead of letting your money sitting in the account, you invest them in financial products, such as mutual funds or ETFs. This investment is for the long term, thus you should not think of using it for trading or speculation. Many banks offer investment solutions through pillar 3A. But as I wrote in another article, comparing some mutual funds with ETFs. ETFs offers great benefits of low cost and proven return from its wide diversification and tax benefits. If you spend several days to study this topic. You may have a better understanding of how to invest your pillar 3a with the lowest cost and similar return to the market. The best DIY solution I found is VIAC. Low cost, an easy construct of an investment portfolio with mainly diversified ETF. And you enjoy 0% tax from US-domiciled investment from the US/Swiss Tax Treaty. I wrote an article on this topic here. Read it yourself, and I will leave a friend link in the comment below, in case you want to use it, you can enjoy a reduced fee. But if you don’t want to DIY, feel free to invest in a banking solution with banks or insurance companies. Then your financial advisor will do everything for you with a percentage cut from your portfolio.

Advantages:

• Enjoy the market return, which is usually higher than the interest rate.

• Flexibility. You can stop depositing whenever you want.

• Tax advantage

Disadvantages:

• Higher risk. You may get less than what you invested when you want to take out the money.

• High fees paid to mutual fund very year. This eats up your return.

• No obvious indirect amortization for your home mortgage payment.

I will list several books that helped me greatly in understanding investment. It requires no advanced financial knowledge. Everyone can understand the concept. Then you will have more clarity on how to invest your pillar 3a money.

3. Buy insurance

You can buy life insurance with your pillar3a contribution. In the case of accident and death, there will be a payout. At the same time, many insurance companies offer a mixed insurance product. It combines investment with insurance elements, such as Generali, Swiss Life, and so on. If you buy the mixed insurance investment product, it has certain benefits and also a big drawback.

Advantages:

• Enjoy the market return, which is usually higher than the interest rate.

• Payout in the event of accident and death.

• It can be used for indirect amortization, hence allows you to use your money for growth instead of directly paying back to the bank.

• Tax advantage

Disadvantages:

• Inflexibility. Insurance product is a long term commitment, by withdrawing early, you will suffer a loss.

Here is a table of insurance cost comparison which I found from Generali. TER is the total expense ration, which you need to pay attention too. That is the part of your money going out of your account.

How to choose

I lost thousands into something which I did not understand and with a long term binding. And I wrote this article to inform you and so that you don’t make the same mistakes as I did.

Think about your risk tolerance level, can you stomach market fluctuations? Think about what would you need pillar 3a money for. For your retirement, for financing a new home, or for creating wealth?

If you have mixed reasons, you can also put some money into one solution, and some into another. For example, 50% in deposit, 50% in insurance for home indirect amortization. Or you put 50% into an investment for growing wealth long term and another 50% in insurance. The mix is depending on your situation. If you understand the consequences of each option well, you can use 3a to your advantage.

One thing to remember: do not rush into something before you fully understand. You can always start with depositing your pillar3a money into a bank account first, then transfer it or start with another solution later. Then you have time to read and understand what is suitable for you.

Where to start? I have several books and tool to recommend:

The Bogleheads’ Guide to the Three-Fund Portfolio: How a Simple Portfolio of Three Total Market Index Funds Outperforms Most Investors with Less Risk

Intelligent Investor

MONEY Master the Game: 7 Simple Steps to Financial Freedom

Investment tool: VIAC