3a on low income? Yes

Banks, Insurances & Third Pillar
1

It is not so clear if the pillar 3a is strictly bad from a purely payoff point of view when not earning enough.

Let’s say we earn some money and want to invest it. We have two options that will be the same except the account: 3a and regular. As an example, I think investing in the SPI at 0.1% TER with Truewealth 3a (UBS (CH) Index Fund - Equities Switzerland All NSL I-A-acc, CH0348228609) vs IBKR (iShares Core SPI (CH), CH0237935652) should be comparable.

Ok, what are our returns for both solutions?

1+ r_{3a} = \left( \prod_{i=1}^{y} (1+ r_{i_{cap}} + r_{i_{inc}}) \right) * (1-t_{y_{3a}})
1+ r_{reg} = (1-t_{1_{reg}}) * \left( \prod_{i=1}^{y} (1+ r_{i_{cap}} + r_{i_{inc}} * (1-t_{i_{reg}})) \right)

where:

  • r are returns (e.g. a growth of 1%). I also split the yearly returns into capital gains and income.
  • t are tax rates (e.g. a tax of 10%). Note, this is the marginal tax bracket for the reg (-ular) taxes.
  • y are the number of years that we compound

We now make two simplifying changes:

  • We replace the compounding product with an assumption of average returns
  • We use the commutativity of the multiplication to pull the 3a exit tax to the front
1+ r_{3a} = (1-t_{y_{3a}}) * (1+ r_{cap} + r_{inc})^y
1+ r_{reg} = (1-t_{1_{reg}}) * (1+ r_{cap} + r_{inc} * (1-t_{reg}))^y

We see that we can use the regular account to only pay the tax rate of year 1 instead of the 3a tax rate in year y, but then we will pay taxes on all dividends in all years.

Now, let’s assume our tax rate in year 1 is very favorable, it is 0%. Let’s assume we will pay a roughly average 19% marginal taxes at a roughly average 80k income later. We assume 5% capital gains and 2% dividends. We will let it compound for 40 years.

1+ r_{3a} = (1-t_{3a}) * 1.07 * (1+ 0.05 +0.02)^{39} \\ \approx (1-t_{3a}) * 14.97
1+ r_{reg} = \underbrace{(1 - 0) * 1.07}_{zero\ tax\ first\ year} * (1+ 0.05 + 0.02 * (1-0.19))^{39} \\ \approx 13.03

We now want to know:

1+ r_{3a} > 1+ r_{reg} \\ \iff (1-t_{3a}) * 14.97 > 13.03 \\ \iff 1-t_{3a} > 0.87 \\ \iff 0.13 > t_{3a}

So, in our example, if our 3a exit tax will be below 13%, we would do 3a even if we would pay no taxes this year. Only in the canton of Zurich, it can even reach 13% (under current tax law).

Rerunning this with different numbers will yield slightly different results. But the main point is this:

The 3a exit tax is also significantly competing with the recurring income taxes on dividend & interest over the compounding period, not only with the initial tax savings.

Also:

The taxation of capital gains in 3a is an illusion when looking at total returns.

Edit: I totally forgot wealth taxes, which strictly pushes the calculus even further in favor of 3a (but would bloat the model).

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The best broker for young adult
2

2 posts were split to a new topic: Wiki threads in the forum

3

nice modeling and formulas :slight_smile:
its been a while since i went into finance maths :sweat_smile:
but if i find the time id like do dig in again.

at this granular level imho you should also model the following aspects:

  • yearly returns of 3a are ~0.5% smaller with the same product due to fees, at least vs. IBKR. best-in-class to my knowledge is finpension with 0.39%, viac has 0.44%
  • you have to account for the different amounts you can input into both systems: If you assume the amount of maximum 3a contribution on both 3a and non-3a accounts, then
    • either you spill over the tax saving from the 3a account of year n onto a clone of the non-3a account in year n+1
    • or you fine-tune the input funds such that including the 3a tax return you can max out the 3a account

from my old simulation i always found that the once-off bonus of 3a from any given year’s investment are slowly eaten away by the higher fees, but i am happy to getting an update / correction here :smiley:

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4

If you choose non income paying investments, the wealth tax becomes the only additional drag for the non-3a.

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5

The funds are usually 0% TER tho (they’re paid out of the 3a fees) so the delta is smaller depending on what you compare it to.

6

Depends on the investments (dividends) and wealth. It’s easy to have the dividend income and wealth tax saving beat the extra fee. (Even before looking at the one off gain when contributing).

7

Have you also taken into account that 3a is taxed upon withdrawal? Usually, you save more than you pay in taxes when you cash out. With little to no income, that’s probably no longer the case.

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8

If you assume you invest in non-income paying investments outside the 3a and wealth tax is 0.0025% then the 3a tax threshold shifts to 8.7%.

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9

Just to add that if you intent (or end up) retiring abroad, the chances of having an exit tax rate of 30%, 40%+ are quite high.

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10

I guess it depends on where you retire to. It could just as easily be 0%.

11

Yes, it depends on the country. In most of Europe though you will be taxed in the destination and with a very high rate.

It cannot be 0% because you will at least have to pay the Swiss tax.

12

Not if you move to a country with an appropriate tax treaty e.g. Singapore.

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13

My understanding was that you pay the taxes in Switzerland and then depending on the country/treaty:

  • Don’t pay anything to the destination country
  • Pay usually a high rate to the destination country. Inform Switzerland about how much you paid. Get back the swiss tax

So at best you pay at least the swiss tax.

Apologies, we are going a little bit of topic…

14

Yes and no.

You basically can pay taxes in Switzerland and the destination country.

So tax optimal approach is to pick a country that doesn’t tax it.

When you leave, you pay the withholding tax in Switzerland.

If you pick a country that has a tax treaty which only allows for taxation in the destination country, then you send a request for a refund of the tax you paid in Switzerland.

So for the magic countries that have both 0% and exclusive taxation rights, you effectively pay 0% after refund claim.

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15

Not expert. I was under the impression that you cannot claim from Switzerland more than you have paid in the destination country. If e.g. the canton taxed you with 10% and the destination country taxed you with 8%, you can only claim that 8%. if it is 0% then you can claim 0% :slight_smile:
Anyway, not an expert.

But lets not diverge the thread.

The main point is that you need to have in mind that the exit rate could be very high depending on the country you retire.

17

There is no way Swizerland refunds you their source tax when you pay 0% taxes in your destination counry, does this actually work?

The way those treaties usually work is with tax credits, not with blaco refunds.

18

Yes.

Every treaty is different so you can’t generalize like that. The treaties often define taxing rights. In some treaties certain taxes a can be taxed only by one jurisdiction.

You are referring to a case where certain income can be taxed by both jurisdictions and some relief from double taxation is given under the treaty (or sometimes unilateral relief under domestic tax laws).

If you look at the SG-CH tax treaty, you will see it is quite clear:

Article 18 Pensions
Subject to the provisions of paragraph 2 of Article 19, pensions and other similar remuneration paid to a resident of a Contracting State in consideration of past employment shall be taxable only in that State.

Switzerland has no taxing rights to pension amounts received by a SG resident (except for pensions paid out of government pension funds). So pillar 2/3a should be safe in most cases (not sure if there exist government pillar 2/3a).

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19

Thanks for the comments.

Truewealth at 0% fees (for now). Probably too low for Switzerland, but VIAC and Finpension are still too high (especially VIAC with their hidden currency conversion fees). This can still come down a lot from 0.5%

It is basically the second option, but the max. doesn’t complicate anything here. E.g. you have 6000 to invest. You can put it all into 3a. Or you can put it into taxable, but it will be less because you first need to pay income taxes.

That final taxes are a bit unpredictable has nothing to do with 3a. You also won’t be able to calculate the exact amount to investing and cash for taxes in taxable. What can be, is that you park the tax float into investing. But that only compounds on the float return.

Yes, see my post, especially the bold parts.

Right, the wealth tax is proportional to the interest, because both come from the total value of assets. Was too tired to see that yesterday.

Many municipalities have terminal tax rate around 8.7% (at e.g. 100m CHF payouts). So it would be a wash. At a more realistic 5 x 250k that number drops a lot. Many of the more expensive ones also have higher wealth taxes though.

If we are optimizing, we could also dump the high income part of our portfolio into 3a (non-US stocks, value stocks, high yield bonds).

20

But you need to look at all levels, right? Municipal, cantonal and Federal and then add them all up.

21

Article 18 of the Singapore-Switzerland DTA generally applies only to periodic, recurring pension payments and does not allow for the reimbursement of Swiss withholding tax on 2nd or 3rd pillar lump-sum withdrawals

In German, the term used is “Ruhegehälter” lump sum payments are off the table with this wording imho.