Second pillar: Falling pensions for future generations
Articles

Pensions for future generations are falling sharply

Lower returns and falling conversion rates – the current labor force can expect lower pensions. The latest study from Credit Suisse calculates how great the differences could actually be as well as who will have to face the heaviest losses.

It's nine o'clock in the morning. Daniel Müller, a teacher, will soon greet his students and begin class. Two hours ago he was accompanying his parents – retired teachers themselves – to the airport. They are about to depart on an Atlantic cruise to Florida to escape the winter gloom of Switzerland.

On his way to work, he begins to think about his own retirement. Will he be able to count on a comparable pension? Will he be able to live like his parents, free from financial worries? – No, probably not. This is demonstrated in the latest study from Credit Suisse "Second pillar: a growing gap between the generations."

Thirteen percent less pension than their parents

The study shows that without counter-measures, Daniel Müller's retirement pension (AHV and BVG) will be 13% less than what his parents received. Even though Daniel's parents earned slightly less than he does, their wealth building was marked by decades of high interest rates and the corresponding returns. In addition, their current pension is calculated based on conversion rates that are clearly too high from an actuarial perspective.  

Pensions are falling despite rising income

A comparison of four pension generations: Pensions are falling.

A comparison of four generations

Pensions are falling despite rising income

Historical performance and financial market scenarios are not reliable indicators of future performance.

Source: SNB, Swisscanto, OAK, Credit Suisse

The "lucky" generation

Daniel Müller's parents belong to the first generation in the above diagram, those who were in the labor force between 1970 and 2010. Although the wages of this generation were lower than those of the following generations, their pension fund assets grew nicely thanks to an average annual interest rate of 5.65%. In addition, the average conversion rate at time of retirement was 6.74%. Together, the first and second pillars combine to equal 57% of Müller's parents' salary at retirement.

The "will it be enough?" generations

The three following generations will feel the effects of lower returns – between 1985 and 2018, the estimated annual interest paid on retirement assets was 4.5%; in 2019, it was only 1.5%. The buildup of their retirement assets is therefore slower. Even though it isn't intentional, there is an ongoing redistribution of assets from the actively insured (like Daniel Müller) to current pension recipients (his parents). This generation is benefiting from conversion rates that are too high and that are no longer appropriate for the current demographic situation and the continued low interest rate environment. Future pension recipients will have to deal with lower conversion rates. According to the calculations of Credit Suisse economists, this means that Daniel Müller, who will retire in 2040, can expect only 45% of his gross income at retirement from AHV and BVG. Will that be enough?

Study "Second pillar: Growing gap between the generations."

Download the study This link target opens in a new window

Maintain your standard of living after retirement

The federal government's goal is for the combined pension from the employee benefits insurance (second pillar) and the AHV retirement pension (first pillar) to equal 60% of gross salary at retirement.

Add in the private pension provision (third pillar), and ideally your income should equal 80% of gross salary before retirement. It is assumed that, with this pension, a person can manage to attain the same standard of living they had before retirement, even though there is, of course, significant individual variation.

The pension gap is defined as the difference between the first and second pillars combined and 80% of last salary before retirement. Daniel Müller's pension gap is estimated to be 35%. For his parents, it was only 23%.

Higher income means larger pension gap

Higher income means larger pension gap

Comparing different income brackets. 

* In calculating the pension from employee benefits insurance, we assumed a minimum conversion rate at time of retirement of 7.0% in 2010 and 6.0% starting in 2021 for low incomes, and a conversion rate of 6.74% (2010), 5.36% (2025), 5.09% (2040), and 4.70% (2061) for average and high incomes.

Historical performance and financial market scenarios are not reliable indicators of future performance.

Source: Credit Suisse

A comparison between three income brackets (salesperson, teacher, lawyer) makes clear: The higher your salary, the smaller the chance that you will achieve 60% of your salary at retirement with AHV and employee benefits insurance. The pension of a retired retail worker was 58% of last salary in 2010. And while the 53% pension for today's sales trainees may not seem that much smaller, reductions in already-small pensions are felt more strongly than reductions in higher pensions.

However, members of higher income brackets will be hit hardest by falling pensions: A lawyer who retired in 2010 receives a pension equal to 51% of their last salary. This leaves them with a pension gap of 29%. According to the study, today's law students, who will retire in 2061, will receive only 34% of their last salary and will therefore have to confront a pension gap of 46%.