Lump Sum or Pension: The Decision When Drawing Your Pension Fund

In brief: When drawing your pension fund, you choose between a pension and a lump sum. The pension secures a guaranteed, lifelong income. The lump sum offers flexibility, the ability to pass it on, and return potential, but it requires personal responsibility. A mixed option of part capital and part pension is often available.

Retirement brings one of the most important financial decisions of your life: should the balance of your 2nd pillar be paid out as a monthly pension, as a single lump sum, or as a combination of both? The question of lump sum or pension cannot be answered in a blanket way, because both routes carry real advantages and disadvantages.

The decision is generally final and has effects over decades. It concerns your income in retirement, your tax burden, and what you can pass on to your loved ones. This article explains the differences between pension and lump sum, presents the mixed option as a third route, examines the tax aspect and the deadlines, and names the typical mistakes.

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The key points at a glance

• Pension: guaranteed, lifelong income with protection against a long life. Taxed annually as income.
• Lump sum: flexibility, the ability to pass it on, and return potential. Taxed once at a reduced rate, but requires personal responsibility.
• Mixed option: a partial withdrawal combines guaranteed income with flexible capital. Often the most pragmatic solution.
• Entitlement: under Art. 37 para. 2 BVG, you are entitled to at least a quarter of your mandatory retirement assets as capital. Many funds allow more.
• Deadline: the registration deadline for a lump-sum withdrawal can be up to three years before retirement, depending on the regulations.
• Conversion rate: the statutory minimum rate in the mandatory portion is 6.8 percent (source: BSV).

Lump sum or pension: what is this decision about?

The retirement assets accumulated in your pension fund can be paid out in two ways when you move into retirement. With the pension, the pension institution converts the capital into a lifelong, annual income using the conversion rate. With the lump sum, the balance is paid out in a single sum and you manage it yourself.

The legal position is as follows: retirement benefits are provided as a pension by default (Art. 37 para. 1 BVG). However, you are entitled to draw at least a quarter of your mandatory retirement assets as capital (Art. 37 para. 2 BVG). Many pension funds go further and allow a higher or full lump-sum withdrawal. If you are married or in a registered partnership, the written consent of your partner is required (Art. 37a para. 1 BVG).

The decision is usually irreversible. Once drawn as a lump sum, the balance cannot be converted back into a pension. It is therefore worth weighing the two options carefully against each other.

What are the advantages of the pension?

The pension is the option of security. It provides a predictable income that does not depend on the stock market, interest rates, or your own discipline.

• Guaranteed and lifelong: the pension is paid out for as long as you live, regardless of how old you become. It therefore protects against the risk of outliving your own capital.
• No investment risk: fluctuations in the financial markets do not affect the ongoing pension. The income remains stable.
• Simple and effortless: you do not have to manage any assets or make any investment decisions.
• Survivor protection: on death, the surviving spouse usually receives a widow’s or widower’s pension, typically 60 percent of the previous retirement pension.

There are disadvantages to weigh against this: the pension is taxed in full every year as income. The accumulated capital is tied up and cannot be used for larger purchases or a flexible lifestyle. And if a single person dies early, the unused balance remains with the pension fund rather than passing to the heirs.

What are the advantages of the lump sum?

The lump sum is the option of flexibility and personal responsibility. You receive the entire balance and decide yourself how to use it.

• Flexibility: you can use larger sums for residential property, travel, or supporting your family, and adapt your withdrawals to your needs.
• Ability to pass it on: whatever you do not use during your lifetime falls into your estate and passes to your heirs. With the pension, this is not the case.
• Return potential: if the capital is invested over the long term and broadly diversified, returns can be generated. This opportunity always carries an investment risk.
• Tax-favourable withdrawal: the capital is taxed once at a reduced rate, not every year as income.

Here too there are disadvantages: you bear the investment risk and the responsibility of making the capital last a lifetime. Anyone who spends too much too soon or invests unwisely may end up with too little in old age. There is no automatic protection against a very long life.

What is the mixed option of capital and pension?

Between the two extremes lies a third route: the partial withdrawal. Many pension institutions allow you to draw part of the balance as capital and convert the rest into a lifelong pension.

This combination unites the strengths of both options. The pension covers ongoing living costs and secures a guaranteed base income that, together with the AHV, covers your essential needs. The capital drawn is available for larger wishes, a reserve, or passing on to the next generation.

For many, the mixed option is the most pragmatic route, because it gives up neither full security nor full flexibility. Which split is possible, and in what steps, is set out in your pension fund’s regulations. Clarify this early.

How are the lump sum and the pension taxed?

The tax aspect is one of the most important differences between the two options and has a considerable effect on your available income in retirement.

• Pension: the retirement pension is taxed in full every year as income, at the ordinary progressive rate. It therefore permanently raises your taxable income.
• Lump sum: the capital drawn is taxed once, separately from ordinary income, at a reduced rate, known as the capital withdrawal tax. It is levied at federal, cantonal, and municipal level and varies considerably depending on your canton of residence, your municipality, and the amount.

The capital withdrawal tax is progressive: a withdrawal twice as large costs more than twice the tax. Anyone drawing a large sum anyway can ease the burden by spreading withdrawals from the 2nd and 3rd pillars across different tax years. This is because capital that you draw from your pension fund and Pillar 3a in the same year is combined for the calculation of the tax.

Which option is more favourable for tax cannot be answered in general terms. The one-off capital withdrawal tax is usually lower than the total income tax payable on the pension over the years. What is decisive, however, is your place of residence, the size of the balance, and your wider income and wealth situation. The tax treatment can change. This article is no substitute for tax advice or for an assessment by a financial professional.

Illustrative calculation example

The following example is for illustration only and is based on simplified assumptions. The actual figures depend on the pension fund, the canton, the municipality, your marital status, and your individual situation.

• Starting point: an assumed retirement balance of CHF 500,000, retirement at age 65.
• Pension: with a conversion rate of, for example, 5.0 percent, this yields an annual pension of around CHF 25,000, lifelong and taxed every year as income.
• Lump sum: the balance of CHF 500,000 is paid out in a single sum, taxed once at the reduced capital withdrawal tax, and thereafter managed under your own responsibility.

Which option delivers more over the whole of retirement depends, among other things, on how old you become and what return you achieve on the capital drawn. It is precisely this uncertainty that makes the decision so individual.

What is the conversion rate and what role does it play?

The conversion rate determines how much annual pension your accumulated retirement assets become. In the mandatory portion of the 2nd pillar, the statutory minimum conversion rate is 6.8 percent (source: BSV). CHF 100,000 of mandatory assets therefore yields an annual pension of CHF 6,800.

On the extra-mandatory portion of the balance, pension institutions may apply a lower rate. Many funds therefore use an enveloping conversion rate that combines the mandatory and extra-mandatory portions and is below 6.8 percent overall.

A lower conversion rate means a lower pension for the same capital. This makes the lump sum more attractive for some people, because the pension is less generous relative to the capital invested than it used to be. You will find the exact conversion rate of your fund on your pension certificate.

What deadlines apply to a lump-sum withdrawal?

Anyone who wishes to draw capital must register this in good time. The registration deadline is set out in the pension fund’s regulations and, depending on the institution, can be up to three years before retirement.

If you miss this deadline, you can no longer request a lump-sum withdrawal and will necessarily receive a pension. Clarify early which deadline your pension institution applies. For married couples, there is the added requirement that the written consent of the spouse must be obtained.

A further point concerns purchases into the pension fund: after a voluntary purchase, a three-year blocking period applies, during which the purchased capital may not be drawn as a lump sum without losing the tax advantage of the purchase. Anyone making a purchase shortly before retirement and wishing to draw capital should bear this period in mind.

What mistakes should I avoid when making the decision?

A few pitfalls can make the decision more expensive than necessary, or mean it cannot be carried out as intended:

• Deciding too late: anyone who misses the registration deadline for a lump-sum withdrawal automatically receives a pension. Clarify the deadline years in advance.
• Underestimating the tax consequences: if capital is drawn from the pension fund and Pillar 3a in the same year, the amounts are combined for the capital withdrawal tax and raise the progressive rate. Staggering over time reduces the burden.
• Ignoring longevity: with a lump-sum withdrawal, the risk of outliving the capital is real. Anyone in above-average health with a long life expectancy tends to benefit more from the pension.
• Overlooking the blocking period after a purchase: a purchase shortly before retirement can make drawing the purchased amounts as a lump sum disadvantageous for tax.
• Forgetting your partner’s consent: without the written consent of your spouse, a lump-sum withdrawal is not possible.
• Ignoring the bigger picture: the decision should take in the AHV, Pillar 3a, your other wealth, and your partner’s needs, not just the 2nd pillar in isolation.

Frequently asked questions about lump sum or pension

Lump sum or pension: which is better?

There is no universally better option. The pension provides a guaranteed, lifelong income and protection against a long life. The lump sum offers flexibility, the ability to pass it on, and return potential, but it requires personal responsibility and carries the risk that the capital may not last a lifetime. Which option suits you depends on your health, wealth, family situation, and the level of security you want.

How is a lump-sum withdrawal from the pension fund taxed?

The lump sum is taxed once, separately from ordinary income, at a reduced rate, known as the capital withdrawal tax. The amount depends on your canton of residence, your municipality, and the sum withdrawn, and it is progressive. The pension, by contrast, is taxed every year as income at the ordinary rate.

Can I combine a lump sum and a pension?

Yes. Many pension institutions allow a partial withdrawal: part of the balance is drawn as capital and the rest is paid out as a lifelong pension. This combines guaranteed income with flexibility. The exact options are set out in your pension fund’s regulations.

Am I entitled to a lump-sum withdrawal?

Under Art. 37 para. 2 BVG, you are entitled to draw at least a quarter of your mandatory retirement assets as capital. Many pension funds go further and allow a higher or full lump-sum withdrawal. Married couples and registered partners require the written consent of their partner (Art. 37a para. 1 BVG).

By when do I have to register a lump-sum withdrawal?

The registration deadline is set out in the pension fund’s regulations and, depending on the institution, can be up to three years before retirement. Anyone who misses the deadline can no longer request a lump-sum withdrawal. Clarify the deadline early with your pension institution.

What is the conversion rate?

The conversion rate determines how much annual pension your accumulated capital becomes. In the mandatory portion, the statutory minimum conversion rate is 6.8 percent (source: BSV). CHF 100,000 of mandatory retirement assets therefore yields CHF 6,800 in annual pension. On the extra-mandatory portion, funds may apply lower rates.

Continue reading in our journal:

• Retirement provision in Switzerland
• Pillar 3a payout
• BVG guide to the 2nd pillar