Using retirement money to buy real estate
Is it a good idea to use your second and third pillars to finance the acquisition of your primary residence?
When a foreigner (like I was) learns about swiss real estate, he gets two shocks. The first one is the prices: it’s almost impossible to get anything around a populated area for less than 500k. And the second is that he has to put at least 20% of the price down because the bank will only lend him up to 80% of the price. Which means that, unless he has 100k in cash or other liquid assets, buying a property in Switzerland is impossible.
But there is good news, says the banker, you may use your retirement money for that down payment!
Today, we are going to explore if using that retirement money is indeed a good idea or if there are better things to do.
But first, a few details that make all the difference:
1) You can only use the money from your second and third pillar if you’re buying your primary residence. That means that you can’t use that money if you plan to buy to then rent the property out. You can’t use that money to buy a chalet in the Alps either, unless you plan on living there most of the year.
2) Those 80% of the price the bank might lend you; those aren’t 80% of the asking price. They aren’t 80% of the negotiated price either. They are 80% of the estimated price. That’s the price the bank thinks the property is worth. Let’s use an example: you like a property put on the market for 1.1 million. But the bank believes that the property is only worth 1 million, so they will lend you 800k (80% of 1 million). Which means that you’ll have to come up with 300k (1.1 million – 800k) in cash to buy the property, not with 220k (20% of 1.1 million). That’s 36% more money.
3) Second pillar and third pillar money is not equal in the eyes of the banker. Money from your second pillar is “soft cash” and third pillar money is “hard cash”. It’s better to have hard cash than soft cash because the deposit can be hard cash only while it can be at most half soft cash. Let me explain: To finance those 300k we talked about above, you may use hard cash (from a savings account, from selling stocks, or from a third pillar account). But if you have 300k in your second pillar and nothing else, you can’t use all of it because it’s soft cash. You may use soft cash up to half of the deposit, but no more. That’s confusing isn’t it? At most, half of your deposit can be soft cash. It can be less, but it cannot be more. The rest has to be hard cash.
Ok, now that we have that down, we can start talking about using retirement money for the deposit.
The consequences of withdrawing the second and third pillars early
The first thing to know is that withdrawing your second and third pillars is a tax event. So you won’t get the full amount because part of it will go toward taxes. How much, you ask? Like everything in Switzerland, it depends on the canton. And it depends on how much you’re withdrawing. Note that the tax office doesn’t consider the withdrawals separately; they combine the amounts withdrawn from the second and third pillars. This little simulator will give you an estimate of the tax rate.
The second thing to know is that withdrawing your second pillar may affect your insurance coverage in case of accident or death. This aspect is specific to each pension fund, depending on how the coverage is set up. Some pension funds will reduce the benefits your family will get upon your death if the amount in the second pillar account is lower, but some won’t. Just ask your contact person to find out.
Third: if you’re using retirement money to buy the property and a few years later, you decide to move somewhere else for whatever reason, you have to “pay the money back”. You’re allowed to have your retirement money invested in real estate as long as it’s your primary residence. But as soon as it stops being your primary residence, you’re supposed to put in the money back in retirement funds. So, unless you have that money ready somewhere else, you can’t keep the house and rent it out: you will have to sell.
Fourth: if you withdraw from your second pillar, you won’t be able to make tax deductible extra payments into your second pillar until you’ve covered the hole made with the withdrawal.
Fifth: this one sounds obvious but… once you’ve withdrawn money from a second or a third pillar, the money isn’t there anymore. So whatever pension or capital you were entitled to get disappears. Make sure that you can survive with whatever is left.
A good idea?
Now, is it a good idea? Well, it depends if you have the choice. And by that, I mean: do you have the means to afford the deposit without using the money in your second and third pillars? If you do, great, keep reading! But if you don’t, well… then it’s simply a question of whether or not you want to buy the house. If you want to buy the house, then you’ve got to use that money, whether it’s a good idea or not.
So for what comes next, and using the example of the house on the market 1.1 million estimated by the bank to be worth 1 million, I’m going to assume that you have a stock portfolio of 300k, 200k in your second pillar, and 100k on a third pillar.
How to best combine those assets to come up with the 300k deposit?
That depends on how the money is invested. Stock portfolios might get 7% a year over the long run. But second pillars will only earn you 1 to 2% a year. Third pillars in cash will earn nothing while third pillars invested will perform like the underlying assets minus the fees.
So, to preserve the best performance, it would be wise in this case to “sell” the asset performing at 1% instead of selling the asset earning 7%.
As a general rule: always first sell the asset that performs worse. If you have 300k in a savings account, that’s your worst performing asset. And if, by miracle, you have a second pillar providing you with 20% interest annually, don’t withdraw your second pillar.
If that was me, I would try to use as much of the second pillar as I possibly can, because it’s the lowest performing asset. Then I would use the third pillar money invested in stocks because it’s performing less than the stock portfolio (because of the fees) and because it’s a good idea to lock in the tax gain. Then, finally, sell part of the stock portfolio because I have no other choice. To summarize: 150k from the second pillar (because soft cash can make up to 50% of the deposit at most), 100k from the third pillar, and 59k from the stock portfolio (wait, why 59 and not 50? Because of the taxes on the money withdrawn from the second and third pillars).
So, in the end, I would be left with 50k on my second pillar, no third pillar, and 241k in a portfolio of stocks. That’s not too bad. But can we do better? Wouldn’t it be great if my third pillar could still be invested in stocks?
A better way
There is a better way to structure this and it’s called pledging. The reason why banks will only lend 80% of the price is that they need guarantees. If you stop making payments, they’ll seize the property and sell it. And they’ll want to sell quickly so they’ll set a low price. They believe that a 20% discount is good enough to get a speedy transaction. But what if you would offer them other guarantees, like for instance, your third pillar account? Wouldn’t they agree to lend you more money? The answer is yes.
You can pledge your second and/or third pillars to the bank and in returns, they will lend you more money.
How does that work though?
Instead of selling your assets and invest the proceeds in the property, you can pledge your assets to them as additional guarantees. That means that the deposit can shrink from 20% to 10% or even less.
The assets that you bring won’t be considered at market value though, because the bank needs a margin of safety. Stocks are risky assets because their value can change a lot and rather quickly. So the bank will only consider 50% of their value. But bonds are much safer so the bank may consider 80 or 90% of their value.
In our example, the third pillar is invested in stocks so the bank with only take 50% of their value, which means that they will lend me 50k if I pledge the third pillar with 100k worth of stocks.
So instead of bringing 300k by selling 100k of the third pillar, I would bring 250k and pledge the 100k. And instead of borrowing 800k, I will borrow 850k. That will increase the interest payments but in exchange, I get to keep whatever interest my 100k will bring in the future. And I don’t pay taxes on the withdrawal since I’m not technically withdrawing any money.
Why stop there, you might ask? Why not pledge the second pillar as well? Well… it’s certainly possible, but it doesn’t make much sense in this case, because I would be borrowing at 1-2% to keep an asset producing 1-2%. It could make sense though if the insurance benefits are strongly dependent on the amount in the second pillar: if you don’t want to lose the benefits, you might as well pledge the account instead of withdrawing the money.
An important thing to know is that the amount pledged is supposed to be amortized. That means that it can’t stay interest only for all eternity.
We’ve covered a lot in this article:
Withdrawing from the second and third pillars has consequences: you will pay taxes, insurance coverage may change, you can’t rent the property out if you move unless you’re ready to pay back whatever amount you withdrew, you can’t make extra payments anymore, and you pension will be lower.
It might be a good idea though, especially if it lets you live in the house of your dreams. And it can be a good financial deal if you withdraw or sell the low performing assets (like the second pillar) and pledge the rest.
If you’re interested in getting more details about pledging, I would recommend this article.
And if you want to know more about swiss mortgage, consider reading The good, the bad and the ugly of swiss mortgages or the main reason why I will not become a home owner in the near future.