Last update: 17.09.2024 08:31
Discover how you can use indirect amortization to pay off mortgages cleverly and save taxes at the same time. Indirect amortization 3a offers many people attractive opportunities to optimize their finances. But how exactly does it work and for whom is it worthwhile? Use our calculator to find out how much you can benefit from indirect amortization 3a!
What is indirect amortization 3a of mortgages?
Indirect amortization is a method of repaying your mortgage in which you do not make the amortization payments directly to the bank, but instead pay your amortization installment into a pillar 3a account. This account is then pledged in favor of the lending bank and serves as collateral. It is said that your deposits amortize the mortgage “indirectly”: your saved capital remains in pillar 3a, grows there and is only used to pay off your mortgage “in one go” when it matures or in the event of an early withdrawal. Both the 1. as well as the 2nd mortgage can be amortized indirectly.
Our tip: do not amortize with a 3a policy
These are expensive and inflexible financial products. In our experience, such policies are very likely to generate lower returns than the interest you have to pay on your loan. Depending on your risk appetite, you are better off with a 3a savings account or a 3a securities solution.
How does indirect amortization 3a work in practice?
With indirect amortization with pillar 3a, you pay the maximum amount into a pillar 3a account each year instead of using this amount to pay off your mortgage. Martin, for example, lives in Bern and has a mortgage for CHF 500,000. Instead of transferring CHF 10,000 a year to his bank to pay off the mortgage, Martin pays the maximum annual pillar 3a amount into his pillar 3a account. The capital saved remains in the pillar 3a account and is only used to repay the mortgage when it matures or in the event of an early withdrawal. You can withdraw the 3a pension capital at any time to repay the mortgage, even before reaching the minimum age for regular lump-sum benefits from pillar 3a. Martin’s 3a capital therefore grows tax-free in the pillar 3a account until retirement or early withdrawal.
Our tip: Don’t wait until retirement to repay your mortgage
You can withdraw funds from pillar 3a every five years to pay off mortgage loans. You can make regular withdrawals from pillar 3a a few years before normal retirement age. To avoid an accumulation of capital withdrawals from 3a and occupational benefits, you should make your indirect mortgage amortization as early withdrawals before the regular 3a withdrawals.
What are the tax advantages of indirect amortization 3a?
With indirect amortization with pillar 3a, you benefit from multiple tax advantages:
- Tax deduction of deposits: You can deduct your annual pillar 3a payments in full from your taxable income.
- Retention of high debt interest deductions: As the mortgage debt is not repaid directly, the debt amount remains the same throughout the term. This means that you can continue to deduct the full amount of interest on the debt for tax purposes.
- Tax-free investment income: The income and interest generated by your pillar 3a assets are tax-free for the entire term.
The trick is that the mortgage is repaid at maturity with untaxed money, which is later subject to a capital payment tax when withdrawn for repayment, which is much lower than the progressive income tax. At the same time, you reduce your taxable income during the term of the mortgage by paying into the 3a account. This is why the solution is often more elegant than a direct amortization from free assets (=taxed money) or with money from the pension fund, because there is no loss of pension for you or your survivors and, unlike a withdrawal of pension fund money, repayment with money from pillar 3a does not lead to a land register entry with a restriction on sale.
Indirect amortization 3a is particularly worthwhile from a marginal tax rate of around 25 percent. Then the tax advantages outweigh the disadvantages, namely the double tax deduction (higher debt interest, tax deduction on the 3a deposit). We will come back to this in more detail in a moment.
Related content
Pillar 3a tax deduction – the ultimate guide!
What are the disadvantages of indirect amortization?
There are some risks and disadvantages to indirect mortgage amortization that you should consider.
A major disadvantage of this method is that the mortgage debt does not decrease over the entire term. This means that you will continue to have to pay high interest rates as the amount of the loan remains the same. In addition, the total debt remains over a longer period of time, which can lead to a higher overall burden.
Your payments into pillar 3a are also tied for the duration of the savings phase. Another risk is that the return on your pillar 3a investment may not be sufficient to repay the mortgage in full on maturity. This can be the case in particular if the markets fluctuate or the chosen investment strategy does not generate the desired returns.
In addition, the maximum amount of indirect amortization 3a is limited to the amount of the annual 3a payments. If you want or need to amortize more, it is best to combine direct and indirect amortization.
Our tip: amortize larger amounts via a pension fund
If you want to amortize larger amounts indirectly, you can also do this by making a purchase into the pension fund if you have purchase potential. And this is how it works: you withdraw your purchase amount as capital at the time of retirement and use the money to repay your mortgage.
In addition, the bank may require direct amortization when you renew your mortgage. This could happen if the loan-to-value of your property is too high, for example because the value of your property has fallen or the affordability has changed with your income (for example, because you earn less). This can jeopardize your original plans for indirect amortization.
After all, some people find it more important to continuously reduce their debts and perhaps even get rid of them altogether than to optimize their tax burden. If you belong to the “Peace of Mind” team, you’re better off with direct amortization.🤗
How can I reverse an indirect amortization?
You can cancel your indirect amortization by withdrawing your pillar 3a assets on a maturity date of your mortgage. This allows you to repay your mortgage in full or in part, depending on the amount of your 3a assets. According to Article 3 paragraph 3 BVV 3, you may withdraw pillar 3a funds for home ownership. This explicitly includes the repayment of mortgage loans. In this case, you can either withdraw the entire 3a account or only make a partial withdrawal. Only the partial withdrawal paid out is subject to capital withdrawal tax at the time of payment.
Note two important conditions if you want to cancel the indirect amortization. Firstly, an early withdrawal for home ownership promotion is only possible every five years. Secondly, a partial withdrawal is only possible up to five years before reaching the reference age – after that you must withdraw the 3a assets in question in full. The termination of the pension relationship then results in taxation of the corresponding benefit as a whole.
For whom is indirect amortization 3a worthwhile?
If you are able to make the maximum payments into pillar 3a, you can make the most of the tax benefits. This is especially true if you are in a high tax bracket and are looking for ways to optimize your tax burden.
Indirect amortization is also interesting if you cannot otherwise afford a pillar 3a with direct amortization – you would lose the 3a tax deduction in the case of exclusively direct amortization.
This form of amortization is also particularly suitable if you are pursuing a long-term investment strategy with shares. This allows you to invest more money in shares whose return in the past was higher in the long term than the cost of the mortgage interest. In other words, you are making a yield differential.
For the banks indirect amortization is always very advantageous. On the one hand, the bank can charge you more interest as a customer. On the other hand, the bank also earns from your pillar 3a – either through low interest from the 3a savings account or expensive fees for its 3a pension funds. This is because you often have to hold them at the same bank for indirect amortization. Only some banks allow indirect amortization with third-party providers. We believe that indirect amortization with the 3a can become a trap for you, where you pay more (fee) money for the bank’s 3a pension fund than you actually gain in tax savings on the higher amount of debt. So take a close look and do the math! 🧐
Find the best pillar 3a
Unbelievable – most people pay too much for their pillar 3a and get too little return. Are you one of them? Find out which pillar 3a is best suited to you with just a few clicks in our free comparison.
Is indirect amortization 3a worthwhile? Our calculator shows the facts
Let’s calculate indirect amortization 3a and use an example to show the advantage over direct amortization. We are talking about a mortgage of CHF 90,000 that is to be repaid in 15 years. With direct amortization, CHF 6,000 is paid to the bank each year at the end of the year. With indirect amortization, you pay an amount of CHF 6,000 into your 3a savings account, which earns interest at 0.8 %. The mortgage costs 2.0% and the marginal tax rate is 33%.
The calculation of the indirect amortization with our calculator shows that you are better off with indirect amortization - around 22,000 francs. This is mainly due to the fact that you can make tax deductions for your 3a contributions.
Is indirect amortization worthwhile for you?
Get our 3a amortization calculator free of charge and calculate with just a few clicks exactly whether and to what extent indirect amortization with pillar 3a is worthwhile for you.
Further FAQs on indirect amortization
What is meant by direct amortization?
With direct amortization, you regularly repay part of your mortgage directly to the bank. This allows you to reduce the loan amount on an ongoing basis and thus also reduce the annual interest on the debt. This method leads to a faster repayment of the mortgage, but you lose the opportunity to deduct interest from your taxes.
How does indirect amortization differ from direct amortization?
With indirect amortization, you do not repay your mortgage directly, but save in a pillar 3a account. The loan amount remains constant. You benefit from tax advantages through the payments into pillar 3a and can continue to deduct interest on debt from your taxes. With direct amortization, on the other hand, you regularly repay part of the mortgage, reduce the debt and thus the interest on the debt, but gradually lose the opportunity to deduct interest from your taxes.
What are the advantages and disadvantages of pillar 3a compared to pillar 3b for indirect amortization?
Pillar 3a offers several advantages over pillar 3b when it comes to indirect amortization. Payments into pillar 3a are deductible from taxable income and the income is tax-free during the term. In addition, the capital in pillar 3a is protected against seizure. The main disadvantage of pillar 3a is its limited flexibility, as deposits and withdrawals are subject to certain conditions. Pillar 3b offers more flexibility for deposits and withdrawals, but no tax advantages like pillar 3a.
What role does the personal tax rate play in the decision to opt for indirect amortization?
Your personal tax rate plays a decisive role in the decision to opt for indirect amortization. The higher your marginal tax rate, the greater the tax advantages of paying into pillar 3a. From a marginal tax rate of around 25 percent, the tax advantages outweigh the disadvantages.
What alternatives are there to indirect amortization with pillar 3a?
Alternatives to indirect amortization with pillar 3a include direct amortization and the use of pillar 3b. With direct amortization, you regularly repay part of your mortgage directly to the bank, which means that the mortgage debt and interest on the debt fall continuously. Pillar 3b offers more flexibility for deposits and withdrawals, but without the tax advantages of pillar 3a. Another alternative may be to invest in other forms of investment to build up capital that can later be used to repay the mortgage.
How does an early withdrawal from pillar 3a affect indirect amortization?
Early withdrawal of pillar 3a to amortize the mortgage is possible. Initially, the withdrawal is subject to capital payment tax, the amount of which varies depending on the canton. This reduces the amount effectively available for mortgage repayment. Amortization also reduces the mortgage debt, which leads to lower deductible interest and thus changes your tax situation.
Disclaimer
We have taken great care with the content of this article. Nevertheless, we cannot rule out errors and cannot guarantee that it is correct and complete. This article is not a substitute for advice. We do not offer investment or tax advice and recommend that tax issues are always clarified with an expert and/or the relevant cantonal authority. We accept no liability whatsoever.
