This chapter analyses the key aspects of the regulation, design and outcomes of Korean funded private pension arrangements. It describes the structure of the system, outlines coverage and contribution levels, explains the tax treatment of these arrangements and explores the trends in assets and how they are invested. It also analyses rules around solvency and funding and the design of the pay-out phase. It then discusses the market structure and competition, as well as fees and supervision. The chapter then explores aspects of public education and attitudes towards retirement savings. It assesses these elements against international standards and practices, identifying key challenges as options for reform. It discusses the key considerations when it comes to having complementary public and private pensions, and then discusses a potential framework Korea can adopt for assessing the adequacy of potential retirement incomes. The chapter concludes with policy options to address all the challenges flagged.
OECD Reviews of Pension Systems: Korea
5. Funded private pension arrangements in Korea
Abstract
Korea has a quasi-mandatory occupational pension scheme and a voluntary personal pension scheme that complement the mandatory public National Pension Scheme.
Ensuring greater reliance on complementary pension schemes is a good way to boost incomes from the public system and diversify sources of retirement income. However, to better serve this complementary role, the take‑up of the schemes should be improved. As discussed in this chapter, this can be achieved by increasing the use of retirement pension plans available in the workplace, making private pension schemes more financially attractive, and improving public understanding about saving for retirement.
5.1. Structure of private pension arrangements
5.1.1. Types of private pension arrangements
The Korean funded private pension system has two main components: a quasi-mandatory retirement benefit system accessed through employment (2nd tier) and a voluntary personal component (3rd tier) (Table 5.1).
Table 5.1. Structure of the funded pension system in Korea
Under the Korean occupational benefit system, employers have to either provide a severance pay plan or a retirement pension plan to their employees. Severance pay plans are not retirement pension products since they are paid to employees when they leave their employment, which may not be at the point of retirement. Retirement pension plans are occupational pension plans designed to be alternatives to the traditional severance pay schemes. They provide members access to retirement income at the retirement age and include Defined Benefit plans (DB), Defined Contribution plans (DC), and Individual Retirement Pension plans (IRP).
An employer has to at least provide every employee a severance pay plan, but the company can instead set up a retirement pension plan. To set up a retirement pension plan, an employer needs to obtain the consent of a trade union if there is one joined by the majority of employees, and if there is not, obtain the consent of the majority of employees.1 Occupational pension plans are therefore considered quasi-mandatory in Korea. As at 2019, 27.5% of workplaces in Korea had retirement pension plans for their employees.2 If retirement pension plans have been selected, employers should prepare a covenant with the consent of their employees’ representatives and submit the covenant to the Minister of Employment and Labour for approval (Financial Services Commission and KDI School of Public Policy and Management, 2014[1]). Once it is approved, employers enter into a contract with external retirement pension providers.
Employers providing severance payments to their employees can hold book reserves and administer assets in-house. Employers have traditionally had book reserves for their severance payments, as advance funding is not required. A reform in 1997 allowed employers to outsource the administration of assets to insurance companies (in retirement insurance plans) or banks and asset management companies (in retirement trusts), thereby funding their liabilities.3 However, it has not been possible for new members to access retirement insurance plans or trusts as of 1 December 2005 as per the Employee Retirement Benefit Security Act (ERBSA).4 As such, retirement insurance plans and retirement trusts have lost prominence. Retirement insurance plans and trusts stopped operating at the end of 2010. Most severance pay plans (about 75% of severance pay liabilities) continue to be based on unfunded book reserves.5 Benefits are typically paid out as lump sums, but annuitisation is possible. Employers participating in the severance payment system can still switch to retirement pension plans.
IRP plans were initially introduced for employers to transfer accrued retirement benefits to an individual’s own account once the employment relationship ends, but now they serve additional purposes. An IRP plan can take two forms: an individual IRP plan and a corporate IRP plan. When an employee participating in a DB or DC plan leaves their job, an employer must transfer any accrued retirement pension plan assets from that employee’s DB or DC plan into an individual IRP account. Amendments of the Enforcement Decree of the ERBSA in 2017 also allowed self-employed people, workers with less than one year of service, part-time workers, public officials and members of the armed forces to open an IRP plan.6 Furthermore, if an employer with 10 or fewer employees establishes an IRP, s/he is deemed to meet the employer’s obligation to establish a retirement pension plan for his or her employees. In this case, the IRP is referred to as a business type or corporate IRP.7 The employer’s obligations under a corporate IRP are comparable to a DC plan, although corporate IRPs have softer administrative requirements.8 Of the individuals with IRP plans in 2019, the self-employed comprised 45.8%, workers under retirement pension systems comprised 32.8%, individuals under special occupational pension plans (e.g. civil servants) comprised 16.4%, and individuals who worked on average less than 15 hours per week comprised 5.0%.
Individuals in Korea have been able to save in voluntary personal plans since 1994. There are three main types of personal pension plans: personal pension insurance, pension savings trust, and personal pension funds. However, new enrolments in personal pension trusts have been suspended since January 2018. Pension providers are able to provide any type of personal pension plan to their members.
5.1.2. Private pension providers
To conduct pension business in Korea, whether personal or occupational, an entity has to be one of the following: a bank, an investment company, an insurance company, a credit union, a Korean Federation of Community Credit Co‑operative, or the Korea Workers’ Compensation and Welfare Service (KCOMWEL).9 A retirement pension provider must be registered as either an investment manager or an asset manager, but most providers are registered as both. Investment managers are responsible for providing employers or policyholders with methods of managing reserves and information on each management method, designing a pension plan and conducting pension accounting (in the case of a DB pension plan), recording the state of reserves, informing asset managers of the management method instructions, and training subscribers. Asset management providers set up and manage an account, receive contributions, keep and manage reserves, implement instructions related to the management of reserves which are given by an investment manager, and pay benefits (Financial Services Commission and KDI School of Public Policy and Management, 2014[1]). Unlike other providers, the KCOMWEL can only conduct investment management work and cannot engage in asset management. It can also only offer DC pension plans to workplaces with 30 or fewer workers.
Plan providers do not differ significantly in terms of the plans they provide and investment management work they do, but there is a difference in terms of their asset management work. Banks, securities firms and insurers can handle different products because of the difference in their asset management contracts. Banks and securities firms (including some insurers) can act as trustees and are required to sign trust contracts, while insurers enter into an insurance contract-type asset management contract. Trustees can invest in various products such as deposits, instalment savings, funds, and derivatives, while insurance type contracts mean the providers are restricted to their own insurance products. Insurers, however, may use separated accounts to invest in dividend-oriented fund products.
5.2. Coverage
Compared with other OECD countries’ quasi-mandatory or voluntary occupational plans, coverage of funded occupational pension plans (the retirement pension plan) was somewhat low in Korea in 2018, at around 17% of the working age population. While high coverage is not common in complementary occupational pension schemes across the OECD, Korea’s coverage rate remains on the low side compared to other OECD countries with voluntary or quasi-mandatory occupational plans (Figure 5.1).
Figure 5.1. Coverage of quasi-mandatory and voluntary occupational plans in selected OECD countries, 2018 or latest year available
Note: Countries were selected for inclusion in the chart if their occupational systems were either voluntary or quasi-mandatory, in Korea. QMO = Quasi-mandatory occupational. RPP = Registered Pension Plan.
Source: Pensions Markets in Focus 2019, Korean authorities.
Take‑up of retirement pension plans among the working-age population is somewhat low for a number of reasons. Coverage requirements exclude some workers for both severance pay as well as retirement pension plans, but there are also many reasons why businesses have not fully transitioned to the retirement pension system.
There are a number of exceptions to coverage requirements. Workers whose consecutive service period is less than one year and workers whose average weekly working hours over a four‑week period is less than 15 hours are not required to be covered by either the severance pay nor retirement pay schemes.10 This coverage rule derives from a legacy issue, as severance payments and pensions originally served the purpose of rewarding tenure. However, the current objective of the retirement pension system should be geared towards preparing employees for retirement, rather than rewarding tenure. As such, there is a case to review this rule, and indeed, a bill is before parliament to widen coverage, although it has not passed the legislative assembly. Under the proposed amendment, all employees with a consecutive working period of one month or more, regardless of their contractual work hours, would be mandatorily subject to the retirement benefit system.11 Passing this legislation would bring Korean retirement pension plans in line with Core Principle 8 of the OECD Core Principles of Private Pension Regulation, which stipulates that: “regulation should aim to prevent unreasonable exclusions from plan participation such as period of service and terms of employment (e.g. distinguishing between part-time and full-time employees)”.
Furthermore, workers who are employed in a special employment form and do not fall under the category of employees defined under the Labour Standards Act are not covered by retirement pension plans. While these workers can access pension plans through the personal pension system, the system does not offer strong incentives for saving for informal workers who do not benefit from tax breaks. Furthermore, self-employed workers, who are not employees, are not eligible for retirement pension plans, which are designed to be offered through an employer. While self-employed people have been able to access IRPs voluntarily since a legislative change in 2017, joining is at the discretion of the self-employed worker and does not come with the same contribution requirements as for standard retirement pension plans. Governments can offer dedicated retirement savings products to cater to non-standard workers such as the self-employed. Such products can include those that allow flexibility of contributions and ease of access.
There are reasons why both employees and employers might resist a switch to retirement pension plans in the workplace. If either party opposes the transition, this can prevent the switch, since it relies on mutual agreement between them.
Some employees favour severance payments as they can access pay-outs earlier and because the severance payment scheme historically offered a better deal than retirement pension plans. For instance, if employees reach a deal with their employer, they can access their severance pay benefit even before the employment period ends, as part of an interim settlement. While early pay-outs from retirement pension plans are also permitted, eligibility conditions apply. There is also an argument that severance pay schemes have at least historically been a better deal for employees. Severance pay is a function of wages in the final year of work, and could offer a higher pay-out than the accumulated value of contributions under a DC plan. Historically, wages grew at generally higher rates than the investment returns from retirement pension plans, which tend to be invested conservatively in Korea, making pay-outs from severance schemes a better deal. While this may no longer be the case in Korea, it has slowed the transition period.
There are also reasons why employers might resist a switch to retirement pension plans. Some employers prefer the ability to defer cash contributions to the point of employment termination under the severance pay system despite a tax incentive to switch to retirement pension plans.12 Firms offering severance pay schemes are only required to have book reserves for their liabilities, and are not required to fund them. However, should they switch to offering retirement pension plans, they would be required to transfer the accrued liabilities to a pension provider. Some have raised concerns that having to produce the capital to fund these liabilities for all employees at once may lead to significant cash flow problems for some employers.
In general, smaller businesses have resisted the transition to retirement pension the most (Figure 5.2). Larger firms are more likely to offer occupational plans to their employees (about 86% of firms with over 100 workers offer retirement pension plans). However, the 100‑299 and >300 employee categories comprise less than 5% of firms combined. Most workplaces have fewer than 10 employees, and less than 20% of them offer retirement pension plans. This is why, overall, only 27% of workplaces offer retirement pension plans to their employees, while 51% of eligible workers were covered by retirement pension plans in 2019. The main reason smaller businesses resist transitioning to retirement pension plans is that they would face relatively greater cash flow challenges in having to fund their outstanding pensions liabilities, compared with larger businesses. Smaller businesses also tend to benefit less from the tax advantages of offering retirement pension plans, compared with larger businesses. Therefore, the incentive for them to replace the severance pay system is smaller.
Figure 5.2. Percentage of firms offering occupational plans by size, 2019
Source: Website of the Korean Ministry of Employment and Labour: https://www.moel.go.kr/pension/statistics/year.do.
Notwithstanding the challenges, the Korean Government is considering mandating a full transition from severance pay schemes to retirement pension plans. There is a bill currently before the national assembly which would require all employers to set up retirement pension plans gradually.13 The transition would happen by business size, with the smallest businesses having to switch to retirement pension plans by 2027. The rationale for the transitional phase is to help ensure smaller businesses prepare financially for the transition.14
Implementing this proposed shift in favour of universal retirement pension plans would be a good way to improve the adequacy of retirement incomes in Korea. The current proposal’s transition period will help address the financial burden smaller businesses might face. Furthermore, some representatives of employer groups have already stated that firms, including small and medium enterprises, have had enough time to prepare for these reforms. As such, unless there is strong resistance to this change from small businesses, the Korean Government should consider a renewed push to pass the proposed law through its parliament. If there remains strong resistance to change, a next best option is for smaller businesses to be subject to a transition period that allows them to gradually increase their funding status (such as by 20% every year). This will avoid a situation of significant financial outlays at one time. Should such an approach fail, a second-best option could be that the government mandate retirement pension plans for all new employees or for all new businesses. This option would mean that eventually all workers will have retirement pension plans. But in the interim, there will remain a generation of workers subject to system that leaves them with lower income for their retirements than the subsequent generation.
Smaller employers may face administrative difficulties in introducing retirement pension plans. There is some concern that smaller employers find it difficult to set up and administer retirement plans for their employees. The Korean Government has tried to address this issue by making it possible for business IRPs to qualify as occupational plans for firms with fewer than 10 employees, reducing reporting requirements. Furthermore, there is evidence that smaller businesses are sometimes unable to access pension products because providers prefer larger pots to manage. As such, one solution is for the government to set up multi‑employer plans, which pool the assets of pension plans established by various plan sponsors. Such an arrangement has already been proposed by the Employee Retirement Benefit Security Act submitted to the National Assembly in July 2020. Those amendments propose the creation of a Small Business Retirement Pension Fund System (SBRPF), which forms and manages a joint fund financed by contributions from more than two employers and employees in small businesses. The SBRPF’s operation would be overseen by the Korea Workers’ Compensation and Welfare Service which would run a Fund System Operation Committee. The Committee’s role would be to decide on the general operation of the system, including a fund management plan. The Committee would be composed of representatives of employers and employees. Furthermore, a company with 30 or fewer employees would be financially supported for contributions paid by an employer and part of retirement pension fees, while being provided with reasonable services of public asset management and training. The National Assembly recently passed a bill amending the Employee Retirement Benefit Security Act and introducing the SBRPF system. This reform is a positive step in favour of increasing retirement pension plan coverage of employees in small businesses, and would likely improve the take‑up of those plans.
As is the case for retirement pension plans, personal pension plan coverage in Korea is less than average for OECD countries. Personal plan coverage is among the lowest of OECD countries, at around 14% of the working age population. This is significantly lower than the OECD average of 26% (Figure 5.3). There are also no signs that pension plan coverage improved over the three most recent years for which data is available, as the coverage rate remained stable at around 14%.
Figure 5.3. Coverage of voluntary personal pension plans in selected OECD countries, 2018 or latest year available
Source: OECD Pensions Markets in Focus 2019, Global Pension Statistics; Korea Federation of Banks (Korea).
Of the people with personal pension plans, the majority are higher income earners and men. The data shows that more than half of personal pension plan holders earn more than 80 million won per year (Table 5.2). Males also represent the majority of personal pension plan membership, at 70.5% as at 2018. It is also important to note that the total value of assets held in personal plans are higher than those in occupational plans, indicating that greater savings are being directed into these vehicles by the people who have them. The earlier introduction of personal plans (in 1994 as opposed to 2005 for occupational plans) could explain that they hold more assets. However, it could also reflect that personal pension plans are used toward tax planning by higher wealth individuals.
Table 5.2. Share of personal plans by income groups, 2018
Source: 2018 Statistical Yearbook of National Tax.
5.3. Contributions
The minimum employer contribution to DC retirement pension plans is 1/12 of an individual’s pay. Employees can voluntarily contribute more to the DC plan, but total contributions cannot exceed 18 million won a year (about EUR 14 000).
Contributions by employers to DB retirement pension plans vary depending on the outcome of valuations, which are the responsibility of the financial institution providing the pension. The law states that contributions should be sufficient to provide a participant at retirement a prorated amount equivalent to average wages earned for 30 days for each year of his / her continuous service. A recent bill which is expected to come into effect on 14 April 2022 also means that authorities can impose fines when the contributions to the DB retirement pension plan made by an employer fall short of the statutory level.
Average contributions to retirement pension plans represent about 21% of the average wage in the economy and personal pension plans represent 7% (Table 5.3). Contributions to retirement pension plans are somewhat high compared to average incomes, particularly since the mandatory contribution rate to occupational plans is 8.3%. This suggests that higher income individuals might be benefitting more from retirement pension plans than lower income people.
Table 5.3. Average contributions to occupational and personal plans, 2015
Note: The most recent GPS providing detailed information about membership of occupational plans was 2015.
Source: Global Pension Statistics, 2015.
5.4. Tax treatment of retirement pension plans and personal pension plans
Table 5.4 summarises the tax treatment of different components of retirement savings, by the source of contributions.
Table 5.4. Tax treatment by source
Note: T = Taxed; E = Exempt (usually up to a limit); credit = Tax credit. Individual contributions can be to either retirement pension plans or personal pension plans.
Source: OECD (2019[2]), Financial incentives for funded private pension plans, OECD Country Profiles, http://www.oecd.org/daf/fin/private-pensions/Financial-Incentives-for-Funded-Pension-Plans-in-OECD-Countries-2019.pdf.
Individual contributions to DC retirement pension plans and personal pension plans are taxed at the individual’s marginal tax rate but benefit from a tax credit.15 The tax credit is equal to 13.2% of the individual’s contributions, but low income individuals get a higher rate of 16.5%.16 However, this tax credit is not refundable (i.e. it reduces the tax due to 0 at the maximum), so it would not provide a significant tax benefit to low income individuals who are liable to pay low or no tax. The maximum amount of contributions that attract a tax credit varies between KRW 4 million (equivalent to about 9% of the average income in Korea) and KRW 7 million (equivalent to about 15% of the average income in Korea) depending on the mix of contributions to personal and occupational plans.17 The limit is KRW 4 million a year if the individual only contributes to a personal plan (excluding IRPs), and an extra KRW 3 million is available to IRP members, bringing the total eligible contributions to KRW 7 million. A recent tax amendment further increased the KRW 7 million limit to KRW 9 million for contributions to IRPs for people aged over 50 to encourage them to contribute more to catch up. The limit is KRW 7 million a year if the individual only contributes to an occupational DC plan. If the contributions are a mix of the two, the limit is somewhere in between, depending on a formula. An additional tax credit may be applied when deposits of an individual savings account (ISA) reaching maturity are transferred to a pension account. In this case, the tax credit would equal 10% of the transferred amount (up to KRW 3 million). Individual contributions to occupational DC pension plans and personal pension plans cannot exceed KRW 18 million a year (EUR 14 000 or about 40% of the average income in Korea).
Employer contributions to retirement pension plans are not treated as taxable income for the employee. The minimum rate for employer contributions in defined contribution plans is 1/12 of the employee’s total annual salary. The tax system provides an incentive for employers to offer their employees retirement pension plans rather than severance payments. Employer contributions into retirement pension plans are tax deductible from corporate tax. Moreover, charges for the Wage Claim Guarantee Fund are reduced by up to 50% if employers set up corporate pension plans rather than severance payment schemes.18
Returns on investment are not taxed and there is no ceiling on the lifetime value of private pension funds.
The taxation of pension income depends on the source of the originating contribution and whether the individual chooses a lump sum or an annuity.19
Table 5.5. Tax treatment of pension income by source and pay-out type
Note: For a fixed-term annuity, the tax rate varies with the age of the annuitant (5.5% below age 70, 4.4% between 70 and 80, and 3.3% above 80). For a lifetime annuity, the tax rate varies as well (4.4% below age 80 and 3.3% above 80).
Source: Summarised from OECD (2019[2]), Financial incentives for funded private pension plans, OECD Country Profiles, http://www.oecd.org/daf/fin/private-pensions/Financial-Incentives-for-Funded-Pension-Plans-in-OECD-Countries-2019.pdf.
If the income started as an employer contribution, the tax treatment depends on which pay-out option chosen. In either case, first the tax base is calculated based on a formula that shrinks the base with more years of work.20 The total tax paid for income taken as a lump sum is calculated with reference to another formula based on marginal tax rates.21 If income is taken as an annuity, the tax payable is 70% of the tax that would be payable on a lump sum, or 60% if the pensioner’s entitlement period exceeds 10 years.
If the income started as an employee/individual contribution, the tax treatment again depends on which pay-out option is chosen. If the individual takes a lump sum, the tax treatment depends on whether the contributions already benefited from a tax credit or not. If contributions did not exceed the maximum set for the calculation of the tax credit (Table 5.5), the lump sum is taxed at the rate of 16.5% (including local income tax). By contrast, contributions that did not attract a tax credit (for example, if contributions in a given year exceeded the contribution limit that attracts a tax credit), they can be withdrawn tax free.
If the individual purchases an annuity, the tax treatment depends on the level of total pension income (including public pensions). If total pension income is below KRW 12 million, the individual can choose separate taxation. For a fixed-term annuity, the tax rate varies with the age of the annuitant (5.5% below age 70, 4.4% between 70 and 80, and 3.3% above 80). The tax rate of a lifetime annuity varies as well with the age of the annuitant (4.4% below age 80 and 3% above 80). On this basis, the tax benefit from taking an annuity compared to a lump sum is between 11% and 13.2%. If total pension income is above KRW 12 million, the aggregate taxation of the combined amount of total private pension income and other income applies.
Examining Korea’s occupational and personal pension plans with comparable plans in other countries again shows that the tax advantage offered is lower in Korea than in comparable systems. Figure 5.4 shows that the tax advantage for an average income earner offered by retirement pension plans compared with voluntary and or quasi-mandatory occupational plans in other OECD countries. Korea is among the countries with the lowest tax advantage. A higher tax advantage would increase the relative value of retirement pension plans compared with severance pay schemes, but it is possible that the advantage offered may not enough to induce enough people to want to replace the severance pay system. Figure 5.5 again shows that Korea is on the lower side when compared with other countries with voluntary personal pension plans.
Figure 5.4. Tax advantage from occupational pension schemes for countries with quasi-mandatory or voluntary schemes
Note: Calculations based on the 2018 tax treatment of the main occupational pension plan in each country. Where ranges are included, that reflects different types of plans.
Source: Based on Table 3.2 of OECD (2018[3]), Financial Incentives and Retirement Savings, https://doi.org/10.1787/9789264306929-en.
Figure 5.5. Tax advantage from private pension schemes in countries with voluntary schemes
Note: Calculations based on the 2018 tax treatment of the main private pension plan in each country. Where ranges are included, that reflects different types of plans.
Source: Based on Table 3.2 of OECD (2018[3]), Financial Incentives and Retirement Savings, https://doi.org/10.1787/9789264306929-en.
The tax system in Korea is complex, but reform to its structure should be considered as a medium-term goal rather than an urgent goal. Complexity can be a strong deterrent to utilisation. The rules around pension tax are difficult to understand, and a different treatment applies if the contributions originated from the employer (EET/EEt) or the individual (tEt/tET). There is room to simplify the tax system, since people need to understand the tax benefits of saving in retirement plans in order to encourage their use. But Korea has already recently reformed its pension tax system, and frequent change can also deter use. As such, any reforms to simplify the system structure should be considered as a medium term goal. In the more immediate term, to improve the attractiveness of retirement pensions and personal pensions, the Korean Government can consider parametric change within the existing structure. Such changes can include increasing the tax credit rate for individual contributions or amending the formulas to reduce the tax on pay-outs.
Changes to pension tax settings can also address more bespoke shortcomings in the pension tax system, such as inequality of tax benefits and incentives to select lump sums over annuities.
The current policy settings do not appear conducive to encouraging personal pension plans among low income people. Overall, the pension tax system delivers a tax advantage of around 20% for individuals on average earnings, but less than 10% for low income earners at 60% of average savings (Figure 5.6).22 This is significantly lower than the tax advantages offered to lower income earners in other OECD countries. Furthermore, in Korea, the tax advantage enjoyed by higher income earners (those earning four times the average wage) is significantly higher than the average, making the tax benefits to private pensions unequal. While some other OECD have similar structures, most offer relatively similar overall tax advantage to different income groups.
Figure 5.6. Overall tax advantage for contributions, by income level
Note: Calculations based on the 2018 tax treatment of the main pension plan in each country. In Korea, the chart shows the tax advantage based on contributions to occupational pension plans.
Source: Based on Figure 3.9. of OECD (2018[3]), Financial Incentives and Retirement Savings, https://doi.org/10.1787/9789264306929-en.
The Korean Government could consider, at the very least, measures that improve financial incentives for lower income people saving for retirement. This is both to encourage voluntary saving but also to improve the adequacy of their potential retirement income. Low income people, especially those who do not pay tax or who pay little tax, currently have little incentive to use the plans. This simply exacerbates what is often a pre‑existing reluctance to forego short term liquidity in the face of limited finances. As such, the government should consider introducing non-tax financial incentives, which are payments made by the government directly into the pension account of eligible individuals. They can take the form of matching contributions or fixed nominal subsidies. Matching contributions involve the government contributing an amount that is equal to or proportional to an individual’s own contribution, usually up to a nominal ceiling. Fixed nominal subsidies involve the government contributing a fixed amount to an individual’s account when the individual makes a personal contribution, Subsidies are designed to attract low-income earners as the fixed amount represents a higher share of their income and are easy to understand.23
Non-tax financial incentives are better tools to encourage retirement savings among low income earners for several reasons. Non-tax incentives are not linked to the individual’s tax status, making them attractive for all individuals. Furthermore, non-tax incentives are automatically saved into the pension account, while this would not be the case with the tax incentives in the Korean system. That is, individuals eligible for a tax credit may not save the value of the tax incentive in the pension account if they do not increase their after-tax contributions in anticipation of the receipt of the tax refund. Fixed nominal subsidies and matching contributions provide a higher overall tax advantage to low-income earners as the value of the subsidy represents a higher share of their income. In OECD countries that use non-tax financial incentives, the incentives are seen as a complement to tax incentives, so that all income groups get an overall tax advantage when contributing to a supplementary funded pension scheme, with an extra encouragement for low-income earners (OECD, 2018[3]).
5.5. Assets and investment
5.5.1. Assets
Assets in the Korean funded pension system have been growing over the last decade (Figure 5.7). While they accounted for 8% of Korea’s GDP at the end of 2009, pension assets represented close to 30% of GDP ten years later. Nonetheless, pension assets remained below the OECD total (92% of GDP) at the end of 2019.
Figure 5.7. Total assets in retirement savings plans, in 2009 (or first year available) and 2019 (or latest year available)
Note: The charts show the evolution of assets in retirement savings plans between 2009 and 2019, except for Finland (2011‑19), Lithuania (2010‑19) and Switzerland (2013‑19). The totals are calculated as the sum of all pension assets (in USD) over the sum of all GDPs (in USD) of all reporting jurisdictions. The number of reporting countries differs between the beginning and the end of the period, but this has only a marginal effect on totals.
Source: OECD Pension Markets in Focus 2020.
This increase is the result of the rise in assets in retirement pension plans (Figure 5.8), coupled with a rise in assets in voluntary pension plans (Figure 5.9). Assets in all types of retirement pension plans (DB, DC, and IRP) have increased since the introduction of these plans. DB pension plans are the main type of retirement pension plan, with assets amounting to KRW 154 trillion (i.e. 60%) of all assets in retirement pension plans (KRW 255 trillion). However, a gradual transition may be underway as DC and IRP plans have been gaining prominence and outpacing DB plans in terms of asset growth since 2011.
Figure 5.8. Assets in retirement pension plans, 2005‑2020
Source: FSS.
Figure 5.9. Assets in voluntary personal pension plans, 2010‑18
Source: OECD Global Pension Statistics.
5.5.2. Asset allocation
Pension assets are invested more conservatively in Korea than in most other OECD countries. The proportion of assets that pension providers in Korea invest in performance‑dividend type products is one of the lowest in the OECD (Figure 5.10). By contrast, guaranteed interest products (such as government bonds and deposits) account for most of the investments of Korean pension providers. The Korea Deposit Insurance Corporation protects deposits and guaranteed interest contracts.
Figure 5.10. Allocation of assets in funded and private pension plans in selected asset classes and investment vehicles, 2020 or latest year available
Note: “CIS” means collective investment schemes.
Source: OECD Pension Markets in Focus 2021.
Employers setting up DB plans decide how to invest pension assets. They mainly choose to invest in guaranteed interest products, favouring the security that these products offer over the potential of investment income that riskier investment strategies could bring (Table 5.6). Returns that guaranteed products can offer may be limited in a context of low interest rates.24
Table 5.6. Asset allocation of retirement pension plans in Korea, by type of plan, 2020
As a percentage of total assets
Source: Retirement Pension Statistics for 2020.
Members can choose their own investment strategy for occupational DC and IRP plans, and are able to change the choice of investment strategy at least once every half-year.25 At least three operating methods with different risk and return structures shall be suggested to the participant at least once every half-year. One of the options should guarantee members that they will get back their contributions with interest.26 This option may be popular among plan members as 65% of assets in individual IRP plans and nearly 80% or more in DC and corporate IRP plans were invested in guaranteed interest products at the end of 2020. Investment strategies that retirement pension trustees offer should be in line with the operating methods and standards prescribed by Presidential Decree. Until recently, there had not been any default investment option for members unwilling or unable to choose one when they joined a DC or an IRP plan. However, a bill passed in December 2021 to introduce a default option.27 The legislation for the default option is expected to be finalised by June 2022 at the latest. The default option could only be based on investment vehicles that suit long-term investments – such as target date funds, money market funds and funds investing in infrastructure – and guaranteed-interest products. A default option such as a target date fund would be a suitable option to yield good investment returns while protecting people against severe value losses immediately prior to retirement.
Members shall be provided information to choose a method of operating reserves, such as information on the risk and return potential of each product or operating method. The retirement pension trustee is required to provide individuals with information on investment strategies that are readily obtainable and understandable. The law provides that the methods of and procedures for evaluating the performance of asset management shall be transparent.28
The investment operations of pension assets shall be implemented within the investment limits set by the Ministry of Employment of Labour (MoEL). While there is no restriction on investments in guaranteed assets such as high-grade government bonds, the current legislation sets a 70% limit on investments in a list of eligible risky or non-guaranteed assets for DB, DC and IRP plans (Table 5.7). This list includes corporate bonds, unit trusts, and real estate investment trusts (REITs) for all retirement plans.29 Listed equity and private equity funds are also part of the eligible risky assets, but for DB plans only. Investment in some other risky assets, such as government bonds rated below BBB- and unlisted equity, are fully prohibited for all occupational plans. Investment in derivatives are only allowed for hedging purposes.
Table 5.7. Investment restrictions for pension providers by type of plan
Note: There is no limit on investments in funds with less than 40% in equity nor in target date funds.
Source: OECD Annual Survey of Investment Regulation of Pension Funds and Other Pension Providers, FSS and MoEL.
Korea has loosened investment restrictions for occupational pension plans recently. Investment limits in risky assets were raised to 70% in 2015. REITs listed on regulated markets have been considered an eligible risky investment since 2018 for DB plans, and since 2019 for DC plans and IRP. Following amendments to the Regulations on Supervision of Retirement Pension Plans in September 2018, deposits and savings of mutual savings banks have been considered as guaranteed assets and the 70% limit on investment in target date funds meeting the standards set by the FSC has also been eliminated (FSS, 2020[4]).
However, the limits that remain may still not be justified, as they might encourage conservativism. Particularly DC and IRP plans are not permitted to invest in listed equities, which may not be in line with the OECD’s Core Principles of Private Pension Regulation that advise diversification of investment. Diversifying investment allocation helps to mitigate risks relating to specific asset classes, such as the risk of low returns due to lower interest rates.
5.5.3. Investment performance
Voluntary personal insurance contracts in Korea have recorded a positive investment rate of return on average over a 15‑year period between December 2003 and December 2018, close to 2% (Figure 5.11). However, this performance is amongst the lowest, below the simple average among reporting OECD countries (2.3%).
Figure 5.11. Real geometric average annual investment rates of return of funded and private pension plans over the last 15 years
Note: Data for Korea refer only to voluntary personal pension insurance only.
Source: OECD Pension Markets in Focus 2019.
Voluntary personal insurance contracts achieved relatively stable real investment rates of return between December 2003 and December 2018 (Figure 5.12). Outcomes ranged between ‑1.5% (recorded in 2008) and 5.2% (recorded in 2009). They failed to achieve positive investment return only twice in 15 years, in 2008 and 2011. However, they reached returns above 5% only once, which top performers in the OECD area usually manage to exceed.
Figure 5.12. Real annual investment rates of return of voluntary pension insurance plans in Korea and pension providers in the OECD, 2003‑18
Note: “Min” and “Max” show the lowest and highest real investment rates of return of pension providers in the OECD area. Countries recording the minimum and maximum real investment rates of return vary over the years. Data for Korea refer to voluntary personal pension insurance contracts only.
Source: OECD Global Pension Statistics.
The investment rates of return of occupational pension plans were also relatively low and stable over the last years, ranging between 1% and 2.6% between 2015 and 2020 (Table 5.8). This stable low investment performance was visible across the board, whether the investment decision belonged to employers (in the case of DB plans) or individuals (in the case of DC and IRP plans). Investment performance was also relatively stable, low and comparable across retirement pension providers, although financial investment companies, investing more in non-guaranteed products than other providers, tended to outperform (e.g. in 2017 and 2019) or underperform (in 2018) depending on how stock markets fared. Financial investment companies have historically achieved higher rates of return over the long-term than other providers, above 3% on average over the last ten years (FSS, 2020[4]).
Table 5.8. Investment rates of return of occupational plans, 2015‑20
In percent
Note: “.” means missing.
Source: FSS.
The high proportion of assets invested in guaranteed products ensures the stable and positive investment returns of pension providers in Korea, but also exposes them to risks related to low and falling interest rates. Guaranteed products provide a stable source of income. However, long-term interest rates have been falling in Korea (from 5% in 2003 to 1.7% in 2019), making it more difficult to achieve high investment returns with newly-issued government bonds yielding less than maturing ones.30
The relatively high proportion of assets invested in guaranteed products mirrors a public preference for guaranteed products and the preservation of initial investments (Kim, 2018[5]). This preference is compounded by a lack of financial knowledge in investment, and the paucity of life‑cycle products available in the market. However, there may also be geographical and generational differences in perspectives, with younger people more willing to participate in market growth and individuals in western and south-eastern regions appearing to prefer guaranteed returns less (Kim, 2018[5]). This presents opportunities for reform through greater public education on the risk/return trade‑off.
While low investment returns may ultimately limit the amount of savings available at retirement and affect the adequacy of retirement income for members of DC and IRP plans, they could also represent a challenge for employers sponsoring DB plans. Employers currently tend to favour conservative investments that may entail little risk of financial losses in the short-term, have low costs and are easy to manage. However conservative investments may not generate returns that are high enough to cover the liabilities of DB plans. The liabilities of DB plans depend on future benefit payments that are influenced by wage growth. Hong (2019[6]) noted that investment returns of DB plans have been lower than wage growth for several years, with a gap between the two growing since 2014. Employers face the risk of having to cover the funding shortfalls coming from this gap through additional contributions.
Labour representatives have been advocating for the introduction of a fund-structure to improve the investment returns of retirement pension plans. A fund structure would imply the creation of a governing body that would involve employer and employee representatives. Employees would have a larger say in the decision of the investment strategy of the plan than in the current contract-based structure, in particular DB plans, and could urge for more risk-taking. The MoEL proposed a bill in 2018 in this sense. Given the current risk aversion of the Koreans when they can select the investment strategy in the case of DC plans, the introduction of a fund-structure may not necessarily be a guarantee per se that assets would be invested in a less conservative way. The governing body of a fund would have to have the appropriate skills and knowledge to make decisions, and seek to enhance its competence and knowledge where needed via appropriate training. Achieving higher investment returns over the long-term could also be possible in a contract-based structure through training and advice given to employers and employees (in the case of DC plans).
5.6. Solvency and funding requirements
Table 5.9. Minimum funding ratio by year
Source: Employee Retirement Benefit Security Act.
The DB plan reserve requirement at each financial year-end is the minimum funding ratio multiplied by the greater of the value of liabilities calculated on a solvency (termination) basis and on a going concern (ongoing) basis.
The calculation under the solvency basis is based on the average market value of the estimated expense for benefits for the 12 months immediately preceding the end of each business year. This value is subject to a lower bound of 90% of the current market value at year-end and capped at 110% of the current market value at year-end.
The calculation on a going concern basis represents the present value of pension benefits to be paid for workers based on their assumed total employment period minus the present value of estimated revenues for the estimated total employment period. The estimated wage growth, retirement rate, and mortality rate (known as base rates) reflect a business’s accrued experience.32 The expected rate of return is also renewed every 3 years to reflect the 36‑month average yield on a 10‑year treasury note.33
If the assets are found to fall short of (100% of) the minimum reserve (i.e. the minimum assets implied under the minimum funding ratio), the pension trustee is required to notify the employer and the representative of employees of the shortfall. If assets fall short of 95% of the minimum reserves, the employer is required to prepare a financial stabilisation plan containing measures to raise funds for the deficiency and payment plans to resolve the deficiency in the reserves within three years, and is required to preserve that plan for three years. Within 60 days from the date the employer is notified of the situation, they are also required to notify the labour union of the financial stabilisation plan if there is one for a majority of employees, or if not, notify all employees. The employer is required to faithfully implement the financial stabilisation plan, such as by paying contributions to make up for shortages in the reserves. Employers that do not deliver on their duty to replenish the plan’s reserves will be subject to the Ministry of Employment and Labour’s supervision and would receive a fine up to KRW 5 million. In 2017, more than half of workplaces had insufficient DB pension plan reserves, but a small minority failed to take appropriate remedial action.
If a plan sponsor fails to pay the whole amount of retirement benefit an employee is due under their DB plan due to a funding shortfall, the government pays the amount of underfunded benefit up to a limit of KRW 10 million. While this arrangement could help address funding shortfalls, it comes with the downside risk of encouraging poor decision-making by employers who know the government would step in, and shifts the burden of the funding shortfall onto the public purse. Furthermore, as the system matures and grows, the fixed amount of KRW 10 million may not be enough to meet the funding gaps from larger accounts. As such, alternative security mechanisms such as a capital buffer or guarantee fund would be better approaches to manage the risk of employers being unable to fund DB liabilities. These approaches are discussed in Section 5.4.
If the funding level exceeds 100%, then under the Employee Retirement Benefit Security Act (ERBSA), employers can use the surplus assets to offset contributions. If the level exceeds 150%, employers can obtain a refund of the surplus assets (above the 150% level).
Regulations specify that mortality tables used by pension providers must be credible and must meet certain specifications as to the size of the supporting data and the time period of collection. Life insurers often use the standard tables modified to reflect their own experience. Retirement pension providers use base rate assumptions to calculate appropriate reserves of DB plans of individual companies. The base rate assumptions reflect mortality, termination, retirement, salary increases and are used by an in-house actuary of a pension provider when conducting financial review each year. In principle, base rate assumptions are calculated on the basis of the company experience. However, small firms or newly established firms, which do not have prior statistics, can refer to base rate assumptions reported to the FSS and estimated as reference statistics for a three‑year cycle by the Korea Insurance Development Institute. Meanwhile, when an employee leaves a company, upon request of an employer, a retirement pension provider transfers accrued pension plan assets from that employee’s pension plan into an individual IRP account, and then the employee directly purchases financial products (lifetime annuity, funds, deposits). When such products are purchased, the underlying mortality assumptions are expected to be reported to authorities as stipulated in the relevant act (Insurance Business Act).
The Korean Insurance Development Institute (KIDI) has been legally responsible for the construction of mortality tables (the EMT tables) for the life insurance sector since 1989. Insurers are required to use these tables for reserve calculations, though they can use their own experience for pricing. The KIDI updates the tables every three years and has to submit them to the FSS for approval. The rates are based on the mortality experience of the insurance sector (Korea Institute of Finance, 2013[7]). While the tables are static, the tables used for annuitants implicitly account for expected future mortality improvements and include additional safety margins. They are typically used by annuity providers and corporate sponsored pensions, and contain separate rates for annuity providers for the period before and after annuity payments begin, as well as separate rates for corporate‑sponsored pensions. As such, three separate tables are applicable to the pensioner and annuitant populations. The EMT table for pensioners applies to pensioners before retirement, and is only used to ensure that the employer has sufficient reserves to meet its liabilities. The EMT table for life insurance applies to annuitants before retirement. The EMT table for annuitants applies to both populations after retirement.
Retirement pension providers (providing trust-based pension plans), except insurance companies, carry out activities, including keeping reserves in trust accounts, purchasing assets such as funds and deposits according to management instructions of pension participants, and paying the reserves back to participants. As they do not guarantee neither interest rate nor pension amount, they do not bear any liabilities associated with future pension payments beyond the range of reserves. Meanwhile, when an employee leaves a company, the employee can use his/her accrued retirement pension plan assets to purchase a lifetime annuity provided by a life insurance company (retirement pension provider or private pension provider). As for financial products offering a guarantee like a lifetime annuity, the related provider is required to report mortality pursuant to the Insurance Business Act (and not the Act on the Guarantee of Employees’ Retirement Benefits). If fund-based retirement pensions were to be introduced in Korea in the future, the development of regulations or guidance on the assessment of liabilities of trustees which manage funds would be needed.
5.7. Pay-out phase
Once an employment relationship ends and until retirement, the rights or assets accumulated in an occupational DB or DC plan have to be transferred to the individual’s IRP account. This can either be a new provider or the same provider who also offers IRP plans. When an employee stops working for a particular employer, a notice is sent to the provider requesting the retirement benefit payment. The provider then either transfers cash or makes in-kind payments to the IRP account designated by the employee. At retirement, the rights or assets in a DB or DC plan are transferred to the IRP account designated by the employee, through which benefits are paid. If the employee does not designate an IRP account, the rights or assets are transferred to a specific account operated by the relevant pension trustee.
The level of benefits that members can expect from DB and DC plans is loosely equivalent. The level of retirement benefits from DB plans should be set in a way that ensures that the amount of lump-sum benefits calculated based on the retirement date of an individual is equal to or higher than 30 days of the average daily wage for each year of his/her consecutive service.34 Benefits from DC plans depend on the amount of contributions and the investment return on these contributions. The minimum employer contributions to DC plans is 1/12 of the individual’s annual wage.
There are two main types of pay-out options in Korea: lump sum payments and annuities. Individuals can receive annuities from the age of 55. They need to have also participated in the plan for at least 10 years to be eligible for an annuity from their occupational plan, otherwise they will get a lump sum payment. Annuities are paid over 10 years at least. These eligibility rules are summarised in Table 5.10. Programmed withdrawals are not allowed.
Table 5.10. Eligibility requirements by scheme and type of pay-out
Note: Individuals can access their savings in their individuals IRPs at any time but they will lose the tax concession if they do so.
Members can choose different types of annuity. Withdrawal options include a lifetime annuity, a periodic annuity and annuity certain. Which withdrawal option is available can depend on the retirement pension plan provider. While life annuities provide longevity insurance, other products with a fixed term (e.g. 5 years) expose individuals to the risk of outliving their assets.
The price of the life annuity is set in the terms of the contract with the pension provider. This price reflects the life insurer’s mortality rate, interest rate, and expenditures. Insurance companies can request reference rates to the Korean Insurance and Development Institute (KIDI) that gathers industry-wide insurance statistics and produces mortality tables based on the experience of the industry.35 Methods of calculating insurance premiums and the liability reserves must be reported to the Financial Supervisory Services.36 Pension liabilities must be valued according to the International Accounting Standard.
Most members entitled to benefits in 2018 received a lump sum payment (Table 5.11). Lump sum payments were paid in more than 95% of the cases. Lee and Lim (2013[8]) explain that lump sums are often preferred to pay off mortgages on real estate investments. Pensions still represented 20% of benefit payment amounts, suggesting that people with larger pots were probably the ones opting for annuities, likely due to the tax advantages of doing so.
Table 5.11. Pay-out choice of members of occupational plans in 2018
Source: FSS.
People receiving an annuity tend to receive their pension monthly although payments can be paid at another frequency. The FSS reports that pension payments were made on a monthly basis in 83% of the cases, and on an annual basis in 16% of the cases in 2018.
Members of voluntary personal pension plans can also withdraw annuities and lump sums from these plans. People can take an annuity if they are 55 or older, have been a member for at least 5 years and request a payment within the limit set in the Enforcement Decree of the Income Tax Act.37 Of people who choose a “pension” option for their personal pension plans, most opt for an annuity certain (over a predefined period) as opposed to a life annuity. As such, personal pension products may not contribute much to longevity protection.
Pension-backed loans and early withdrawals from occupational retirement pension plans are allowed under several circumstances. These include: the acquisition of a property or paying a leasehold deposit; illness or injury subject to hospitalisation of 6 months or more; court order of bankruptcy or personal turnaround; university tuition fees, wedding costs, funeral costs (except for early withdraws) and various natural disasters.38 People are usually allowed to withdraw the whole balance of their DC or IRP plans if they meet the eligibility conditions (Table 5.12). Members of DB plans cannot withdraw their assets from their accounts but can secure a loan on some of their pension rights instead (Statistics Korea, 2019[9]).
Table 5.12. Conditions for early release
Early withdrawals have soared over the last years, with the number of requests for early access to savings more than doubling between 2015 (28 080) and 2019 (72 830). The most common reason is for house purchase (35%), followed by long-term care (34.8%), deposits for housing rent (21.2%), and rehabilitation procedures (8.9%) (Statistics Korea, 2019[9]). Reasons for accessing savings under emergency circumstances vary by age groups. People in their 20s mainly use their retirement assets for renting a house, those in their 30s to buy a house and those over 40s for long-term care. The Korean authorities have tightened the conditions to access savings for medical reasons since 30 April 2020, limiting it to cases where expenses for long-term care over at least a 6‑month period exceed 12.5% of the annual wage of the plan members.
Individuals can also withdraw their savings in personal pension plans before retirement. They benefit from a low tax rate if they do it for emergency reasons such as bankruptcy or medical reasons. Early withdrawals are also possible under normal circumstances without any emergency reason, but at a higher tax rate. Such withdrawals are significantly more common than withdrawals due to the emergency circumstances. To illustrate, in 2018, about 300 000 withdrawals from personal pension plans were arbitrary withdrawals, compared with about 10 000 which were due to emergency circumstances arising.
This is in line with anecdotal evidence in the academic literature arguing that individuals tend to use personal pension plans as short-term savings instruments and withdraw their savings early.39 Some studies explain that the main reasons people withdraw their personal pension savings in Korea is to meet the costs of their children’s education and the costs of their children’s marriages (Lee and Lim, 2013[8]). The work argues that personal plans are popular due to tax incentives but although early withdrawals are penalised, people still view these personal pension products as good financial investment vehicles and accept having to pay marginal tax rate penalties to utilise them. As such, they are not used as long-term retirement savings vehicles. There is also further evidence that demand for personal pension products is declining, since yields have been falling and since the government reduced the tax benefits of private pensions (a change which mostly affected higher income earners).40
Overall, the combined effect of high rates of early withdrawals and opting for lump sums means that these products are, in the majority of cases, not used for the purpose of obtaining a steady income in retirement.
Additionally, there is a discrepancy between the eligibility age for the private pension system and the public system. From 2033, the normal pension age will be 65, and the early pension age will be 60. However, the eligibility age for access to occupational and personal plans is 55. It is important to align the retirement age from the private system with that of the public system, and one way to do so is to gradually increase the age of access to private savings. In order for occupational and personal pensions to directly complement pensions from the NPS, their access ages should be consistent. Ideally, the age of access to private savings would aim to align with the normal retirement age of 65. When employees retire in their 50s, they may have limited income until the normal pension age of 65. The relatively early retirement age might be related to the practice of employers enforcing a strict mandatory retirement policy and the practice of honorary retirement. Many Koreans have historically relied on pay-outs from their employers to maintain their standards of living or to open small businesses. Increasing the age of access to private pension savings should therefore happen gradually while ensuring this does not leave old-age workers more economically vulnerable before retirement.
5.8. Market structure and competition
The following entities can become retirement pension trustees (pension providers) in Korea:
Banks
Investment traders, investment brokers, or collective investment business entities
Insurance companies
The National Credit Union Federation of Korea
The Korean Federation of Community Credit Co‑operatives
To become pension providers, the entities must meet the requirements of the Presidential Decree, such as financial soundness, personnel and physical resource requirements. Any retirement pension trustee can operate individual retirement pension plans.
With respect to personal pension plans, individuals invest in pension savings products provided by banks, asset management firms and insurers.
Retirement pension trustees can provide two main types of services: the administration of the plan (e.g. managing administrative records) and asset management (e.g. receiving and investing contributions). Employers can choose the same provider for these two main services (opting in such case for a bundled service arrangement) or use different service providers (unbundled service arrangement). Banks, insurance companies, securities companies can provide both types of services. By contrast, Korea Workers’ Compensation and Welfare Service only administers plans.
Figure 5.13 shows that banks dominate most of the business for occupational plans, followed by life insurance companies, financial investment companies and general insurance companies. In 2020, banks occupied the largest share of business at 51.0%, which was followed by life insurance companies (22.3%), financial investment companies, (20.2%), general insurance companies (5.2%) and the Korea Workers’ Compensation and Welfare Service (1.3%).41
Figure 5.13. Split of occupational plan assets
Source: FSS.
While the Korean market for retirement pension plan provision has a large number of players, there are signs that there might not be the same level competition by type of provider. Within the banking sector, there appears to be a reasonable amount of competition, since the largest 5 banks each hold between 6.6%‑10% of the market share. The within-industry Herfindahl‑Hirschman Index (HHI) for the banking sector is 0.14, which suggests moderate competition.42 Similarly, the securities and investment companies industry has a HHI index of 0.19, which suggests higher but still somewhat moderate competition. However, the life insurance and non-life insurance industries are more concentrated, with HHIs at 0.38 and 0.24 respectively. There is therefore a case for the Korean authorities to monitor the competitiveness of some sectors and respond with policy changes if excessive market concentration is likely to lead to poorer outcomes to members.
Another potentially problematic feature related to the competitiveness of pension provision in Korea is the degree of ownership of banks. Banks hold the most assets in occupational plans, with just over a 50% market share (Figure 5.14). This feature is somewhat common in the international experience, since banks tend to have greater access to potential customers through their existing lines of business and are able to “sell” more products to them.
Figure 5.14. Assets backing occupational pension plans
Note: Data reflect combined assets in DB, DC and IRPs and held by different occupational plan providers (excluding the Korea Labour Welfare Corporation, which holds less than 1% of assets).
Source: Data are based on an FSS report (Retirement Pension 2018: Earning and operation status analysis) available at the FSS website: http://pension.fss.or.kr/fss/psn/bbs/view.jsp?url=/fss/pn/1295490315749&bbsid=1295490315749&idx=1554700676377&num=142.
Furthermore, it is important to note that while there are many potential providers in Korea, some are part of the same financial group. For example, Samsung Life Insurance, Samsung Fire and Marine Insurance, and Samsung Securities are all part of the Samsung Group, so together the group owns about 17% of the market for retirement pension provision in Korea. Due to the issues discussed, it may be important for the Korean authorities to monitor risks to competition and take policy measures to improve competition wherever possible.
One way to stimulate greater competition is through disclosure initiatives. In Korea, there are a number of ways members can compare the performance of different pension providers. A number of comparison tools are available to employers and individuals to compare providers across and within industries.
The Ministry of Employment and Labour (MoEL) also releases information comparing different returns and costs by provider for retirement pension products. It is currently developing a system for users to compare different pension providers’ fee structures, split by operational management fees and asset management fees.43 The MoEL also publishes annual evaluations of retirement pension plan providers’ investment performance, fee adequacy and customer service.
Financial Supervisory Service (the pension system supervisor) has a provider comparison tool. It provides information for users to compare costs and yields across industries and within different provider groups by providing links to the relevant industry associations. The FSS also publishes comparison data of different personal plan providers and their products’ average returns and fees through the pension savings plan comparison disclosure feature on Integrated Pension Portal website.44 However, it does not make available a projection tool.
The FSS’s Integrated Pension Portal also allows individuals to get a cumulative picture of their entitlements from the NPS as well as private pensions. The portal also makes it possible to obtain future simulations. However, there is little public information on this portal and as such it is difficult to form a view regarding its efficacy.
Providers themselves are required to report their business aggregates and results. They do so in their own reports (such as through annual reports) and their websites, following official templates. Industry associations also summarise reports and compare reserves and yields in a standardised way for occupational plans (DBs, DCs, and IRPs). For example:
the Korean federation of banks provides a comparison of occupational pension costs, yields, and reserves for products offered by banks.45
the life insurance association publishes annual statistics, but it is not clear where (and if) they publish numbers of accounts and assets for different products offered by life insurance companies.46
the general insurance association publishes tables comparing general insurance pension products’ product designs, terms, earnings rates, and reserves.47
the financial investment association publishes information regarding outcomes for securities and collective investment companies.48
Personal plan providers are required to periodically send pension savings plan performance reports to their members. In addition, pension providers provide information on a rate of return and fees for their pension plans on their websites so that pension participants can search and browse, and the FSS provides an online integrated pension portal which offers a comparison tool on a rate of return and fees by financial institution and by product.
There are signs of increasing competition between pension providers. For example, some providers offer promotional deals to attract new membership, such as waiving the fee for new entrants or discounts for long-term customers. However, as will be discussed in the next section, this has not been enough to bring down the costs.
5.9. Fees
The Korean public generally view fees for pension products to be high relative to the cost of providing the service. On average, overall fees for retirement pension plans were about 0.42% in 2020 (Table 5.13). Total fees ranged between 0.38% and 0.62% of assets between 2016 and 2018, although fees varied between industries and types of plans (Table 5.13 and Table 5.14). While that level of costs would not be excessive if assets were managed actively, it may represent poor value for money given the assets are invested in savings products which are invested mostly in fixed income instruments with low returns. For this reason, the public tends to view their fees as excessive, particularly relative to regular everyday savings products offered by banks, which provide similar returns for lower fees.
Table 5.13. Total cost ratio by type of retirement pension plan
Note: The cost ratio is calculated as: Annual total cost operation management fee + asset management fee + fund total cost) / year-end average assets, where fund total expenditures = fund commissions (transactional commission, management commission, trust commission, transfer agent commission) + transactional fees.
Source: MoEL and FSS.
Table 5.14. Total cost ratio by retirement pension plan provider
Note: The cost ratio is calculated as: (Annual total cost operation management fee + asset management fee + fund total cost) / year-end average assets. The Korea Labour Welfare Corporation cannot handle asset management.
Source: Website of Ministry of Employment and Labour, Korea. https://www.moel.go.kr/pension/statistics/year.do
High fees are a key risk for Korea’s funded pension system, since the perception of poor value can deter utilisation and discourage people from viewing them as genuine sources of potential retirement income. Some researchers already make the case that fees almost completely offset the investment returns in most personal pension products, leaving the tax deduction the only real advantage.49
There are a number of ways government policy can help reduce fees. The main one that the Korean system seems to rely on is increased transparency through disclosure of fees and comparison tools. However, while measures to improve transparency are essential, alone they are not enough to align costs and charges. The transparency measures discussed in Section 5.8 are important steps to encourage employers to select the best value pension provider, but those measures are not achieving enough. For example, banks remain the most popular choice of provider, despite having the highest fees (Table 5.14). Insurance companies are similarly the most popular choice of personal plan provider, despite not necessarily having the lowest fees and having the lowest returns on average. Furthermore, only 3% of businesses switched their retirement pension plan provider in 2019. Switching can be laborious since doing so requires the consent of the trade union or a majority of workers, but is low notwithstanding, indicating that disclosure mechanisms are not working enough.
The Korean authorities can consider other ways to reduce pension fund fees. These can include potentially introducing pricing mechanisms which may drive down fees or changing the fee structure.
The Korean Government can also take steps to reduce costs through direct pricing initiatives to limit what providers can charge. Chile, Sweden, Türkiye and the United Kingdom have imposed charge caps. To illustrate, the United Kingdom introduced a charge cap on workplace default funds. The cap applies to all direct and indirect administration and investment costs, but does not include transaction costs. The charge cap appears to have been effective in reducing fees for DC funds: all qualifying schemes (those that are eligible to be used as defaults) are now priced below the cap and the prices of other schemes have also fallen. However, charge caps can have unintended consequences. If the cap is set too high, charges tend to rise to the level of the cap. If the cap is set too low, plan providers might try to cut costs by offering lower quality plan designs.
Another direct pricing initiative is to introduce low cost plans. Australia, Estonia and Hong Kong (China) are examples of jurisdictions that have done so. In those examples, the providers were required to introduce simplified products with limited fees. In Australia and Hong Kong (China), the low cost option was also the default investment option. Some OECD countries have also attempted to influence the cost structure of providers by establishing new, centralised institutions. These institutions can present additional competition to plan providers. For example, the UK’s NEST, a low cost provider, competes with other providers for auto‑enrolment business. It offers low-cost solutions directly to underserved populations, and has an obligation to take on smaller accounts. The KCOMWEL in Korea already provides a similar function for small businesses. Over time, its functions could be expanded to larger businesses to be a low cost public provider, potentially a default provider, that other providers will be forced to compete with. This could help push down investment management costs.
There is also a case to revise the types of permissible fees. Asset-based fees are the only type of fee that is permitted for Korean retirement pension plans (Table 5.15).50 However, asset-based fees can fail to provide incentives to investment managers to become more efficient or to share efficiency gains with clients.
Table 5.15. Fee structures in OECD countries
Note: “x” means that the type of fee does not exist or is not allowed in the country.
Source: OECD (2021[10]), Pensions at a Glance 2021, https://doi.org/10.1787/ca401ebd-en.
Performance‑based fees may be a suitable alternative for Korea. Unlike price caps which specifically limit charges, performance‑based fees aim to better align the interests of investment managers and pension fund members and sponsors. Performance‑based fees must be structured in such a way as to give the right incentives to pension funds and their investment managers. Rewards should be paid for delivering high returns per unit of risk taken, and a fair share of returns should stay in the portfolio rather than being paid out in fees.
Finally, improved financial advice can help people better plan for retirement and switch to providers that offer better value. Most individuals get their financial advice from financial institutions themselves, which may not be the best place to get unbiased information about pension products. The National Pension Service offers basic financial advisory services to their members. In addition to its own services, the NPS has to provide for matters related to support for people’s preparation for old age so as to ensure a healthy and stable life in their old age. One option is to expand this service to provide comprehensive financial advice to people that includes a better understanding of their options for retirement pensions. Furthermore, Korea has an integrated online tool that allows people to cumulatively see their full entitlements under different pension arrangements. This tool could be expanded to one that allows users to see their potential retirement incomes under different scenarios, with information or links to how they can achieve the improved scenarios they might be seeking.
5.10. Supervision
The Ministry of Employment and Labour is mainly responsible for supervising retirement pension plans. After employers select retirement pension plans and prepare the covenant with the consent of more than half of their employees, they report the covenant to the Minister of Employment and Labour.51
Korea has a two‑tier system supervisory system to supervise and monitor financial institutions that are registered as retirement pension plans or personal pension plans. The Financial Services Commission (FSC) assumes the primary responsibility for rulemaking and licensing. The Financial Supervisory Service (FSS) is responsible for prudential supervision, capital market supervision, consumer protection, and other oversight and enforcement activities.52 The supervisor provides guidelines on how to perform investment management and asset management services and establishes detailed criteria for the management of the reserves. As the government regulatory authority, the FSC is staffed by civil servants, but the FSS as a specially legislated supervisory authority is staffed by private sector employees who are not part of the government civil service system.
The FSS is in principle independent. The Governor of the FSS is appointed by the President of Korea. Senior deputy governors of the FSS (up to four) are appointed by the FSC on the recommendation of the Governor, and deputy governors of the FSS (up to nine) are appointed by the Governor. An Auditor is appointed by the President of Korea upon the recommendation of the Chairperson of the FSC. A Chief Accountant is also appointed by the Governor of the FSS to assist with matters relating to accounting standards.
5.11. Public education and attitudes towards retirement
Research around consumer behaviours in Korea suggests that, overall, individuals do not tend to seek help from financial professionals on retirement planning. In one survey, 78% of respondents who were financial decision-makers in households stated that they did not seek professional guidance for their retirement planning.53 Almost 1 out of 2 respondents were very involved in monitoring and managing their retirement savings. However, only one‑third of them expect to have enough savings to last until the end of retirement. More than half of respondents were concerned that they may not being able to live the retirement lifestyles they want. But they also do not seek help from financial professionals, more than half of them would like to have more information and advice from their employers on retirement savings and planning.
The survey found that 77% of the respondents consider it their own responsibility to fund their retirement. This suggests that there is room for national financial education strategies to steer the national discussion towards gaining better professional advice, as long as that advice is trustworthy. Further, since 57% of respondents stated that they are willing to purchase a financial product that will provide guaranteed lifetime income, the strategy could be used to emphasise how annuities could be purchased and to communicate individuals’ different options. This suggests that there is scope to encourage an annuity market, in contrast to many other OECD countries where such an appetite tends not to exist.
Most Koreans intend to start saving for retirement later in life than their peers in the region (Figure 5.15). When surveyed Koreans were asked when they intend to start saving or investing for retirement, the average response was 44, while on average they expect to retire at 63. This leaves Koreans with a short timeframe to save enough for retirement, leaving many with no choice but to continue working later in life to avoid poverty in retirement. The same survey also found that 84% of respondents felt they would have 80% less than the retirement funds that they needed to have a comfortable retired life. It is important that Koreans start saving in private pensions earlier, and governments need to do more to encourage take‑up of pension products that facilitate long-term saving.
Figure 5.15. Survey results about retirement preparedness
Source: Kim (2018[5]), Spotlight on Retirement: South Korea 2018, www.kidi.or.kr.
Improving education about retirement savings products is also a good way to help individuals with their retirement preparedness and address misconceptions about products such as personal pension plans. Some studies (such as Lee and Lim (2013[8]) state that personal pension plans, especially those offered by insurance companies, suffer from low take‑up and high costs simply because people do not view them as retirement saving vehicles. People treat them as short-term savings tools, which in turn drives up the cost and pushes down demand. Some commentators have raised the point that Koreans have a deep-rooted distrust of long-term financial investments which manifests in low take‑up and risk aversion in choice of investment strategies. Providers, in turn, prioritise tailoring their investment products to their risk-averse customers. When individuals do engage in long-term investments, Koreans also have a preference for real estate, which is where the data shows most of their assets are. However, Lee and Lim (2013[8]) make the case that Koreans are not opposed to insurance, but rather savings. They view that framing pensions as a form of insurance that protects individuals’ principal investments is a way to make them see more palatable.
The Korean Government already has some good initiatives around financial education, but more could be done to better prepare people for retirement. The OECD (2019[11]) explains that the Korean Financial Education Activation Plan aims to improve the infrastructure for the provision of financial education (training teachers, developing incentives for adoption of financial literacy in the curricula, etc.), to enhance customised education programmes, to improve the level of the programmes and instructors, and to establish a follow-up management and evaluation system. Financial education activities are co‑ordinated by the Financial Education Council (FEC), a body led by the Financial Services Commission that co‑ordinates basic policy directions, examines how financial education is provided by each institution and continues to upgrade the Financial Education Activation Plan. However, it does not appear that much of these efforts are directed explicitly at matters regarding retirement. As such, the government could consider extending financial education initiatives to better guide individuals to the retirement products and savings strategies that suit their purposes.
The government could also reach individuals through their employers or through financial institutions, as well as internet campaigns. Kim (2018[5]) found that of people surveyed on retirement planning, only 7% responded that they received information on investments, financial products, or retirement planning from their employer. Workplaces are currently an underutilised resource to reach people to help them plan for retirement. The government could also leverage existing financial institutions, which the majority of respondents in the survey stated that they trust (79%), by influencing the messaging that they provide. Most tended to rely on the internet and financial websites. Internet resources are therefore a good place to start. But face to face methods, such as through the workplaces and financial institutions are also effective.
5.12. Complementarity of public and private pension systems
A key question many countries face is how to design private pension systems that best complement public pension systems provided by the state. The OECD encourages countries to diversify sources of retirement income and to strengthen the degree of funding in the overall pension mix through a combination of PAYG and funded, public and private provision. Different combinations of retirement system arrangements can offer varying solutions for meeting pension systems’ competing objectives. Different arrangements are also better capable of covering the various types of risks that people face throughout their lives. This is because the mechanisms through which shocks flow into different pension arrangements vary. For example, population ageing, low interest rates, or low economic growth can have a different impact on the NPS and private pension arrangements, or DB and DC pension arrangements.
The question of how to best design a complementary pension system is an important one in Korea, as the country is in need of pension reforms that will improve retirement outcomes for the population. Pension reform can present an important opportunity to reassess how retirement pension plans and personal pensions can better complement the retirement incomes from the National Pension Scheme in the future.
The NPS will likely remain the most important source of pension income for workers in Korea, but there is certainly potential for complementary pension arrangements to play a greater role. The fiscal strains facing the NPS have led to incremental reforms that have negatively affected pension adequacy. This suggests that complementary pension arrangements, such as retirement pension plans and personal pension plans, can fill the pension adequacy gap. Importantly, Korea is in a favourable position to transition to greater reliance on funded or private pension arrangements, if it should choose to do so. A high level of contributions to the public system would normally reduce the scope for supplementary pensions. However, this should not be an issue for Korea, since it has one of the lowest contribution rates to the public scheme in the OECD. Indeed, in countries where contributions to or benefits from public pensions are low, then supplementary pensions could help in improving pension adequacy for individuals. Putting a greater reliance on private, funded pensions can give policy makers more leeway to implement reforms necessary to improve the sustainability of the public system.
However, complementary pensions work best when they are linked to clear objectives and are designed to address specific risks. The role of complementary funded pensions in Korea should be a function of policy makers’ objectives for the entire retirement pension system and what they believe is the most suitable approach to meeting the various risks, which are discussed below. By understanding their objectives and the risks they face, policy makers can then determine which features of pension design best support the goals they intend to achieve, and whether these design features should be implemented via the NPS or private pensions.
5.12.1. Objectives and goals
When considering how best to design a complementary pension system in Korea, it is important for policy makers’ decisions to reflect what they intend for the pension system to achieve. The main purpose of pension systems is to make sure that people have resources at old age, that is, income security. However, policy makers may have in mind other, sometimes related, objectives they wish to meet. What follows therefore explains the possible objectives policy makers may have in mind for the Korean pension system, and the potential risks that may arise under different pension arrangements. With this information, the onus is then on policy makers to form a view about how best to design complementary pension arrangements. Possible objectives can include:
poverty relief: poverty relief at a minimum level is typically provided through public pensions or other social benefits in all OECD member jurisdictions. It is an element of a broader objective of retirement income adequacy. In Korea, the Basic Pension aims to serve this purpose. This universal provision cannot be successfully substituted by the private sector. As such, the Korean authorities would not consider a role for complementary pension arrangements in achieving this objective.
consumption smoothing: this entails that people should be able to experience smooth utility when transitioning from working life to retirement. The objective of consumption smoothing is another element that is central to achieving pension adequacy. However, the NPS, without any significant changes that would boost income in retirement from it, will not alone achieve the objective because the level of income replacement it provides is relatively low. Consumption smoothing is more likely to be achieved through a combination of income from the NPS and private funded pensions. There is no single arrangement that “best” achieves consumption smoothing, since achieving the objective is effectively a function of the total income individuals receive in retirement. However, if policy makers’ goal is to improve consumption smoothing outcomes for all individuals (as opposed to each individual considered in isolation), the objective may overlap with that of redistribution. As such, some pension arrangements would be better placed to deliver on a redistribution objective (as discussed below). Personal pension plans are also pension products that can help deliver on the consumption smoothing objective, if they represent new savings and as such do not divert other savings. If personal pension plans do not increase overall savings, then they would not improve retirement income outcomes for individuals and therefore would not assist with the consumption smoothing objective.
redistribution: involves a transfer from those who would otherwise have a sizeable pension income to those who will have less. In OECD countries, the redistribution objective is commonly achieved through a public DB system which can have built-in progressive or redistributive features. And indeed, as discussed in Chapter 2, the NPS is a defined benefit scheme with a large redistributive element as the accrual formula is made up of two components that are equally weighted: one is based on the average contribution level of all participants while the other is calculated based on individual contributions. Redistribution is also possible within private funded DB arrangements; however, if one group makes a bigger claim on the assets of the scheme than is justified by its contributions, the difference will ultimately have to be made up by reducing benefits to other groups or by injections of funding from the plan sponsor. However, redistribution can also take place through other private pension arrangements via tax incentives for retirement saving, as is the case in Korea since more favourable tax incentives apply to lower income earners.
providing insurance against risks during working life and in old age: risks may be common to the system as a whole, such as macroeconomic or financial market risks, or they may be related to the situation of the individual. Different types of pension arrangements play different roles in addressing the objectives and risks of pension systems (as discussed further in the next sub-section below)
maximising coverage, which refers to how many people the system reaches, both as contributors and as beneficiaries. Mandatory systems are those which are best placed to achieve the objective of high coverage. The NPS plays a key role in this objective, with retirement pension plans potentially contributing to the objective should Korea implement the plan to make retirement pension plans mandatory for all employees. Personal pension plans tend to be the least useful in achieving this objective, since they are usually used by higher income earners. When it comes to the objective of maximising coverage, there remains a risk that non-standard workers (such as the self-employed) may continue to fall behind when it comes to pension coverage from any part of the retirement pension system in Korea.
preserving inter- and intra-generational equity, which means that one group is not excessively disadvantaged to benefit another group. DB arrangements (whether through the NPS or retirement pension plans) can be designed in such a way that ensures inter- and intra-generational equity. However, the assessment and measurement of any risk and value transfers is necessary to determine whether the design of the retirement income arrangement is seen as fair vis-a-vis different groups of participants. It is not possible to achieve equity objectives through individual DC arrangements.
fiscal or financial sustainability, which refers to the objective of keeping the cost of pension provision sustainable, for whichever entity bears the burden of that pension provision. The question of sustainability can have different subjects – it can refer to sustainability with reference to the state, employers, individuals, and so on. This issue is evident in Korea, where sustainability concerns relating to public finances have resulted in reductions in benefit promises over time. Sustainability concerns can also apply to employers, who may resist introducing or contributing more to retirement pension plans for employees. Individuals may also have financial sustainability concerns which manifest in preferences for severance payments, lump sums, and up front wages rather than contributions to their pension plans. Financial sustainability concerns, particularly from the perspective of employers and employees, can risk delaying or derailing other important goals for pension systems. As such, the objective of fiscal sustainability is often in tension with other objectives such as pension adequacy.
Policy makers have a key role in deciding what objectives they intend for a pension system to achieve, and then designing or reforming a pension system in order to meet those objectives. Given such objectives, a starting point for clarifying the role of complementary pensions is to first understand how the NPS will address policy makers’ objectives and the risks inherent to pension provision. From this basis, policy makers can better visualise the role that supplementary pensions are expected to play, or rather, the gaps they intend to fill.
Using the objectives above, it is possible to illustrate with examples. For instance, the objective of consumption smoothing could be achieved through raising contributions to the NPS or private arrangements. However, either choice comes with trade‑offs. The choice of which arrangement to use to help people improve their retirement incomes may come down to fiscal sustainability issues, practical issues of implementation or even what may be more palatable to the public. Conversely, other objectives, such as redistribution, can be easier to achieve through the NPS. However, redistribution can also be achieved through more generous but well-targeted tax incentives to lower income earners for saving in private pension plans.
5.12.2. Key risks in complementary pension arrangements
Another key question when considering the structure of complementary pension arrangements, is how pension design will account for the different risks. Risks are important, and can be considered in tandem with retirement system objectives, since policy makers should be prepared for the risks that come with any pension arrangements that aim to meet particular objectives. Risks may be more or less pronounced, depending on the mix of different pension arrangements. Some key risks are outlined below.
Labour market risks include loss of employment and unfavourable earnings patterns. They can have a significant impact on the rate at which pension rights are accrued or the rate at which pension assets are accumulated, and thus on the level of pension income received. In Korea, these risks are partially mitigated through basic benefits that provide a back-stop security against the failure or inability to pay into schemes such as the NPS and private pension arrangements. However, the benefits do not completely offset the negative effects on retirement income adequacy that come with lost contribution years.
Macroeconomic risks refer to factors stemming from the real economy that can have a bearing on pension outcomes.
low growth and low productivity affect both public and private pension systems. They make it less likely that an individual will receive an adequate pension income. Low growth and low productivity can also limit the fiscal capacity to fund the Basic Pension and result in lower contributions to the NPS and funded schemes. It may be difficult to raise contribution levels in both public and private schemes in a weak economic environment without reducing the pre‑retirement consumption by too much compared to post-retirement consumption, especially for low earners. As such, low wage and productivity growth also make it harder for governments or plan sponsors to meet the promises embedded in DB arrangements, whether PAYG or funded.
Inflation reduces the future purchasing power of savings that people put aside today for the purposes of consumption smoothing in the future. While the NPS provides benefits that are indexed to price inflation, inflation may pose greater problems to private pension schemes, particularly DC retirement pension plans and personal pension plans.
The risk of low interest rates can also affect any funded pension arrangements since low returns can inhibit asset growth. Low interest rates can result in lower pay-outs from funded DC schemes by reducing the returns on invested assets and lowering annuity values. They may also damage the sustainability of funded DB schemes as liability values increase. As such, they would pose a more immediate risk to funded pensions than to pensions from the NPS. However, low interest rates can reduce the size of the NPF Reserve fund, leading to it being depleted earlier than expected.
Financial market risks refer to shocks that can reduce the value of accumulated assets. Retirement benefits in funded systems are particularly vulnerable to financial market risks because they are financed by accumulated assets and financial market shocks can reduce the value of those assets. As such, financial market risks can affect Korean pension assets through the NPS reserve fund or through the private funded pension arrangements. However, they can impact individuals differently. Financial market shocks can be particularly damaging for members of individual funded DC arrangements if the shock occurs towards the end of the accumulation period, when the individual has less time to rebuild their savings before beginning to draw down their assets. Investment strategies such as lifecycle or target date funds can help mitigate this volatility in investment. Financial market risks appear to be a key issue in Korea, and are at the forefront of investment policy decision-making that tends to favour conservative investment strategies over more aggressive investment strategies. While financial market risks are a legitimate concern, they should be balanced against the risk of low interest rates which can also reduce the value of invested assets and jeopardise retirement income adequacy.
Operational risks also principally affect funded systems, since excessive operating costs or badly-designed investment strategies will have a direct impact on the assets in a funded scheme. This is because it is always possible for a funded scheme, particularly DB schemes, to become insolvent without the right regulations in place. This tends to be less of an issue in public arrangements such as the NPS. However, it is possible for governments to help mitigate operational risks by putting in place schemes that guarantee pension arrangements. OECD countries such as Germany, Switzerland, the United Kingdom, the United States and Ontario (Canada) all have pension guarantee schemes in place for the private funded DB sector. Korea does not currently have one such guarantee scheme, and may wish to consider doing so to address any concerns around potential plan insolvencies.
Longevity risk is the risk that an individual will live longer than expected and so exhaust their resources. Public DB PAYG offer protection against longevity risk to individuals by providing a lifetime stream of benefits. However, this leads to issues of sustainability and inter-generational equity if a relatively smaller working population is required to support the pensions of a relatively larger retired population over a longer period. Public systems such as the NPS are the most vulnerable to demographic shifts that alter the ratio between the size of the cohort that is working and contributing and the size of the cohort that is receiving benefits paid for by those contributions. Longevity risk within public arrangements can be reallocated more neutrally across generations by adjusting benefit levels and accruals. In the case of private DC plans, individuals bear the risk of outliving their savings except if they purchase products providing protection against longevity risk (such as a lifetime annuity).
A key question when it comes to designing complementary pension arrangements is which party bears the relevant risks. In public DB pension arrangements, such as the NPS, the State notionally bears all of the risks, although it is possible for individuals to ultimately share risks with the State should sustainability issues lead the State to reverse course on any promises. In private DB retirement pension plans the employer bears most of the risk, which again can fall on individuals in instances of plan underfunding. The growing role of DC retirement pension plans and personal pensions in Korea (like in most OECD countries) may leave individuals more exposed to many of the risks discussed. This is because individual DC arrangements establish a direct link between the value of accumulated assets and the level of retirement income, so any risks that impact the amount of assets a person can accumulate will directly affect their potential retirement income. Collective funded and public arrangements such as the NPS have greater scope for risk pooling and burden sharing but are also vulnerable to sustainability concerns in the event of lower contributions, lower returns on assets and higher claims.
As the role of private pensions in meeting the objectives of pension systems grows, so must their role in addressing the risks. Their capacity to do so will depend on their design. A functioning annuity market would allow DC arrangements to guarantee their members a lifelong income, with annuity providers bearing some proportion of the longevity risk. Private pensions are in general more vulnerable to macroeconomic and financial risks than public pensions, and as such, additional measures may need to be taken to protect individuals in those schemes. These can include mandating default investment strategies such as lifecycle strategies which protect individuals by ensuring investments are made in safe assets in the years prior to retirement. Such schemes also require stringent governance requirements to ensure that pension providers and investment managers manage assets in the best interests of members.
5.12.3. Benefits and shortcomings of funded arrangements
Most countries are increasing the role of funded pensions in pension systems. However, as discussed above, the growth of private funded pensions, such as retirement pension plans and personal pensions in Korea, increases the possibility that individuals will be exposed to more of the risks. This is because building up savings comes with risks that do not apply to the NPS. Private pensions also shift much of the responsibility on individuals for ensuring savings are sufficient to last over their full lifetime in retirement. These risks are greatest for individuals saving into DC schemes.
However, funded pensions also offer a number of advantages compared to public, particularly PAYG pensions. They may provide stronger incentives to participate in the labour market and to save for retirement. They create a pool of savings that can be put to productive use in the broader economy. Increasing national savings or reallocating savings to long-term investment supports the development of financial markets. This could be a boon to Korea if greater retirement savings assets are directed away from conservative investments (cash and bonds) in favour of growth-oriented financial market instruments. Greater domestic savings also reduces dependency on foreign savings to finance necessary investment. Higher investment may lead to higher productive capacity, increasing GDP, wages and employment, higher tax revenues and lower deficits.
Invested assets can also prove to be a better deal than public pensions when contributions to PAYG fail to go to public investment and thus increasing the productive capacity of the economy as a whole. For example, retirement savings that are invested in a way that exploits opportunities in financial markets to earn more than the rate of the wage bill growth, which is the implicit rate of return of the NPS scheme, can lead to higher incomes to individuals. This argument is even more salient in a context of population ageing and low productivity growth. Within DC schemes, each cohort is self-funding, reducing labour market distortion.
Funded schemes can also enable employers to offer targeted recruitment packages to attract employees. This is already the case in Korea, where large conglomerates tend to offer retirement pension plans as part of an attractive package. Broader rollout of funded schemes such as retirement pension plans can extend these benefits to other, particularly smaller, workplaces.
However, funding reduces the opportunities for inter- and intra-generational risk sharing that is a source of economic efficiency within the public systems. Within schemes such as the NPS, risks can be shared between workers and retirees by adjusting contribution and benefit levels. The gains in social solidarity that are available through inter- and intra- generational redistribution within such schemes may also offset some of the fiscal costs. This type of redistribution could also happen via a non-contributory basic pension financed out of general tax revenues, or by adjusting the parameters of private funded DB schemes.
5.12.4. Trade‑offs between DB and DC pensions
Should Korea choose to pursue reforms that lead to greater reliance on private pensions, particularly retirement pension plans, it is important for policy makers to weigh the trade‑offs between the main two types of pension provision, DB and individual DC.
DC arrangements establish a direct link between contributions and retirement income, so are they provide the greatest incentive to individuals to contribute to pension plans. DC arrangements are mechanisms that automatically adjust benefits to demographic, economic and financial realities. However, DC plans transfer the responsibility for financial security in retirement onto individuals without offering them insurance against the multiple risks that can affect funded pensions. Notwithstanding, it is possible to introduce elements of insurance into DC pensions. For example, Chile covers some labour market and social risks with compensatory pension contributions from the state for periods of missed earnings such as maternity leave. Many OECD countries have also implemented policies that aim to protect individuals from financial market risks. For instance, some require DC providers to offer a default strategy that either follows a lifecycle approach or offers some other protection against financial market risk. In Estonia, Latvia and the Slovak Republic, individuals who do not make an active choice are allocated to a conservative strategy as a way to protect them against these risks. By contrast in Sweden, where the public system insures individuals relatively (and therefore of itself protects members from the downside risk of financial market shocks), the default investment strategy in the funded pension arrangement, the Premium Pension Fund, is quite aggressive.
Individual DC plans are better suited to changing labour market patterns, such as multiple employers and increased self-employment, than DB schemes. Within DB plans a uniform contribution rate combined with a uniform accrual rate can lead to redistribution from lower earners to higher earners and from new members to long-standing members, which could impede labour mobility. However, career breaks early on are especially costly for members of DC plans in terms of building up retirement assets (because the opportunity for compounding returns is lost). Pooled DC plans that are not tied to a specific employer, such as the Canadian Pooled Registered Pension Plans, could be a means of addressing changing labour market patterns while offering more risk pooling than individual DC arrangements.
A key shortcoming of individual DC pensions is managing longevity risk. DC pensions adjust automatically to demographic changes, which means that individuals can face greater risk of inadequate pensions. For example, if life expectancy increases, payments from a DC pot will run out. Another shortcoming is that individuals find it difficult to smooth their consumption post retirement using DC arrangements. There is evidence that individuals are not good at planning for their retirement needs and spreading their accumulated wealth effectively. For instance, there is evidence from Australia that retirees underspend because they are afraid of exhausting their savings. However, some longevity protection can be added to DC systems. One option is to have programmed withdrawals with a deferred life annuity as a default option for the pay-out phase. Examples can be drawn from other OECD countries as well. For instance, Norway imposes a pay-out phase for accrued pension capital of at least 10 years. Mandatory annuitisation could call for an enhanced role for the public sector to maximise the benefits of risk pooling and avoid self-selection issues, and overcome behavioural barriers to choosing the right annuity. Examples of countries with mandatory publically provided annuities (under certain conditions) include Sweden, Singapore and Lithuania.
DB schemes also face some risks. In recent years DB schemes have faced threats to their solvency due to historically low interest rates, increasing longevity, and, in some countries, a series of financial crises that have left them unable to fulfil their retirement income promises to their members. As the sustainability of pure DB systems has come under threat, different methods of risk sharing have been introduced that push more of the longevity, economic and market risk onto members but retain the risk pooling of DB. New designs may be referred to as “shared risk schemes” or “collective defined contribution”. There are also security mechanisms to back guarantees, which can help that help providers manage the risks they face in providing DBs, but these come at a cost. Relevant security mechanisms include:
A capital buffer, which helps ensure that the sponsor/provider of retirement income arrangements will have sufficient capital set aside to meet promised retirement income obligations with a high probability, even in the event of a significant adverse financial, demographic, or business shock.
A sponsor covenant, which refers to the obligation of the sponsor of the retirement income arrangement, typically the employer, to make additional contributions to the plan if assets are not sufficient to finance the retirement income liabilities.
A pension protection fund, which guarantees the payment of retirement income promises, either in full or partially, in the event that the sponsor becomes insolvent. Covered retirement income arrangements usually pay premiums to finance these funds, which effectively function as an insurance pool against the risk of sponsor default. How these premiums are set, the mechanisms the fund uses to cover the pension liabilities, and the extent to which the fund is backed by the government drive the strength of the protection fund.
Policy makers should consider the risks that come with each of DB and DC arrangements and respond with policy solutions that help bolster both arrangements. This will be particularly important once the government passes legislation expanding retirement pension plans to all employees, as all workers will be subject to one of the two types of arrangement. The different strategies to manage the risks of DB and DC pension arrangements discussed above will be particularly salient to the case of Korea.
5.13. A framework for assessing retirement income adequacy in Korea
Retirement income adequacy is a key issue in Korea. The OECD’s Pensions at a Glance 2021 showed that the replacement rate for mandatory pensions in Korea (31% of pre‑retirement earnings for individuals with full careers, excluding personal income tax and social security contributions) is one of the lowest in OECD countries, and significantly lower than the OECD average (over 50%). This replacement rate reflects hypothetical outcomes from the National Pension Scheme for individuals at certain income levels with full careers. However, the NPS does not cover the entire population and people who are covered by it often do not contribute for the equivalent of a full career. As such, in practice, the income replacement rates received by many people in the population would be even lower.
Reforms that mandate retirement pension plans for all employees will improve retirement income adequacy for some people, but alone are unlikely to solve the retirement income adequacy issues in Korea. This is because there will still be many who are at risk of being left behind. This is because, as discussed in Section 5.2, there are some exceptions to coverage that apply to both retirement pension plans and severance pay plans, which would likely persist if retirement pension plans become mandatory. Those exceptions include people with short service periods or those who work less than 15 hours per week. Furthermore, some non-standard workers such as the self-employed or informal workers remain would not be eligible to participate in the plans, as they are not deemed to be workers. To add to the lack of universal coverage, it is also not clear whether the contribution rate to retirement pension plans will be sufficient to achieve the government’s retirement income policy objectives.
As, such in order to understand the adequacy of the retirement incomes that existing pension policy is likely to deliver in Korea, the Korean authorities should conduct a full review of retirement income adequacy. Following the framework presented in Chapter 2 of the OECD Pensions Outlook 2020 (OECD, 2020[12]) for assessing the adequacy of future retirement incomes, the review should:
1. Establish a retirement income adequacy objective for Korea’s retirement system. Having an objective is important to establish what a retirement income system intends to achieve. Different objectives offer different perspectives for what an adequate income might entail. Examples of potential objectives are: alleviating poverty in retirement; maintaining individuals’ standard of living in retirement; achieving equity; and ensuring people live comfortable retirements.
2. Forecast retirement incomes under existing policy settings, and use those forecasts to calculate indicators of retirement income adequacy. Using administrative datasets or representative samples of populations, it is possible to forecast future retirement incomes to get a sense for the range of potential outcomes. Those forecasts would be based information about pension assets and pension entitlements for individuals in the analysis. Using that data, it is possible to project future retirement incomes using assumptions about future demographic, labour market, and economic outcomes, as well as likely behavioural patterns. As much as possible, those assumptions should reflect genuine expectations of future outcomes and behaviours. Using the forecasts for retirement incomes, then indicators of retirement income adequacy can be calculated for each individual in the sample or dataset. Depending on the objective, different indicators can be calculated. Indicators include the forecasted level of retirement income, replacement rates, and equity measures.
3. For the indicators to be meaningful in assessing retirement income adequacy, they should be compared to adequacy targets. Targets are reference points for determining if retirement incomes are adequate. Setting targets involves establishing an adequacy standard. In particular, it involves forming a view on issues like an appropriate replacement rate, a minimum subsistence standard, the standard of living that allows people to live comfortably, etc. Effective targets are ones which are impartial, based on evidence pertaining to a particular jurisdiction, and, where relevant, tailored to different types of individuals or stages of retirement. An independent body, such as a taskforce or academic body could conduct an impartial assessment of adequacy targets.
4. By comparing adequacy indicators across a sample or population and comparing them to targets, policy makers should make an assessment of whether the system provides broadly adequate retirement incomes. This assessment should refer to policy makers’ goals, which in turn should reflect their tolerance for risk and tolerance for potential adequacy shortfalls. Policy makers can quantify these goals. For example, they can aim that a particular percentage of the population to achieve the adequacy targets that are right for them, or their policy goal could be to minimise adequacy shortfalls. By assessing the adequacy of future retirement incomes with reference to these policy goals, it is possible to identify adequacy shortfalls and formulate any policy responses. The process could then be repeated to test how different reforms could change retirement income adequacy outcomes.54
An independent taskforce could conduct this review, and can be given the power and authority to access the relevant data from stakeholders such as pension providers. This may require co‑ordination with governments who may also have key administrative information and are also able to conduct surveys that might be needed. In particular, surveys might be needed to come up with appropriate adequacy targets or to inform assumptions around future behaviours, such as voluntary take‑up and contributions to occupational and personal pension plans, as well as early withdrawals, where relevant.
5.14. Policy options
1. Fully transition from severance pay schemes to retirement pension plans. The Korean Government should proceed with its plans to legislate a full transition from severance pay schemes to retirement pension plans for all workplaces. The current plan, which involves a transition period to give smaller businesses time to adapt, is a suitable approach. The OECD’s discussions with various stakeholders in Korea suggest that businesses are expecting the change to happen and have had sufficient time to adapt. Furthermore, the option for KCOMWEL to provide a low-cost solution for small businesses is a good way to cater to the needs of smaller businesses and potentially offer low-cost pensions provision.
2. Limit exemptions to occupational pension plan coverage. Korean pension policy currently provides that workers who have worked less than one year and those who work less than 15 hours a week are not required to be covered by occupational plans (even under the proposed bill what would mandate occupational plans). While recent legislation has made it possible for these people to become members of IRP plans, it is still not a requirement that they are covered by occupational plans. This should be changed, as per the OECD Core Principle of Private Pension Regulation No° 8, which provides that a member’s entitlements should accrue and vest immediately upon entry into a plan.
3. Boost tax incentives and introduce non-tax financial incentives. The tax and non-tax financial incentives for retirement savings are low in Korea relative to other OECD countries. The government could expand tax incentives to encourage use of pension. This can be done within the existing system, for example, by increasing the tax credit rate for individual contributions or amending the formulas to reduce the tax on pay-outs. Furthermore, the fact that low income earners do not benefit from tax credits if they do not pay taxes means that they have almost no financial incentives to voluntarily contribute to occupational DC or personal pension funds. The government could address this shortcoming by introducing non-tax financial incentives such as matching contributions or fixed nominal subsidies to encourage contributions to pension schemes, especially for lower income individuals. Alternatively, it could make the tax credits refundable to benefit low-income people.
4. Simplify the pension tax system. Different tax rules apply depending on whether contributions originated from the employer (EET/EEt) or the individual (tEt/tET). The Korean authorities could considerably simplify their system, and potentially transition to a universal EET system. The EET system delivers immediate full tax relief at the time of the contribution, it provides a better incentive for individuals to contribute, but this would come at a fiscal cost. Another potential shortcoming is that if existing contributions (i.e. accounts that have already been taxed under the tEt regime) are grandfathered, there would be two parallel systems, making administration harder. Of course, this might have to be a long-term solution, as the pension tax system has just recently come out of a transition period from the last set of reforms.
5. Improve pension plan coverage for informal workers and self-employed workers. There is low pension coverage across all pension plan types for informal workers and self-employed people. A large number of them are not covered by the NPS, and low coverage of private pension plans exacerbates this problem. There appears to be no bespoke policies to promote pension plan coverage for informal workers. This is a problem in Korea, given the old age poverty rates and low level of social safety net support. The government could attempt to reduce the level of informality itself by increasing the relative cost of being informal compared to being formal. To reduce this cost, the government could subsidise the pension contributions of low-income or informal workers, as discussed in the previous recommendation. This measure could be accompanied by the possibility of having a flexible contribution schedule and rate and innovative collection mechanisms such as through utility bills. Behavioural nudges that increase the likelihood that they will contribute could accompany those measures. Given that some self-employed workers have volatile earnings, they may value flexible contributions and hybrid pension products mixing an emergency savings account with a retirement savings account. However, these approaches raise adequacy issues and need to be complemented by reminders. To replace automatic payroll deductions, the self-employed could benefit from automatic savings mechanisms, using digital services and platforms they already use to run their business. Informal workers could also be offered the possibility to save small amounts automatically, for example through consumption, to reduce the impact of inertia and procrastination. Policy makers could make use of new technologies and easily accessible points of contact (e.g. convenience stores) to simplify the contribution process. Korean policy makers may also wish to consider, once retirement pension plans are mandatory for all workplaces, automatically enrolling the self-employed into retirement pension plans. The tax authorities or a pension provider such as KCOMWEL could play the role of enrolling the self-employed.
6. Lift investment restrictions and encourage more suitable investment strategies. The current investment regulation limits the possibility of pension providers to invest in non-guaranteed assets. These restrictions create barriers, limiting the possibility of pension providers to diversify their assets in a context of low and falling interest rates. The government should also take steps to address what appears to be an overly conservative bias for investment choices. For example, the government could promote life cycle investment strategies or target date funds as a solution that improves investment performance while also accounting for risk aversion in later years of life. The government should also de‑link tax incentives from guarantees. Personal pension plan products currently only attract a tax deductible status if they offer guarantees. There does not appear to be a strong rationale to encourage guaranteed investment strategies in this manner.
7. Pension providers should better communicate about risk and rewards of different investment strategies. When given a choice of investment strategy for DC plans, most individuals and employers in Korea select a conservative investment option. Investing conservatively can significantly reduce investment gains and limit the accumulation of assets, particularly for younger people. Most do not seek financial advice before selecting their retirement savings investment strategy. It is therefore important that regulators ensure that individuals and employers receive adequate information to compare their alternatives and make better choices with respect to their investment strategy. In doing so, they should be mindful of the behavioural biases that people have when making choices and adjust communication accordingly.
Communication about investment strategies and their associated risks, rewards and costs needs to be adapted to the target audience. In Korea, for instance, communication to plan members and employers may require risks to be framed in a way that also emphasises potential rewards. This can help overcome individuals’ risk aversion. One way to better communicate on risk is to frame it in terms of probabilities that people can understand. For example, risk bands can be used, with each band corresponding to the expected number of negative return years to expect over a particular saving period (see, for example, Table 7.1 of (OECD, 2020[13])).
Jargon and complex metrics should be avoided when communicating to individuals about their investment options. Standardising the communication on risks may be necessary for comparison purposes, but should also be accompanied by visual aids for people to interpret risk measures. Providers using standardised risk indicators may mix them with other commonly used visuals or colours in order to ease communication.
Policy makers should consider designing tools to assist people in determining their risk appetite. Entities such as the FSS can provide guidance on the mapping of risk and return categorisations to that of individuals’ personal risk appetite. People should be able to understand whether an investment strategy’s risk and return profile is appropriate, given their personal circumstances and preferences.
8. Implement the requirement for pension providers to have a default investment option. Individuals should receive appropriate information about the different investment options they have, but need to have a default option in case they are not willing or able to choose. This default option should be designed in a way to ensure it is aligned with the risk appetite of most people who will end up with this option. For example, the default investment strategy could be adapted to provide a more optimal lifecycle approach, providing a more gradual de‑risking as individuals approach retirement and more flexibility around how different types of savings are invested.
9. Consider introducing additional security mechanisms to help providers manage the risks they face in providing DB plans. The government currently provides a cash injection of KRW 10 million if a retirement benefit is due when a DB plan is in a funding shortfall position. This can encourage poor decision-making by employers. The government can consider instead enforcing mechanisms such as a capital buffer or setting up a pension protection fund.
10. Restrict permitted cases of early withdrawal. Individuals are currently allowed to access their savings early under certain circumstances. This is contrary to the purpose of retirement saving products which are intended to provide income in retirement. Limiting the cases of early withdrawal to cases such as severe financial hardship is more in line with best practice in other systems. Limiting these cases of early withdrawals for occupational plans once they are mandatory should not be controversial, as it will no longer be needed as an incentive to use the plans. Banning withdrawals (albeit with penalties) under normal circumstances from personal pension plans also helps ensure the products are used for their intended purpose. On the other hand, for personal plans, limiting the cases of early withdrawal might discourage their use. However, it is important to limit early withdrawals for personal plans to ensure they are used for their purpose and to maximise assets at retirement. This might reduce their attractiveness, but making this change as a package reform alongside increased financial incentives might make the change more palatable. One way of introducing this change is to do so gradually – for instance, by starting with a cap on early withdrawals to ensure they still meet market demands, with the option of increasing those caps for new entrants over time, as society becomes more accustomed to longer-term saving instruments.
11. Encourage people to purchase annuity products to protect them against longevity risks. Most members tend to receive lump sum payments. As such, private savings do not protect Korean retirees against longevity risk as they face the risk of outliving their assets.
While annuities may not always be suitable, especially when private pension savings are small, it is important to remove any necessary barrier that could prevent people from selecting an annuity. It may be appropriate to eliminate the current requirement to be a member for more than 10 years of an occupational plan to be eligible to purchase an annuity.
Another way to better encourage individuals to purchase annuity products is by increasing the tax differential between lump sums and annuities. Under the current situation, individuals’ preference for an immediate lump sum is enough for many to forego the tax incentive associated with an annuity, particularly when the amounts saved are small. One way to increase the tax differential between a lump sum and annuity is to reduce the rate of tax that would be due (currently 70%) under an annuity compared with a lump sum. Another option may be to remove entirely the tax incentives of taking out a lump sum (that is, the smaller tax base) to discourage individuals perceiving lump sums as a good deal.
The promotion of deferred annuities could also be an alternative to ensure people are protected from longevity risk at the end of their life while leaving them some flexibility on the way they use their private pension savings in the early days of their retirement.
12. Increase the age of access to private pension plans to align it to the retirement age of the public system. In order for occupational and personal pensions to directly complement pensions from the NPS, their access ages should be consistent. One way to do so is to gradually increase the age of access to private savings up to the future normal retirement age of 65. Many Koreans have historically relied on pay-outs from their employers to maintain their standards of living or to open small businesses. Increasing the age of access should therefore happen gradually while ensuring this does not leave old-age workers more economically vulnerable before retirement.
13. Improve fee structures to better align the incentives of providers and members. Fees based on assets do not provide incentives for fund managers to be more efficient, and may reward poor performance and penalise good performance. Asset-based fees are not linked to the relative performance of the fund compared to the market, and a fund that underperforms the market with positive returns can earn more in absolute terms than one who outperforms the market but with negative returns. Instead, performance fees could better align the incentives of providers and members while also helping ensure higher risk-adjusted returns. Performance based fees pay higher fees for higher risk-adjusted returns. Combining an appropriate investment benchmark with a performance‑based fee structure would incentivise the fund managers to seek higher risk-adjusted returns with more innovative strategies. However, excessive fees are also a problem for conservative investment strategies, and switching to a performance fee structure is less likely push down those fees. As such, the Korean authorities could also reduce costs through appropriately designed direct pricing mechanisms such as fee caps, in line with approaches taken in other OECD countries. Another way to reduce costs is to encourage greater competition through a low-cost provider. This function could be performed by KCOMWEL in Korea which already provides a not-for-profit pension provision service which competes with other providers. Over time its function could be scaled up and extended to larger businesses.
14. Improve financial knowledge around retirement income. While Korea already has some financial education programmes, more can be done to specifically focus on how financial decisions today relate to retirement income outcomes in the future. Financial knowledge programmes could equip people with the tools to understand the relationship between the different schemes that can provide them income in retirement. People could be helped to assess their personal circumstances with reference to this system, and to decide to what extent contributing to the voluntary pension system would be beneficial to their individual circumstances. Financial education programs could also aim to reach individuals through their employers or through financial institutions, which individuals tend to trust. Financial education programs may also be helpful when people transition to retirement to help them select the most appropriate pay-out options for them while ensuring they are covered against longevity risk. The public education programs can also target key areas of particular importance for the public to understand.
Better communication about incentives to save. The Korean Government offers tax incentives to individuals who save through retirement pension plans and personal pension plans. However, much of the public may not understand that these tax incentives are available. They also may not appreciate how those tax incentives might compare to other forms of saving, such as through bank accounts or real estate. Public education campaigns can help publicise pension saving, particularly by focussing on how they can lead to higher incomes in retirement. Similarly, if the government proceeds with any plans to provide non-tax financial incentives to encourage individuals to save (as recommended above) that should come with a communication campaign aimed particularly at explaining those incentives to lower income earners in a simple way.
The Korean public continues to favour short-term, or immediate, benefits over long-term needs. This manifests in a preference for severance payments, early pay-outs from pension plans, and lump sums. While such behaviours are difficult to reverse, one way to help shift the public mind-set is for public communication campaigns to highlight the risks of under‑saving. It is important to highlight the need to balance people’s current needs with those of the future which is difficult to predict and comes with genuine risks to long-term financial security.
The evidence suggests that the general public in Korea mistrust private pensions. This is particularly true of retirement pension plans, as there is a perception that if an employer becomes insolvent then they will lose their retirement pension. However, since funded pension assets are held separately with investment, they would not be affected in the case of an employer’s bankruptcy. It is important that the public better appreciate the safety of funded pension arrangements. As such, policy makers should try and capitalise on the benefits on funded arrangements by better communicating their benefits. The opportune moment for doing so would coincide with the passing of legislating that requires all employers to provide retirement pension plans to their employees. Severance pay, until RPPs, continue to rely on book reserves and may in fact be vulnerable to instances of employer bankruptcy. Accordingly, a communication campaign that accompanies the change should aim to capitalise on the benefits of RPPs over severance pay and reinforce the safety of funded pension arrangements.
Finally, there is greater scope for financial education around investment to be targeted at employers and individuals. Doing so can help refocus preferences away from conservative biases and in favour of a more balanced understanding of risk and potential returns.
15. Improve coherence of the pension system. It is not yet clear how the public and private schemes are intended to complement each other. To date, many changes to the different pension system components appear to have happened in a piecemeal way and without a systematic plan to achieve particular objectives or address key risks. There are also no apparent adequacy targets for retirement income in Korea. Pension adequacy is a problem, and pension system reform is needed to improve retirement incomes for the population. The replacement rate on public pensions is relatively low and the private pension system, as it is currently designed, will not be sufficient to compensate for its shortcomings. As such, it is important that the Korean authorities take these important deliberative steps to formulate an overall plan for pension system complementarity as a foundation for any future reform.
References
[1] Financial Services Commission and KDI School of Public Policy and Management (2014), 2013 Modularization of Korea’s Development Experience: Institutions and Policy Measures for the Development of Korea’s Asset Management Industry.
[4] FSS (2020), 2019 Annual Report.
[6] Hong, W. (2019), Retirement Plan Returns and Participant Burden.
[5] Kim, S. (2018), “Spotlight on Retirement: South Korea 2018”, http://www.kidi.or.kr (accessed on 2 January 2020).
[7] Korea Institute of Finance (2013), The Growth and Development of the Korea Insurance Development Institute (KIDI), http://cifc.newdept.com/files/reference/total/en/81042d06c27b4059dfc55ef537c7a8f1_20181018130117.pdf (accessed on 8 March 2021).
[8] Lee, Y. and B. Lim (2013), Establishing the role of Personal Pension Plans as Supplementary System for National Pension and Ways for Future Development, National Pension Research Institute.
[10] OECD (2021), Pensions at a Glance 2021: OECD and G20 Indicators, OECD Publishing, Paris, https://doi.org/10.1787/ca401ebd-en.
[12] OECD (2020), “A framework for assessing the adequacy of retirement income”, in OECD Pensions Outlook 2020, OECD Publishing, Paris, https://doi.org/10.1787/760ca223-en.
[18] OECD (2020), Average wages (indicator), https://doi.org/10.1787/cc3e1387-en (accessed on 3 January 2020).
[13] OECD (2020), “Communicating on investment strategies”, in OECD Pensions Outlook 2020, OECD Publishing, Paris, https://doi.org/10.1787/b1e52a63-en.
[17] OECD (2020), OECD Pensions Outlook 2020, OECD Publishing, Paris, https://doi.org/10.1787/67ede41b-en.
[2] OECD (2019), Financial incentives for funded private pension plans, OECD Country Profiles, OECD, http://www.oecd.org/daf/fin/private-pensions/Financial-Incentives-for-Funded-Pension-Plans-in-OECD-Countries-2019.pdf (accessed on 19 December 2019).
[11] OECD (2019), OECD/INFE Report on Financial Education in APEC Economies: Policy and practice in a digital world, https://www.oecd.org/finance/financial-education/2019-financial-education-in-apec-economies.pdf (accessed on 14 January 2020).
[3] OECD (2018), Financial Incentives and Retirement Savings, OECD Publishing, Paris, https://doi.org/10.1787/9789264306929-en.
[14] Phang, H. (2010), “Building private and occupational schemes in Korea”, in Yang, J. and T. Klassen (eds.), Retirement, Work and Pensions in Ageing Korea, https://books.google.fr/books?hl=fr&lr=&id=DFuOAgAAQBAJ&oi=fnd&pg=PA96&dq=third+pillar+pensions+in+korea&ots=j7KOO8kz6V&sig=Rps0aYBwh2a1m3Nxa-CqxxgrE14&redir_esc=y#v=onepage&q=third%20pillar%20pensions%20in%20korea&f=false (accessed on 2 January 2020).
[16] Ryu, G. and S. Lee (2011), Directions for policy support for individual pension subsidy for low-income families.
[9] Statistics Korea (2019), Retirement Pension Statistics in 2018, http://kostat.go.kr/portal/eng/pressReleases/1/index.board?bmode=read&bSeq=&aSeq=382089&pageNo=1&rowNum=10&navCount=10&currPg=&searchInfo=srch&sTarget=title&sTxt=pension (accessed on 22 December 2020).
[15] Yang, J. (2010), Retirement, Work and Pensions in Ageing Korea, Routledge, https://doi.org/10.4324/9780203860182.
Notes
← 1. Article 4 of the Employee Retirement Benefit Security Act
← 2. National Statistics Bureau, Retirement Pension Statistics 2018, available at:
http://kostat.go.kr/portal/eng/pressReleases/1/index.board?bmode=read&aSeq=382089.
← 3. See IOPS country profile of Korea: http://www.iopsweb.org/resources/IOPS-Profile-Korea-2017.pdf
← 6. Act on the Guarantee of Workers’ Retirement Benefits, Article 24, Paragraph 2; Enforcement Decree of the Act on the Guarantee of Workers’ Retirement Benefits, Article 16‑2. The eligibility criteria for an IRP are: individuals who received their retirement benefits in lump-sum distribution; members of a DB pension plan or DC pension plan who wish to set up an additional individual retirement plan funded through their personal contributions; self-employed individuals; individuals who worked for an employer that does not offer a retirement plan for less than one year, based on the length of continuous employment; individuals whose weekly hours worked without a retirement plan is less than 15 hours, based on a four‑week average; individuals covered by a lump-sum retirement benefits programme; civil servants; military personnel; teachers; or employees of special post offices.
← 8. For example, in workplaces with ten or fewer employees who opt for an IRP, the obligation to prepare the retirement pension covenant is exempted (Financial Services Commission and KDI School of Public Policy and Management, 2014[1]).
← 9. Article 26 of the Act on the Guarantee of Employees’ Retirement Benefits
← 10. Employee Retirement Benefit Security Act
← 11. This is part of an amendment to the Employee Retirement Benefit Security Act, submitted to the National Assembly in June 2020.
← 13. Proposal for a Partial Amendment to the Workers’ Retirement Benefit Guarantee Act, available at: http://likms.assembly.go.kr/bill/billDetail.do?billId=PRC_R1C9V0S6Z1Y1A1B7S4O6S4U4X0Y2H1
← 14. According to the Partial amendment to the Workers’ Retirement Benefit Guarantee Act Bill, the smallest businesses will only be required to transition to retirement pension plans by 2026: http://likms.assembly.go.kr/bill/billDetail.do?billId=PRC_R1C9V0S6Z1Y1A1B7S4O6S4U4X0Y2H1
← 15. Individuals cannot make contributions to occupational DB pension plans.
← 16. Low income individuals are those with an income lower than KRW 40 000 000 (or KRW 55 000 000 when the only income source is salary income).
← 17. Average wages are from OECD (2020[18]). In that publication, the average wage figure is the national-accounts-based total wage bill divided by the average number of employees in the total economy, multiplied by the ratio of the average usual weekly hours per full-time employee to the average usually weekly hours for all employee.
← 18. The Wage Claim Guarantee system and corresponding fund aim to provide compensation to provide payments to workers laid off from bankrupt companies.
← 19. Note that there have recently been reforms to the tax rules and the ones describe here are current as of 2020 and follow from a transition period that lasted from 2016 to 2019.
← 20. 𝑇𝑎𝑥 𝑏𝑎𝑠𝑒=(𝑝𝑒𝑛𝑠𝑖𝑜𝑛 𝑖𝑛𝑐𝑜𝑚𝑒−𝑑𝑒𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑓𝑜𝑟 𝑐𝑜𝑛𝑡𝑖𝑛𝑢𝑜𝑢𝑠 𝑦𝑒𝑎𝑟𝑠 𝑜𝑓 𝑠𝑒𝑟𝑣𝑖𝑐𝑒)×12÷𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑒𝑟𝑣𝑖𝑐𝑒 𝑦𝑒𝑎𝑟𝑠. Where the deduction is calculated as:
← 21. 𝑇𝑎𝑥 𝑝𝑎𝑖𝑑=(𝑡𝑎𝑥 𝑏𝑎𝑠𝑒−𝑑𝑒𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑓𝑜𝑟 𝑖𝑛𝑐𝑜𝑚𝑒 𝑙𝑒𝑣𝑒𝑙)×𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠𝑖𝑣𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒𝑠×𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑒𝑟𝑣𝑖𝑐𝑒 𝑦𝑒𝑎𝑟𝑠÷12. Where the deduction is calculated as:
← 22. These results are based on the tax rules in 2018. These rules have changed since then.
← 23. Some Korean commentators also have already flagged that more can be done to encourage the use of personal plans in Korea, including through means such as matching contributions. See, for example Lee and Lim (2013[8]) and Rye and Lee (2011[16]).
← 24. https://www.kcmi.re.kr/en/publications/pub_detail_view?syear=2019&zcd=002001017&zno=1438&cno=5117
← 25. Article 21 of Employee Retirement Benefit Security Act.
← 26. See Article 30 of Employee Retirement Benefits Security Act. Article 25 of the Enforcement Decree of the Employee Retirement Benefits Security Act specifies the investment instruments or vehicles that are considered as guaranteeing the principal and interest, such as bank deposits and insurance contracts with a guaranteed return for example.
← 28. Article 30 of Employee Retirement Benefits Security Act.
← 29. Assets in DC plans and IRP can be invested in REITs, following an amendment of the Enforcement Decree of the Act on the Guarantee of Employees’ Retirement Benefits in December 2019.
← 30. See OECD data portal: https://data.oecd.org/interest/long-term-interest-rates.htm.
← 31. Article 16 of the Employee Retirement Benefit Security Act, available in English at: http://law.go.kr/engLsSc.do?tabMenuId=tab45#
← 32. Article 3 of the Enforcement Rule on the Act on the Guarantee of Employees’ Retirement Benefits. An MoEL decree providers for base rates which can be used if (1) it has been less than 3 years since the establishment of the business (except for establishment via merger or acquisition); (2) If historical data has been damaged by accident such as fire; or (3) If historical data is inept to be used for future projection.
← 33. Article 16 of the Employee Retirement Benefit Security Act, available in English at: http://law.go.kr/engLsSc.do?tabMenuId=tab45#; wid
← 34. The average daily wage is calculated as the total wages paid for 3 months immediately preceding retirement divided by days that befell in those 3 months.
← 36. Insurance Business Act.
← 37. Article 40‑2, paragraph 3.
← 38. University tuition fees, wedding costs and funeral costs are allowed for pension-back loans only (and not for early withdrawals).
← 39. See for example: Kim (2018[5]), Phang (2010[14]) and Yang (2010[15])
← 41. National Statistics Bureau, Retirement Pension Statistics 2018, available at:
http://kostat.go.kr/portal/eng/pressReleases/1/index.board?bmode=read&aSeq=382089.
← 42. The Herfindahl-Hirschman index is a measure of industry concentration. The value of the index is the sum of the squares of the market shares of all firms in an industry. Higher values indicate greater concentration.
← 48. http://dis.kofia.or.kr/websquare/index.jsp?w2xPath=/wq/compann/DISRtrPsnCmpAnn.xml&divisionId=MDIS02003001000000&serviceId=SDIS02003001000
← 50. For personal plans, fees on contributions are also permitted for insurance products.
← 52. Website of the FSS: http://www.fss.or.kr/fss/eng/wpge/eng111.jsp
← 54. A comprehensive discussion of the OECD’s framework for assessing the adequacy of retirement incomes is available at OECD (2020[17]).