[Financial Essay] What Is the 3rd Layer Pension?

[Asia Economy Reporter Kim Min-young] What kind of retirement preparation can an ordinary office worker do? Do you need to have tens of billions of won in cash assets? Should you become a multi-homeowner with several houses? Should you buy a small building in the outskirts of Seoul to increase rental income?

For office workers who have no inherited wealth from their parents, these are like dreams.

For office workers to have a stable retirement, making good use of the pension policies introduced in Korea is almost the only and easiest way.

Korea’s pension system has a three-tier structure. The first tier includes public pensions such as the National Pension, Government Employees Pension, and Military Pension. The second tier is the retirement pension introduced instead of the severance pay system, and the third tier consists of private pensions such as pension insurance, pension funds, and pension savings.

The National Pension requires mandatory enrollment for those working from age 18 to 60. Self-employed individuals, job seekers, and homemakers over 18 who are not office workers can also join voluntarily. A minimum of 120 months of contributions is required to qualify for pension benefits.

The retirement pension was introduced in 2005 to guarantee the retirement of office workers. It is a system where the company entrusts the severance pay owed to employees to financial institutions and pays it as a pension upon retirement. Although lump-sum payment is possible, it is better to receive it as a pension in line with the purpose of retirement preparation.

There is also an individual retirement pension (IRP) product that individuals can directly subscribe to at banks and other institutions. This product offers a tax credit of up to 7 million won per year (16.5% if annual salary is 55 million won or less, 13.2% if over 55 million won).

Private pensions include pension insurance and pension funds. Insurance products are literally made by insurance companies, while pension savings funds are created by asset management companies. Pension insurance pays a fixed interest based on the announced interest rate and guarantees the principal, but pension funds’ payouts vary depending on the asset manager’s performance and carry the risk of principal loss, so caution is needed.

According to a survey, as of 2018, the average monthly pension amount combining public and private pensions for the elderly was only 570,000 won. Although it varies by institution, studies show that a minimum of 2.5 million to nearly 4 million won per month combined for a couple is needed for retirement living expenses. This means living on pensions alone is not feasible. There are two ways to increase pension amounts: either increase monthly contributions or lengthen the subscription period. This is why retirement preparation should start early in life.

A pension expert advised, “Salaried workers should take an interest in private pensions,” adding, “However, telling the 20s and 30s to prepare for retirement early is a message they find hard to relate to. Their interests lie in real estate and stocks, but to secure adequate living expenses in retirement, pensions must be prepared.”