[Insight & Opinion] Without Asset Allocation Skills, Stable Retirement Is Impossible

[Asia Economy] Discussions on National Pension reform are gaining momentum. Pension reform is not just a problem unique to our country. It is a challenge faced by all countries experiencing low birth rates and aging populations. Japan, the world’s oldest country, is also discussing pension reform again after 20 years. Germany is reportedly considering raising the pension eligibility age to 70. The direction of these pension reforms is clear: contribute more, receive less, and receive it later.

The meaning of pension reform is that since the government cannot provide more pension benefits than now, citizens themselves must make greater self-help efforts. Starting this year, authorities have raised the existing tax deduction limit for pension savings from 7 million won to 9 million won. Additionally, if at least one spouse over 60 years old who owns a single home downsizes to a lower-priced house, they can make additional pension savings contributions up to a difference of 100 million won. From a broad perspective, such government measures are welcome.

To prepare for longevity risk, humanity has yet to discover a financial system superior to pensions. The pension system, which involves steadily saving and investing small amounts while earning income to use as retirement funds later, is the strongest means of retirement preparation in any country. However, in Korea’s case, there are several critical weaknesses compared to advanced pension countries. Above all, the income replacement rate of public pensions is low. If the National Pension is reformed, the income replacement rate will inevitably decrease further. Considering the demographic structure where fewer people pay into the National Pension and more people receive benefits, it is safe to say that the income replacement rate is unlikely to increase. Another issue is that household asset composition is heavily concentrated in real estate. Real estate accounts for a staggering 70-80% of Korean household assets. Most real estate mortgage loans are variable-rate. Unlike the fixed-rate loans common in the U.S., Korean households are very vulnerable to interest rate fluctuations. When interest rates rise as they have recently, household income and saving capacity rapidly decline as a side effect. Fortunately, there are effective means to manage longevity risk, such as reverse mortgages, but it is difficult for the entire population to benefit. The only feasible measure is to provide strong incentives so that citizens can secure more pension assets themselves. Although tax deductions for pension savings were increased this year, about 2 million won is not enough to see a noticeable effect. Given the reality, there is hope for more radical tax benefits.

The ways individuals can increase pension assets through private pensions are to contribute more, invest longer, or achieve higher returns. Except for inheritance or gifts, there are no other methods. One of the most powerful variables determining returns in the investment world is asset allocation. Fortunately, financial innovation has introduced powerful asset allocation tools such as Exchange-Traded Funds (ETFs), and automatic investment options like default options and Target Date Funds (TDFs). Global asset allocation is now possible worldwide.

The problem lies in asset allocation ability. The global trend in pensions is to strengthen individual responsibility, requiring people to allocate assets themselves or manage investments directly. We are entering an era where without asset allocation skills, stable retirement life is impossible. Faced with the unprecedented challenge of longevity risk, it is time for deep reflection and effort on what we must do and how to manage our assets.

Lee Sang-geon, Head of Mirae Asset Investment and Pension Center