[PB Notebook] Am I Subject to Comprehensive Financial Income Taxation? ... Focus on Tax-saving Products

Seonyeong Lee, Head of PB Team at Shinhan Bank Shinhan PWM Seoul Finance Center

Photo by Getty Images Bank

"There will be no interest rate cuts within this year." This is the statement made by Jerome Powell, Chairman of the U.S. Federal Reserve (Fed). Although many believe that the interest rate hike cycle has effectively ended with the Fed's Federal Open Market Committee raising the benchmark interest rate by 25 basis points (1bp=0.01%) in May, his remarks suggest that the high interest rate era will inevitably continue for the time being.

We are living in a high interest rate era that seemed unlikely to return after the 2008 global financial crisis. Until last year, it was not difficult to find fixed deposits with annual interest rates in the 6% range and installment savings with rates in the 7% range.

Accordingly, the income tax issues related to financial income, which were once concerns only for high-net-worth individuals, have now become a headache for middle-asset holders as well. For example, depositing just 500 million KRW in a fixed deposit with a 4% annual interest rate generates 20 million KRW in financial income, making it subject to comprehensive financial income taxation.

Comprehensive financial income taxation means that if annual financial income exceeds 20 million KRW, the excess financial income is combined with other comprehensive income such as earned income, business income, and rental income, and taxed at the comprehensive income tax rate (progressive tax rate). If annual financial income is 20 million KRW or less, taxation ends with a 15.4% withholding tax, but income exceeding 20 million KRW is combined with other income amounts, and the higher the other income, the higher the tax rate, up to a maximum of 49.5%.

The tax issue does not end there. Additional health insurance premiums must also be paid. The criteria for additional health insurance premiums can be simulated on the National Health Insurance website. For workplace subscribers, if income outside of salary exceeds 20 million KRW annually, about 8% combined health insurance and long-term care insurance premiums must be paid on the excess amount. This is another reason why high interest rates are a concern for asset holders.

So, what are the ways to reduce taxes? It is time to consider so-called 'tax-saving products' that either exempt taxes (non-taxable), reduce taxes (separate taxation), provide tax credits, or defer taxes (tax deferral).

A representative non-taxable product is the Individual Savings Account (ISA). Within the ISA, financial income generated during the investment period and investment losses are offset, and up to 2 million KRW (4 million KRW for the low-income type) is completely tax-exempt, while excess income is subject to separate taxation at 9.9%. Additionally, if the ISA product is terminated after a 5-year maturity and the funds are transferred to a pension account, an additional tax credit of 10% (up to 3 million KRW) of the transferred amount can be received. Other options to consider include domestic equity funds, exchange-traded funds (ETFs), low-coupon bonds, and savings-type insurance.

Brazilian government bonds are also attracting attention as a tax-saving product. Investing in government bonds issued by Brazil exempts all interest income from taxation, unlike general bonds. Capital gains from exchange rate fluctuations and trading profits are also tax-exempt. This is because, under the treaty with Brazil, Korea does not have the right to tax these incomes. Currently, Brazil does not impose taxes on interest income from government bonds. However, Brazilian bonds must be invested in Brazilian Real, which has high exchange rate volatility, making the investment riskier, so a cautious approach is recommended.

Separate taxation products include U.S. dollar-denominated Korea Electric Power Corporation (KEPCO) bonds, publicly offered REITs, and real estate funds. The dollar-denominated KEPCO bonds were issued with a 30-year maturity until 2027 during the 1997 foreign exchange crisis to raise foreign currency. According to the tax exemption regulation law at that time, interest income tax is exempted. However, under Article 5, Paragraph 1, Item 2 of the Special Taxation for Rural Areas Act, individuals are subject to a 1.4% rural special tax, which is 10% of the exempted interest income tax, and corporations are subject to a 2.8% rural special tax, which is 20% of the exempted interest income tax.

Tax credit products include pension accounts. When contributing to pension accounts such as pension savings and retirement pensions, a tax credit of 13.2% (for comprehensive income exceeding 55 million KRW) or 16.5% (for comprehensive income 55 million KRW or less) is applied up to a maximum contribution of 9 million KRW. Taxes on investment gains are deferred until withdrawal, providing a tax deferral effect. Additionally, when retirement funds are deposited into a retirement pension account, retirement income tax is paid at once, allowing the investment gains to accumulate, and if the pension is received over more than 10 years, only 70% of the originally payable retirement income tax must be paid.

Taxes can also be deferred by using insurance. If you subscribe to savings-type insurance, even if you withdraw early or receive a pension before exceeding the principal, no tax is imposed. Taxation occurs only when the insurance contract expires due to maturity or when the pension payments exceed the principal, allowing you to defer the tax payment timing to your preferred time. Especially, receiving the pension in installments rather than a lump sum can help distribute financial income annually.

Other tax-saving methods include managing the timing of financial income attribution by staggering maturities or making pre-gifts to spouses or children within the gift tax exemption limits. Prepare wisely for May next year by choosing the method most suitable for you.