Your Retirement Will Be Decided by the Pension Reform Debate... Learn About It in Advance [Seungseop Song's Financial Light]

9% Insurance Premium, 40% Income Replacement Rate from Age 65
National Pension Benefits Dependent on Population Structure
My National Pension and Retirement Depend on 500 Citizens

The National Pension Service (NPS) is the foundation and cornerstone of South Korea's old-age security system. By paying 4.5% in contributions, you receive an incredible benefit of 40% in returns. However, the NPS is expected to be depleted in several decades due to low birth rates and an aging population. The government is preparing measures to overhaul the pension system. Starting today (the 13th), four discussion sessions will be held to debate pension reform plans that will determine our retirement. Here is some useful information about the National Pension before the discussions begin.

[Image source=Yonhap News]

Contribution Rate 9%, Income Replacement Rate 40%, Starting at Age 65

The contribution rate for our National Pension is 9%. This rate is split evenly between employees and employers. In other words, the government collects an amount equal to 4.5% of your monthly salary.

The government uses this money to create the ‘National Pension Fund.’ The fund’s net assets reached 1,035.8 trillion won last year, an increase of 145 trillion won from the previous year. The fund is invested in various assets, and its returns are publicly disclosed. In 2023, the National Pension Fund recorded a return of 13.59%. Since the fund’s establishment in 1988 until the end of last year, the average annual cumulative return was 5.92%.

The accumulated fund is then redistributed as pensions during retirement. The question is how much is paid out. This is where the ‘income replacement rate’ comes into play. The income replacement rate is the ratio of the pension amount to the average income during the period of National Pension enrollment. With an income replacement rate of 40% (as of 2028), if your average monthly income during contribution was 1 million won, you would receive 400,000 won as a pension.

However, this seems odd. Many pension recipients feel their pension amount is too low. This is because the income replacement rate assumes a contribution period of 40 years. As of 2022, the average enrollment period for the National Pension was only about 19.2 years. Naturally, a shorter contribution period results in a smaller pension amount. When compared to OECD countries, South Korea’s actual income replacement rate is lower than average at 31.2%, mainly due to the short enrollment period.

When you start receiving the pension is also an important factor. The later you start, the larger the gap becomes. As of 2033, the age to begin receiving the National Pension is 65 (for those born in 1969).

In summary, we pay 4.5% of our salary as National Pension contributions while working. At age 65, we begin to receive money back. The pension amount is 40% of our average income. However, if the contribution period is short, the pension amount decreases accordingly.

National Pension Benefits Dependent on Demographic Structure

There is a significant problem with the National Pension structure. Contributions are 4.5% of income, but pension payments are 40% of income. Simply put, the government must pay out pensions that are about ten times the amount collected in contributions. No matter how well the National Pension Fund invests, it cannot generate such returns annually.

The reason the National Pension has maintained such generous benefits so far is due to the demographic structure. There are two types of pension financing: ‘pay-as-you-go,’ where funds are collected annually through taxes or contributions to pay current pensions, and ‘funded,’ where contributions are collected in advance and accumulated in a fund. South Korea’s system is closer to the funded type. There have been enough working people to support guaranteeing a 40% income replacement rate for the elderly generation. This remains true today.

In fact, the National Pension Fund’s assets have increased every year since its inception. As mentioned earlier, the fund size was 1,035.8 trillion won in 2023. Ten years ago, it was about 427 trillion won. Moreover, it is expected to continue growing. According to calculations by the National Pension Research Institute, the fund will increase annually and reach a record high of 1,755 trillion won by 2040.

With a fund exceeding 1,700 trillion won, why are we worried about the National Pension? This is also due to demographics. South Korea is an unprecedented low birth rate and aging society. While the current situation is manageable, in several decades, the number of pension recipients will surge, and the number of contributors will sharply decline. According to Statistics Korea, in 2058, 100 working-age people will have to support 101.2 young and elderly dependents. By 2072, this number will rise to 118.5. This means fewer workers will have to support more than one dependent each.

Consequently, the future outlook for the National Pension is quite bleak. At the current rate, the fund is expected to be depleted by 2055. The National Pension Financial Projection Committee also anticipates worsening demographics due to low birth rates. They have calculated how the fund size will change in the distant future depending on fertility rates. If the total fertility rate falls to 0.98, a ‘ultra-low birth rate’ scenario, and the pay-as-you-go system is applied, contribution rates could rise to 34.3% by 2060. By 2093, they could soar to 42.1%.

The government has been aware of this for a very long time and has implemented two reforms. When introduced in 1988, the income replacement rate was a whopping 70%. The first reform in 1998 lowered it to 60%. The second reform in 2008 adjusted the income replacement rate downward by 0.5 percentage points annually, setting it to 40% by 2028.

My National Pension and Retirement Depend on 500 Citizens

Nevertheless, it is difficult to prevent depletion. This is why pension reform is currently being discussed. The current government has pledged to achieve pension reform. Accordingly, in October last year, the National Pension Deliberation Committee announced the ‘5th Comprehensive National Pension Operation Plan.’ However, it omitted specific figures such as contribution rates and income replacement rates, which are core to the National Pension. This is why critics inside and outside the government have called the reform plan ‘watered down’ and indecisive.

Ultimately, the responsibility has shifted to the National Assembly. The ‘Public Deliberation Committee’ will derive pension reform measures. The process is as follows: the committee’s ‘Agenda Deliberation Group’ selects several reform proposals. Then, 500 citizens review, evaluate, and discuss these proposals. Since they are ordinary citizens, they receive prior education before participating. Afterwards, the citizens conduct a survey, and the results will be announced on April 22.

There are two proposals. The first is to raise the contribution rate from 9% to 12% while maintaining the income replacement rate at 40%. The second is to increase the contribution rate to 13% and raise the income replacement rate from 40% to 50%. The first proposal reflects ‘financial stability,’ while the second emphasizes ‘income security.’ Fierce debates over these two pension reform plans will take place starting today.

Other important discussions include the ‘age to start receiving pensions.’ Proposals include maintaining the pension eligibility age at 65 and raising the mandatory enrollment upper age limit from the current 59 to 64. There will also be debates on how to structure the National Pension and the Basic Pension, as well as how to ensure intergenerational equity.