[Insight & Opinion] Unending Cash Flow, Dividends, and Retirement Planning

Three-Tier Pension System Is Fundamental
Stock Dividends Are a Strong Source of Cash Flow
Dividend Income Tax Burden Hinders Activation

Working in retirement planning, I often receive questions about preparing for old age. Many experts offer their own opinions on this, but from a financial perspective, it can be summarized in one sentence: "Ensure that your cash flow does not dry up until the time of death!" There are various ways to achieve this goal.

First, prepare assets that can secure cash flow even before retirement. This includes the so-called three-tier pension system: the National Pension, the Retirement Pension, and the Personal Pension. Next, create a self-pension from existing assets. A self-pension refers to investing in assets that generate cash flow such as rental businesses, dividends, and interest, or withdrawing a certain amount or percentage from owned assets to cover living expenses. Third, generate cash flow from existing assets. The housing pension is a typical example. The biggest advantage of the housing pension is that you can live in your owned home while generating cash flow until the time of death.

Currently, the three-tier pension, rental businesses, and housing pensions seem to have a certain institutional foundation, although opinions may vary by individual. Interest income is determined by market interest rates and deposit amounts, so it does not need separate mention. The problem lies with stock dividends. In a capitalist society, dividends are the most reliable source of cash flow and a powerful way to share the fruits of corporate growth. From an investor's perspective, unlike real estate, dividends allow accumulating assets that generate long-term cash flow even with smaller investment amounts. However, in South Korea, there are several disadvantages for investors trying to create cash flow through dividends themselves.

First is the perception of shareholders by companies. Companies that consistently pay dividends can be considered considerate of their shareholders. Of course, if a company can grow better through investment rather than dividends, that is a better capital allocation, but companies that cannot should share their performance with shareholders through dividends or stock buybacks. Unlike in the U.S., there are not many domestic companies that increase dividends over a long period.

Regarding this phenomenon, many experts point out the problems with dividend income tax as much as corporate perceptions. Major shareholders must pay up to 49.5% tax due to comprehensive income tax on dividends received. Rather than paying nearly half in taxes, it is more tax-efficient to find other tax-saving methods.

For individual investors, if dividend income exceeds a certain threshold, health insurance premiums and comprehensive real estate tax burdens increase. Some argue firmly that taxes should exist where income exists, and it is natural for taxes to increase proportionally with the amount. This argument has merit. However, in reality, no perfect system or logic exists in a black-and-white manner. It must be viewed from a cost-benefit perspective.

Should we maintain the current tax system, or would it be better to provide incentives for dividends so that investors can share in the fruits of corporate growth? We need to consider whether it is better for major shareholders to use loopholes like physical division to avoid paying dividends, or to provide tax incentives on dividends, which might be more suitable for South Korea’s future as it enters a super-aged society (with over 20% of the population aged 65 or older). Considering both present and future, we should contemplate which option offers higher cost-benefit.

Those advocating for reforming dividend income tax or for the wealthy paying more taxes have clear arguments. However, what is more important is policy that fits societal changes. What was right in the past is not necessarily right now, and what is right now may not be right in the future ? to think otherwise might be stubbornness. It is time for a more serious discussion on dividends in the process of capital market value-up.

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