[Financial Planning for the 100-Year Life] Pension Investment You Should Start Learning as Soon as You Begin Your Career

You Should Join the Three-Tier Pension System in Your 20s and 30s
Effort Needed to Manage DC-Type Pension Assets
Invest Long-Term in Installment Plans for 10 to 40 Years

Many people are surprised when told that preparing for retirement in the era of 100-year lifespans should begin in their 20s and 30s as they start their social lives. They often think it’s too extreme to start that early. However, preparing for a happy retirement takes that much time. A prime example is pension preparation. When we think of welfare-advanced countries, we tend to imagine nations where most elderly people hold billions of won in retirement funds, but that’s not the case. A welfare-advanced country is one where the state ensures that people receive at least a minimum living expense through pensions until they pass away.

To receive a pension sufficient to cover living expenses in retirement, short-term pension enrollment is impossible. Even small monthly contributions must be made consistently over 30 to 40 years. Therefore, employees must clearly recognize how important pensions are for their retirement and join the three-tier pension system (National Pension, Retirement Pension, Personal Pension) as soon as they start their social life in their 20s or 30s, while also studying about pensions.

The first tier of the three-tier pension system, the National Pension, is a public pension managed entirely by a government agency, including pension asset management, and although not explicitly stated, the state guarantees pension payments. Therefore, subscribers only need to focus on strategies to “receive more from the National Pension.” However, Retirement Pensions and Personal Pensions are different. For DB (Defined Benefit) plans, where the company (for Retirement Pension) or financial institution (for Personal Pension) manages the pension assets, subscribers do not need to worry about asset management. On the other hand, for DC (Defined Contribution) plans, where the subscriber is responsible for managing pension assets, it is essential to study and actively work to increase investment returns.

This is because the success of one’s retirement fund depends on the performance of pension asset management. Moreover, in this low-interest-rate era, the proportion of DC-type plans is increasing for both Retirement and Personal Pensions.

To successfully manage DC-type pension assets, keep the following three points in mind.

First, DC-type pension asset management involves long-term, installment-style investments over 10 to 40 years. Second, even if there is short-term price decline risk, the focus should be on investment-type products that can expect higher returns than deposit interest rates in the long term. Third, such long-term management is possible precisely because of DC-type Retirement or Personal Pensions. This means not being swayed by short-term price fluctuations and practicing long-term diversified investments.

The main reason many American employees become pension millionaires is due to the high returns on pension asset management. Although there is no official data on the returns of American DC-type pensions, according to the Investment Company Institute, the average annual return over the past 10 years is about 8%. Comparing this to Korea’s DC-type Retirement Pension’s average annual return of 2.3% over the past 10 years as of the end of 2023 shows a significant difference.

So, what causes this difference in returns between Korea and the U.S.? There are several reasons, but the biggest is the difference in how DC-type pension assets are managed in the two countries. In Korea, 78% of managed assets are placed in principal-guaranteed products such as deposits or short-term financial products. Only 22% is invested in products that can expect some returns (as of the end of 2023). In contrast, about 80% of U.S. pension assets are invested in investment products, indicating a much more aggressive management approach.

If an employee earning an annual salary of 60 million won joins a DC-type Retirement or Personal Pension and contributes 5 million won (equivalent to one month’s salary) once a year for 30 years, the retirement pension amount after 30 years would be 206.9 million won at a 2% annual return, but if managed at 8%, the amount would be 611.73 million won?nearly three times more. Yet, many employees find it bothersome to pay attention to pensions they will receive 10 to 40 years later and are afraid of potential principal losses, so they avoid actively investing in investment products. Hopefully, in the new year, more employees will grow their dreams of becoming pension millionaires through active study of pension asset management principles and methods for selecting promising domestic and international investment products.

Kang Changhee, Representative of the Happy 100-Year Asset Management Research Association