[Free Speech] Improve the System to Raise Pension Returns

Retirement pensions are one of the important means of preparing for old age. Retirement pensions are broadly divided into DB (defined benefit), DC (defined contribution), and IRP (individual retirement pension), but they have various problems in terms of both returns and structure.

As for returns, they remain stuck in the 1–2% range, which is significantly lower than in the United States and other countries. Korea’s particularly poor retirement pension returns are often attributed to workers not subscribing to investment products, but in fact, under the current retirement pension management system, the dominant structure itself makes it difficult to generate high returns. Therefore, at a time when mandatory retirement pensions are being discussed, the need for structural improvements and the corresponding solutions to raise returns must also be debated.

The reason retirement pensions in Korea currently cannot achieve higher returns is that, because of various regulations, safe and reliable investment products are not properly available. Most Korean workers leave their retirement pensions in deposits or invest in principal-protected, low-yield products. Why, then, are workers unable to invest actively and instead preoccupied merely with “protecting the principal”?

This is because regulations on investment products and providers leave workers with no products truly worth investing in. In Korea, there are many regulations on retirement pension investment products and providers, including restrictions such as caps on risky assets that do not exist in some other countries. These rules prevent individuals from investing and lower returns. In some cases, even the principal is damaged, leading workers to focus only on preserving what they have. This, in turn, again blocks opportunities to raise returns on retirement pension products, creating a vicious cycle.

Regulations on investment products also lead to high fee rates. Compared to the low returns of just 1–2%, the fees collected by retirement pension providers such as banks, securities firms, and insurance companies are fairly high, totaling more than KRW 1 trillion last year alone. Until now, these high fees relative to returns have placed a considerable burden on subscribers and have hindered more active participation. However, if returns rise, individuals’ relative burden from fees can be reduced, making this an area where natural improvement is possible.

The logic of economies of scale can also be applied to the fee issue. Currently, retirement pension providers operate a very wide range of investment products, but while the number of products is large, they have failed to improve returns. From the investor’s perspective, there are no attractive products that offer meaningful return potential, and it is also difficult to perceive the differences or economic effects of each of these many products. If, rather than offering a large number of products, providers were to operate products expected to deliver high returns, the problem of high fee rates would be resolved automatically according to market principles. Recently, fierce competition among securities firms has been pushing fees gradually downward, but if regulations on products are eased, that could prompt a more fundamental improvement: higher returns.

Retirement pensions are not used at a high rate as retirement funds in the true sense of a “pension.” Upon retirement, workers are given the choice of receiving their severance pay as a lump sum or later as a pension. If they choose to receive it as a pension, they are entitled to a 30% reduction in the tax on their retirement benefit. Nevertheless, the fact that the rate of pension receipt has shown little improvement means that the utility of this 30% tax reduction is not very great. Stronger incentives beyond a 30% tax exemption are needed so that workers can clearly feel the benefit. In addition, retirement pensions may be terminated early, and midterm withdrawals are common; in the case of IRPs, early termination also carries the risk of an additional tax of up to 16.5%. Yet given the still-high rate of early termination despite these additional taxes, offering clearer incentives rather than imposing penalties on cancellation would be more effective in encouraging continued investment.

The weak returns of retirement pensions mean, to that extent, that the old age of our citizens is unstable. Currently, 37% of Korea’s elderly population remains unable to leave economic activity even after retirement, and that figure is expected to continue rising. If pensions cannot cover insufficient retirement living expenses, the burden will ultimately be passed on intact to the younger generation in the form of taxes. As a solution, regulations on the development and management of investment products should be eased, and institutional support should be provided for the benefits of receiving pensions. These improvements will lead to higher retirement pension returns and expanded investment, thereby ensuring a more stable and comfortable life in old age.

Jungmin Park

Intern Researcher, Center for Free Enterprise (CFE)

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Original title: [자유발언대] 퇴직연금 수익률 높이려면 제도 개선해야

Author: Jung-min Park

Date: 2021-10-07

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=free_opinion&pn=10&idx=24254