The National Pension System needs a dramatic overhaul. One think tank recommends restructuring it to include personal accounts.
Many Koreans are in a ôstate of denialö regarding the parlous state of their prospects for retirement, and the government needs to radically overhaul its social security programs if the nation is to avoid the crises now common in other aging societies, according to the Center for Strategic and International Studies (CSIS).
CSIS is a Washington, DC-based think tank with a unit dedicated to demographic and pension issues. It has just released a report, ôThe Aging of Korea: Demographic and Retirement Policy in the Land of the Morning Calmö, which calls for Seoul to introduce personal accounts alongside a revamped National Pension System.
The good news is that Korea still has time. The NPS' unfunded liability today is 33% of GDP, compared to 100-200% for many other OECD nations. If government, business and labour act soon, the nation can introduce fully funded pensions without incurring a massive economic and political cost.
The bad news is that without radical change, Korea will surely adopt the same kind of pension problems that plague nations such as Japan, Italy, Germany and the United States.
The NPS is meant to provide universal benefits but in reality falls far short. Only 65% of the labour force gets any benefit from the NPS or one of the government-funded pension plans for state employees. Although there are political pressures to curb NPS benefits, in fact these need to be augmented, not scaled back, argues the CSIS. But the existing system is financed on a pay-as-you-go basis and is unsustainable, given the nation's rapidly aging population.
Many Koreans expect their children to take care of them, but the majority have taken a fatalistic view, accepting great uncertainty about where their support will come from but taking no action to help themselves. The CSIS cites a recednt survey of 1,000 Seoul office workers conducted by the Korea Chamber of Commerce and Industry, which found that 45% admitted having no retirement savings at all.
this flies in the face of the facts. First of all, most household savings are not geared to retirement. 83% of household wealth is tied up in property; three-quarters of the remainder remains in low-return bank deposits. Korea's high national savings rate is mainly government savings and retained earnings by corporations; household savings rates are a modest 6.5% of GDP and personal savings even less.
The existing severance payment system, called the Retirement Allowance (RA), covers only a fraction of the workforce, and is almost entirely unfunded. Therefore, as painfully discovered during the 1998 financial crisis, when a company goes bust or has to lay off employees, they have nothing. To date around 77% of severance payments are in book reserves rather than being funded.
The government has established a new corporate pension law that can, in theory, play a major role in addressing these problems. As of November 2006, however, a mere 3.1% of eligible firms and 2.7% of eligle employees had enrolled in these new pension plans. This suggests that the reform will be meaningless without more government support. The CSIS says Seoul should improve tax treatment for companies setting up pension plans and remove the existing tax gains for RA schemes.
CSIS also argues that the current debate in government, about whether the NPS reserve fund is solvent or needs to be augmented, misses the point. "While the system's long-term deficit needs to be closed, reforms that merely raise NPS contributions and cut NPS benefits will not correct its underlying problems," says the report.
If an aging population is to care for its elderly without putting an impossible burden on the younger generations, the government must consider some new options. One is a basic, flat pension payment. The NPS is in theory to provide this but it will clearly fail to do so, given weak enforcement, lots of self-employment and irregular employment patterns. This would be expensive, but the NPS's inability to meet its promises will generate even worse political problems, the CSIS believes.
Tax deductions for the new corporate pension plan must be made far more attractive; corporate pensions must become an "opt out" rather than an "opt in" for labour groups; the government should consider establishing a pension insurance agency akin to America's Pension Benefit Guaranty Corporation in case companies go bankrupt; and, most importantly, the government should combine the NPS with a system of fully funded personal retirement accounts.
The CSIS proposes each NPS member also open a personally owned account. These would be mandatory, fully funded schemes that would allow private fund managers to invest account money in a well-regulated environment (perhaps just via index funds), with all personal-account assets to be transformed into monthly beneifts according to an annuitisation formula.
The CSIS also suggests the government rein in the grossly disproportionate benefits it pays out to government employees, military people and teachers via state-sponsored pension funds, as a means of cutting costs which can be transferred to a national system, and in the name of social fairness.
The Korean government has a choice. Its current proposals to rescue the NPS would see monthly salary contributions raised from 9% to 12.9% while cutting the nominal replacement rate to 50%. Even so, the system will only be able to pay benefits until 2065, at which point contributions would have to rise to 30% of monthly salary - an impossible sacrifice. Korea has introduced pension reform but of the most tepid kind, and this is the stark choice it will face if those reforms are not beefed up and taken further in the next few years.
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