Pension Scheme
South Korea's pension system has taken shape in the last two decades with the state-run National Pension Service (NPS), the Serverance Pay System and tax-favoured private pension plans.
Public Pensions -National Pension Service (NPS)
The NPS is a partially funded, defined benefit (DB) system covering 53% of the labour force. Groups that are not in the system include low-income people, temporary and daily workers as well as self-employed workers who do not declare income.
Employers and employees contribute 4.5% of wages each. The benefit formula consists of basic and earnings-related portions. The system is progressive and applies an average accrual rate of 1.5% over a 40-year contribution period. Benefits are paid mainly in the form of an annuity, which is indexed to prices, with the full pension available at age 60. The retirement age will rise to 65 by 2033.
Other public schemes
South Korea runs additional pension schemes for public sector employees, which were introduced before the NPS and operate independently from it. These cover 1.4 million employees (6% of the workforce):
- The Government Employees Pension System (1960)
- The Military Personnel Pension System (1963); and
- The Private School Teachers Pension System (1975)
These schemes operate according to the pay-as-you-go principle and are earnings-related. At 17%, contributions are higher than in the NPS, and are equally shared between the government and employees. At around 70% after 30 years of contributions, replacement rates are generous. However, all three schemes are either already facing financial hardship, or will in the future.
Occupational Pensions
South Korea has two occupational systems that exist alongside each other.
The severance pay system
Until recently, the severance pay system was the main pension scheme for private sector employees, and it is mandatory for companies with five or more employees. Contributions are made by employers only, who contribute 8.3% of wages. Employees are entitled to severance pay after one year of continuous employment. Companies running severance pay schemes may qualify for tax benefits of up to 30% in the case of internal reserves and 100% in the case of external funding. Investment income is tax-exempt, while benefits are taxed; benefit taxation differs for annuities and lump sums.
Employers have traditionally financed severance payments through book reserves, as advance funding is not required. If employers decide to fully or partially fund severance payments, they use insurance or trust-based contracts. However, most plans continue to be based on unfunded book reserves. According to estimates, 75% of severance pay liabilities are unfunded. Benefits are typically paid out as lump sums, but annuitisation is possible.
The corporate pension system
Based on the Employee Retirement Security Act (ERSA), the corporate pension system operates on a voluntary basis. Companies with five or more employees can convert severance pay into corporate pensions. This conversion needs to be based on an agreement between employers and employees, and at least 50% of a company's employees must agree to the conversion. Unlike in the severance pay system, enterprises with less than five employees and part-time employees are allowed to participate in the new system. Employees can contribute voluntarily.
This system allows both DB and DC plans. Plan sponsors and members are free to choose the plan they want. DB plans must provide a minimum benefit equivalent to one month's final salary per year of service and be managed by a separate trust, which can either be a bank, insurance or trust company. In the case of DC plans, employers must make contributions of at least 1/12 of total annual salary. Additional employee contributions are also possible. DB plans require funding of 60% of accrued termination benefits, while DC plans must be 100% funded.
Employers with less than 30 employees are allowed to offer Individual Retirement Accounts (IRA) instead of occupational schemes. These accounts are subject to the same regulatory treatment as the DC schemes. Sponsors must provide at least three investment options in DC plans and IRAs, including one with an interest guarantee. Benefits are payable in the form of annuities from age 55, based on number of years of service.
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