Story by: Paul Sharkie, Photos by: Michael Roy
In Korea, a pension plan can be set up by one of three parties: you (through a private pension scheme), your employer or the state. For those unfamiliar with the specifics, deciphering a country’s pension terminology is often a hurdle for those just hoping to make basic inquiries, not to mention trying to make the right decision regarding one’s own pension. One thing to note, however, is that in order to live a comfortable retirement, you will likely have to consider more than one option.
This is Part II.
Pensions: Defined benefit vs. defined contribution plan
Last time, we looked at pension plans from a broader perspective. This month weíll take a closer look at two of the most common types of pension plans on offer from your employer: defined benefit (DB) and defined contribution (DC).
Defined benefit (DB) plans
A defined benefit plan guarantees a certain payout at the time you, the employee, leave a company and/or when you retire. This payout is usually based on your salary and the number of years youíve been under the plan.
Contributions from your employer and (sometimes, but not always) yourself are invested in a fund that is regularly assessed to ensure it will meet its promised obligation. With DB plans, the investment risk is assumed by your sponsor/employer and not by you, the individual employee.
Points to consider:
– Many DB plans include early retirement provisions to encourage employees to retire early. But keep in mind that in such cases, the payments you receive upon early retirement will often be reduced, since they will be spread over a longer period of time.
– Employers or trustees make decisions about the type of benefits available, which ultimately affects the lifestyles of their employees.
– Under DB plans, the employer typically tends to pay higher contributions.
Defined contribution (DC) plans
Under these plans, contributions are invested and the returns are credited to you. Upon retirement, your account is used to provide a lump sum and/or annuities. Unlike DB plans, here the investment risk and rewards are the responsibility of each individual employee or retiree, who will have to communicate with a service vendor (such as a bank) to manage their investments.
Advocates of this system point out that, in comparison to DB plans, each employee has considerable freedom to tailor their investment portfolio. Critics, however, point out that there are many workers who may not have the financial knowledge to select and manage their own investments. In addition, some may lack the discipline to make regular, voluntarily contributions to their funds, which are crucial to their growth.
Defined contribution plans are now the dominant form of plan in the private sector in many countries, as they are more cost-effective for employers.
Points to consider:
– Participants who do not purchase annuities with their savings (and instead take a lump sum) bear the risk of exhausting their assets; it is for this reason that now, in many countries, it is a legal requirement to use the bulk of the fund to purchase an annuity where regular payments are received over a long period of time.
– Under DC plans, the contribution (funds invested by the employer at regular intervals) is known, but the benefit (the final amount available to the employee at retirement) is unknown until the employee wants to utilize the assets.
– Although the participant technically has control over investment decisions, the plan sponsor retains a significant degree of legal responsibility over the plan, including the investment options and selecting administrative management.
Benefits in Korea
In Korea, the governing legislation is the Employee Retirement Benefit Security Act (2012), which has, among other actions, raised taxation on lump sum payments and lowered taxation on annuity payments. Given that Korea has an aging population, people will have to make their retirement funds last longer; short of raising the retirement age, making annuities a more attractive option is a good initial step for both individual and the state.
Points to consider:
– DB and DC plans are required for businesses with one or more employees.
– Foreigners can invest in the same products as Korean nationals, although documentation is more likely to be done in Korean than in English. Therefore, do not invest in products that you do not know well.
– Legislatively speaking, withdrawal from your plan (in Korea) is permitted under DC plans only when funds are required to purchase a house or when a dependent family member requires hospital treatment for an extended period of time.
For more information on the most up-to-date governing legislation (in English), you should ask your employer or a service vendor. As always, this column is intended to act merely as a guide and professional advice should always be sought.