To Make the National Pension Worthy of Its Name

[Seoul Economic Daily · Op-Ed · November 5, 2015]

Yun Suk-myung, Research Fellow at the Korea Institute for Health and Social Affairs (KIHASA)

Following the reform of the Government Employees Pension, controversy is growing over whether the National Pension is at an appropriate level. This is due to claims that the National Pension was cut too severely, making the Government Employees Pension appear excessive. Such claims sound persuasive because the average monthly benefit of the Government Employees Pension is 2.2 million won, whereas that of the National Pension is 340,000 won (880,000 won for those with a contribution period of 20 years or more). This is also the background behind the emerging argument that instead of vilifying civil servants for receiving high benefits, the benefit rate of the National Pension—which was heavily cut—should be raised to equalize public pensions toward the middle. The goal is to raise the income replacement rate, which will drop to 40% by 2028, to 50% to "make the National Pension worthy of its name."

The reason such claims sound persuasive is the short contribution period of the National Pension. Currently, the average contribution period for the National Pension is about 16 years, and even far into the future in 2050, it is projected to be around 25 years. An income replacement rate of 40% is a figure achievable only if one contributes for 40 years; if the average contribution period is only about 25 years even 30 years from now, the effective income replacement rate is a mere 25%. All of this is a problem arising from the widening gap between the nominal income replacement rate and the effective income replacement rate.

To objectify the problem, let us examine foreign cases. The average income replacement rate for public pensions in member countries of the Organisation for Economic Co-operation and Development (OECD) is 40.6%, and the average contribution is around 20%. Compared to Korea, the income replacement rate is similar, but they bear twice the contributions. In the 27 European Union (EU) countries, where life expectancy is similar to ours, the average contribution period already exceeds 36 years. This reveals that the essence of the problem we face is not the pension system itself, but the surrounding environment. In this situation, how can a pension become worthy of its name?

The solution may lie in increasing the actual contribution period by encouraging older workers to remain employed and by raising the pensionable earnings (the basis for calculating benefits and contributions), which have failed to reflect reality since 1995. Currently, the upper limit of pensionable earnings for the National Pension is 4.21 million won per month, which is about half that of the Government Employees Pension. This is because, among Korea's public pensions, only the National Pension has failed to reflect income growth over the past 20-odd years.

Taking the United States, which sets the ceiling at about twice the average worker's earnings, as an example, the National Pension's income ceiling would have to exceed 6 million won, since the average worker's wage is above 3.5 million won. The ceiling has not been properly raised so far because of concerns about fiscal instability and about lower tax revenue as income deductions grow. It seems desirable first to raise it to around 5.3 million won a month, a level that does not greatly affect the date of fund depletion, and then to index it to growth in the average worker's wage. This is because the average income of National Pension contributors, the A value (the economy-wide average of insured earnings), at slightly over 2 million won a month, does not properly reflect actual income levels.

If the income upper limit is raised, an advantage arises in that the average income of contributors increases, thereby raising the pension amount for all National Pension contributors. The problem is that as pensionable earnings are raised, corresponding efforts for fiscal stabilization are necessary. Therefore, despite the pain, efforts must be made to build a national consensus regarding the magnitude and timing of contribution increases.

Another way to expand the actual pension amount is to work longer and increase the contribution period. Given that the economically active population is projected to decrease in the future, we must find ways to activate employment for older workers while minimizing current youth unemployment. Gradual retirement—where working hours are reduced after the retirement age, with a corresponding decrease in monthly salary—could be an alternative. If a gradual retirement system is activated, the National Pension contribution period could increase dramatically. If youth employment occurs as the working hours of older people decrease, job sharing between the younger and older generations will become possible, and the actual contribution period of the National Pension will increase, making the pension worthy of its name.

Source: Seoul Economic Daily (original article)