Executive summary

This review provides a detailed analysis of the different components of the Korean pension system, which consists of public pensions, occupational pensions and voluntary individual schemes. It assesses the system according to the OECD best practices and guidelines, and draws on international experiences to make recommendations for improvement.

Korea has made tremendous progress towards improving social security in old age over the last decades, but the pension system has not reached maturity yet. The introduction of the National Pension Scheme (NPS) in 1988 was a major achievement. The initial values of pension parameters raised the income prospects of the first cohorts of NPS retirees well beyond what their contributions could have financed. This also means that these parameter values could not be maintained over time, and substantial reforms have been implemented to improve long-term financial sustainability. Major reforms included: higher contribution rates, lower benefit promises and higher retirement ages. Moreover, the 1998 reform of the management of the National Pension Fund (NPF) led to significant upgrades in its governance and financial investment policy. Overall, the assessment of NPS income and financial prospects is backed by solid analyses conducted in regular actuarial reviews. Furthermore, the introduction of safety-net pensions since 2007 has provided small benefits to the most needy.

Despite significant progress, much more needs to be done. The current defined benefit system generates low pension levels, leading to significant income vulnerability in old age. One severe difficulty arises from the exceptionally fast demographic changes facing Korea, which implies that even these low future pension levels cannot be financed in a sustainable way without further important reforms. This means that Korea has to tackle the formidable joint challenge of raising pension levels while enhancing pension finances. As both contribution levels and coverage rates are low, and the pension system remains fragmented, there is a number of reform options to make the Korean pension system better fit for purpose, raising old-age social protection in a sustainable way.

This review focuses on pension policies to improve contributory pensions, with two implications. Even though contributory pensions interact with the means-tested basic pension component, this review does not include recommendations to improve old-age safety nets. In addition, the effectiveness of some of the proposed policy measures would be enhanced by labour market changes, primarily related to the practice of enforced retirement before the statutory retirement age, itself closely related to seniority-wage practices. Yet, labour market reforms are not within the remit of this review.

Korea also has an occupational benefit system, where employers have to either provide a severance pay plan or a retirement pension plan to their employees, and voluntary personal pension schemes that complement the mandatory public National Pension Scheme. Ensuring greater reliance on complementary pension schemes is a good way to boost incomes from the public system and diversify sources of retirement income. However, to better serve this complementary role, the take-up of the schemes should be improved. This can be achieved by increasing the use of retirement pension plans in the workplace, making private pension schemes more financially attractive, and improving public understanding about saving for retirement.

Recommendations to improve public contributory pensions

• Increase NPS contribution rates considerably and as soon as possible. Use additional resources to increase accrual rates in a financially sustainable way and to preserve at least a small reserve fund

• Extend the contribution period after age 60 such that pension entitlements continue to accrue until at least the statutory retirement age

• Ensure a gradual convergence of pension rules covering different occupations towards a full integration of all schemes

• Raise the wage ceiling to contributions substantially

• Finance some pension redistributive components from the state budget

• Ensure active participation in the pension system of all eligible individuals, by improving co-ordination with tax authorities to verify income levels for the individually insured and increasing penalties for employers who do not enrol their workers

• Link the retirement age to life expectancy, reduce the current 5-year gap between the early and the statutory retirement ages and consider moving faster to age 65

• Fully permit combining work and pension receipt from the statutory retirement age by removing the earnings ceiling beyond which pensions are reduced

• Extend the duration of both unemployment and childcare credits and include the first child in the latter

Main recommendations to improve funded private pensions

• Fully transition from severance pay schemes to retirement pension plans

• Limit exemptions to occupational pension plan coverage

• Boost tax incentives and introduce non-tax financial incentives

• Simplify the pension tax system

• Lift investment restrictions and encourage more suitable investment strategies

• Restrict permitted cases of early withdrawal

• Encourage people to purchase annuity products to protect them against longevity risks

• Increase the age of access to private pension plans to align it to the retirement age of the public system