By YAN Guihua

 

In an attempt to alleviate the burden on the pension system, China’s personal retirement program began on April 21.

Details are still being worked out, but each participant can contribute up to 12,000 yuan (US$1,831) a year to their retirement accounts and enjoy some tax benefits. Jiemian News talked to TUO Hongwu, of the China Association of Gerontology and Geriatrics about the program.

Jiemian: Why does China need this program now?

Tuo: There are three ways to fund retirement –  government pensions, employee plans, and individual plans. The new program helps people save for retirement through private funds.

In China, government pensions are much bigger than the other two (Government pensions account for about 65 percent of all retirement savings by some estimates - Editor). This is very different from the situation in other countries. In the US, for example, most retirement funds are in employee plans or personal savings. 

Young people pay taxes to fund the pensions for retirees. As the population ages, the system faces a widening shortfall when retirees outnumber workers.

Jiemian: Some places have been testing plans since 2018. How do these programs compare to the new ones?

Tuo: An insurance plan guarantees an amount of money in return for monthly premium payments. An endowment life insurance plan is no different from other insurance products in the way that the money belongs to the insurance company, and the policyholders do not get any excess return beyond the promised payments.

The new program is more like a mutual fund. Maybe an asset manager manages the portfolio but at the end of the day, the money belongs to the account holder. The individual retirement program means everyone can set up an account and enjoy the tax benefits that come with it, but the money cannot be withdrawn until retirement. It will be more closely regulated than an average mutual fund product.

Jiemian: Deposits into the fund are now capped at 12,000 yuan per person per year. Why 12,000? And who can participate?

Tuo: The government has been looking into the matter since 2019. Most researchers said let’s not start with too much money. Many tax-deductible expenses, such as child care and mortgages, allow a 1000-yuan-per-month write-off. So 1,000 yuan a month, 12,000 yuan a year, sounds like a fair starting point.

Theoretically, everyone can participate. But eventually, participation will depend on how the program is run. If returns are high and the program is well-run, more people will be willing to invest.

Jiemian: Will the 12,000-yuan-per-year cap be adjusted up?

Tuo: It depends on how much tax benefit the government is willing to give out, which itself depends on the overall fiscal condition. In other countries, contributions are often tied to personal income. High-income individuals are not allowed to put too much money in their retirement accounts to save on tax, for example. I expect the current limit will remain unchanged for some time.

Jiemian: Are the contributions tax-free?

Tuo: The details are not finalized. In some countries, the account holders do not pay taxes until the fund is withdrawn. For working-age people, the proportions of their incomes that are put into the retirement plan are tax-free, the same as child care.

Jiemian: Will it be used for tax avoidance then?

Tuo: Theoretically yes, but only to a limited extent. First, you can save tax on only 1000 yuan each month, at least for now. Also, the money cannot be taken out before retirement.

Jiemian: Can the account holders decide for themselves which assets to invest in?

Tuo: Yes. Even if the money cannot be taken out before retirement, they can move it from one asset to another, or from the portfolio of one fund manager to another. Of course, any mutual fund that manages people’s retirement savings will have to receive special approval and be subject to extra scrutiny and regulation. 

Jiemian: Are individual retirement plans better for freelancers and gig workers?

Tuo: The three methods are not in conflict, but yes. For freelancers and gig workers, who have no employer to speak of and cannot easily participate in government pension programs, this helps them save for retirement.

Jiemian: Will the plans be tied to hukou (household registration)?

Tuo: No. You can open an account anywhere and access it everywhere. The program will be run by the Ministry of Human Resources and Social security and connected to the financial system. There will be no local rules and restrictions.

Jiemian: Everyone already has a government pension. Is this pension related to my future individual account in any way?

Tuo: Not really. The pension account you mentioned is a legacy setup that shows how much each person has contributed to the pension system. The “money” in it doesn’t belong to the account holder because, as I said, the fund collected from working-age people is paid out immediately to retirees. The individual retirement account is different. The money is funded by the account holder and belongs to the same person. 

Jiemian: The current policy says the money can be withdrawn either all at once or on a monthly basis when the account holder reaches retirement age. How is it different from an annuity?

Tuo: We don’t know yet how much an account holder is paid each month if she chooses monthly payment. Assume the median age is 75 and the account holder retires at 60, do we divide the total amount by 15 times 12? We’ll see.

An annuity pays the policyholder a fixed amount each month until she dies. It can be appealing to some people because it ameliorates the risk of retirement savings running out. Of course, in many countries, people can buy annuities with money in their retirement plans. But the two setups – retirement plans with monthly payments versus annuities – are different in terms of risk and benefits.

For an annuity, the risk is with the insurance company. The policyholder is guaranteed a fixed stream of payment no matter how the stock market performs and how long she lives. And if she dies shortly after the payment starts, her beneficiaries get the premium back and nothing more. The retirement plan can be bequeathed, and all the proceedings from the investment belong to the account holder or her beneficiaries.

Jiemian: You said that if the program is run well, more people will invest. What are the challenges?

Tuo: All the operational and managerial challenges of any mutual fund. And it has to work around and work with hukou, as well as the existing pension system, which is tied to location. 

Beyond basic setups, the fundamental question is how to generate high returns. Inflation is an important factor. The long-term performance of the capital market is even more crucial. If no one makes money, no one participates.

To complicate the matter even further, typically larger funds make more money. So the question is, first, how do we convince more people to participate even without a track record, especially those with low to medium income?

The government should provide some incentives or even straight subsidies, otherwise, the program will completely defeat its original purpose and simply become a tax avoidance tool for people with high income.

Jiemian: Speaking of fiscal burden. Should we be worried that government pensions are running out?

Tuo: The government has been replenishing the pension system every year. Pensions are run at the provincial level, but the central government has been giving out larger subsidies to provincial funds. There is also a social security reserve that has been growing in size steadily.

The government has been making up for the shortfall so technically the money is not running out. But yes, there is a shortfall and it is widening.

The main reason is aging. Simply put, more people are taking money out but fewer are putting money in. And there are more freelancers and gig workers, who don’t necessarily contribute to government pensions.

It is a common problem around the world but China faces a particularly sharp deficit because people born in the 1962-1964 baby boom are entering retirement all at once. (Retirement age is 55 for women and 60 for men - Editor.)