Nine in 10 Korean retirees take severance as a lump sum, but an IRP pension could cut their tax by up to half

Some 80 to 90 percent of retirees in South Korea take their severance pay as a lump sum, yet Hong Chun-uk, head of an economic research institute, strongly recommends receiving it as a pension through an IRP account instead. He also warns that most workers' retirement pensions fail to keep pace even with consumer price inflation.

Savings that lag inflation

Market volatility has recently heightened anxiety about managing assets for old age. If the national pension is the most basic foundation of retirement, the retirement pension built on top of it is the core asset that determines quality of life, the article notes. For most salaried workers, however, it remains "sleeping money."

About 75 percent of retirement pension reserves in Korea are tied up in capital-guaranteed products. In the video, Hong said people tend to cling to safety because they see severance pay as a last line of defense in life. He pointed out that most capital-guaranteed products are bank deposits, which make it hard to defend against inflation.

Over the past decade, consumer prices rose by an average of 3.1 percent a year, while the average return on retirement pensions stayed in the low 2 percent range. In real terms, that means asset values are falling. Hong compared the gap using 100 million won in severance pay. Run in a capital-guaranteed product at a 3 percent return, it would grow to about 130 million won after 10 years. In a performance-based product at 6 percent, it would come to nearly 200 million won.

Checking your plan and deciding on DC

In this lecture, delivered through Hong Chun-uk's Economics Lecture Notes, he distinguished the three types of retirement pension: DB (defined benefit), DC (defined contribution) and IRP (individual retirement pension). He then proposed ways to redesign a plan around a person's life stage and pay structure. He stressed that workers should check how their pension is currently being managed through the Financial Supervisory Service's Integrated Pension Portal and think about how to raise returns.

The choice of plan type should start with the company's pay structure. Where salaries rise steadily every year, the DB type, in which the company bears the management responsibility, is advantageous. The picture changes when pay growth slows or a worker is entering the wage peak system.

In the video, Hong advised that once a worker feels monthly pay is no longer rising, switching to a DC plan deserves serious consideration. In a DC plan, workers manage their reserves directly and can pursue returns while accepting appropriate risk. Citing the national pension's annualized compound return of about 6.5 percent over the past 26 years, he said investors should aim for returns of 6 to 7 percent even if that means accepting a loss about once a decade.

There is a caveat. Switching from DB to DC is possible, but once a worker moves to DC, returning to DB is not. Decisions should therefore be made carefully, weighing room for wage growth and one's own investing ability.

Why an IRP pension beats a lump sum

Hong strongly recommended taking severance through an IRP account for the tax benefits. If severance pay goes into an IRP and is received as a pension from age 55, retirement income tax can be cut sharply. Depending on the payout period, the tax is reduced by 30 percent in years one to 10, by 40 percent in years 11 to 20, and by up to 50 percent for payouts lasting 21 years or more.

Additional contributions to an IRP account also qualify for a tax credit at year-end settlement. This builds a larger retirement nest egg while lowering the tax burden, killing two birds with one stone.

Hong urged viewers not to give up on managing their retirement pension just because the terminology is difficult. Understanding the differences among DB, DC and IRP and finding a management approach that suits one's own circumstances, he said, is the start of a better retirement.

Source: original video (YouTube)