Innovation at the institutional level is needed to develop personal pensions in a flexible way

China became a middle-level aging society this year. The guideline document titled "Opinions on Promoting the Development of Private Pensions", issued by the General Office of the State Council, China's Cabinet, in April is a significant policy document.

A key element of China's proactive strategy to respond to its aging society is to establish a pension system that is underpinned by the three pillars of basic pension insurance, enterprise annuities and personal pensions.

The move to include pensions from three sources－personal contributions, enterprise contributions and government subsidies－into the pool of social funds and personal accounts can increase the replacement rate of pensions.

The way to increase the pension replacement rate lies in developing personal pensions and enterprise annuities. In 1997, as China started to become an aging society, the nation established basic pension insurance for employees. The nation integrated the pension system for civil servants and employees of public institutions in 2014.

According to the Ministry of Human Resources and Social Security, the average amount of pension that enterprises' retirees receive each month was about 2,900 yuan ($436.2) in 2021. The figure is determined on the basis of average monthly salary of enterprise employees above designated size, which was 6,654 yuan in 2020. The pension replacement rate is 43.6 percent.

Data released by the Organization for Economic Cooperation and Development in 2019 showed that the average replacement rate of basic pensions was 39.6 percent. With the addition of private pensions, the net replacement rate could reach 55.2 percent.

However, China faces challenges in developing personal pensions. The guidelines say that personal pensions, supported by government policies, should enable individuals' voluntary participation and market-oriented operations. The system should be aligned with the basic pension system and enterprise annuities.

As of the third quarter of 2021, the number of employees covered by enterprise annuities was 28.3 million, accounting for 5.6 percent of employees covered by basic pension insurance. The sluggish growth in enterprise annuities can be attributed to the following factors: first, businesses are now in a period of high-quality competition in which they seek lower costs; second, employers have to pay a premium rate that is as high as 16 percent for the basic pension insurance for their employees; third, large private enterprises are not very enthusiastic, and prefer using equity incentives and high wages to lure employees instead; fourth, a large number of small and micro-sized enterprises cannot afford to pay pension and annuities for their employees.

Another important reason is that the current annuity policy China has adopted, designed with reference to the experience of Western countries from the 1970s to 1990s, emphasizes the dual responsibilities of employers in making contributions and conducting proper management. The series of procedures for establishing annuity plans has increased the cost of labor, time and expenses. It is also difficult for employees to transfer their annuities if they switch employers.

There may be two types of individuals who would open personal pension accounts. The first type is employees and residents who have been covered by the basic pension system, and the second type is employees who have been covered by the pension system and enterprise annuities, mainly employees of government departments, public institutions and State-owned enterprises. China's basic pensions and annuities are mainly contributed by employers and are paid before tax. The burden on employees is relatively small.

Therefore, employees of government departments, public institutions and State-owned enterprises may be the primary group that opens personal pension accounts. The move would allow them to enjoy preferential terms on their individual income tax as the annual contribution of 12,000 yuan would be seen as pretax expenditure. It would lead to a low coverage rate of personal pensions and reduce the fairness of pension policies.

To sum up, we should carry out innovation at the institutional level to develop personal pensions in a flexible way:

It is imperative for human resources and social security departments to establish and refine an information platform covering pensions from three different sources as the nation moves forward the process of unified national management of pension funds. Small and micro-sized enterprises should be encouraged to participate in the basic pension insurance in a more flexible and convenient manner. Measures such as lowering rates, offering flexible payment terms, allowing intermittent and follow-up contributions and contributions from different employers should be rolled out in order to remove the institutional obstacles for workers on flexible payrolls to open personal pension accounts.

It is significant to integrate housing provident funds and enterprise annuity plans. After participants of the housing provident funds complete their house purchase plans, the contribution rate of the funds can be reduced, and the funds can be incorporated into the enterprise annuity. In doing so, employees, after buying their homes, can save more pension, while businesses can cut their corporate costs. The nation can increase the annuity coverage and improve the efficiency of welfare resources.

It is also important to transform the duties of employers from managing annuities to conducting smart operations through information platforms in order to reduce labor and time costs, and facilitate the transfer of annuities after changes in labor relations. Meanwhile, more work must be done to make public the strengths of China's enterprise annuities, especially in its high security index and good long-term returns and encourage large private enterprises to start their annuity plans for employees.

In order to meet the needs of a large number of small and micro-sized enterprises and people on flexible payrolls, China can learn from other nations and enable the alignment between annuities and private pensions. It is important to establish a plan for contributions from employers on top of the current plans of annuities, allowing small and micro-sized enterprise employers to provide pensions for employees in a flexible and convenient manner without having to participate in specific annuity plans.

Industry associations can use such plans as one of the indexes for evaluating employers. The funds can be managed with reference to a pooled plan or channeled directly to employees' personal pension accounts. Accounts for the annuity contributions from employers can be set up separately in the individual pension accounts, which should be in keeping with relevant regulations on enterprise annuity and enjoy relevant tax benefits.

The author is a professor at the School of Public Policy and Management at Tsinghua University.

Contact the editor at editor@chinawatch.cn