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China’s retirement system hears what does — and doesn’t — work in 401(k)s and IRAs

August 4, 2011

China is working hard on expanding its government-backed retirement plans. A delegation from China’s Ministry of Human Resources and Social Security was in Boston last week to talk with fund industry executives about the strengths and shortcomings to the U.S. approach to retirement plans. The delegation was headed by Zhang Hao, the Deputy Director-General of the Ministry’s Department of Social Insurance Fund Supervision.

Chinese charactersAt a lunch meeting at the Harvard Faculty Club hosted by Robert Pozen, Chairman Emeritus of MFS Investment Management, Ms. Zhang outlined the ambitious goals for the Chinese pension system:

  • By 2015, to cover close to 100% of the population of China (all 1.3 billion people) in one of the penion programs offered to different segments of Chinese society.
  • In the process, to pay closer attention to social equality by expanding pension coverage and raising benefit levels for rural areas.
  • To increase the social security funding in overall government expenditure. The Individual Account component under the Basic Pension will be fully or partially funded (vs. current form of notional Individual Account) with a better investment management mechanism in place that ensures capital preservation and appreciation.
  • To create a consistent national approach out of a very fragmented system that meets the needs of labor market mobility through national pooling and universal programs. Urban workers, civil servants, workers at quasi-government institutions, rural residents and urban residents are each covered by a different Basic Pension program. At the same time, different provinces and cities have their own Basic Pension contribution and benefit standards

China hopes to reach these goals partly by broadening the coverage of the government’s Basic Pension system, which is the equivalent of Social Security. Today, only 76% of urban workers are covered by a Basic Pension — and a much smaller percentage for rural and some other population segments. In fact, rural residents weren’t included in the program at all until 2009, and a program for urban residents (i.e., non-workers) will be established only this year.

As in the United States, however, China realizes that it must look beyond government-administered programs to meet its citizens’ retirement income needs — so privately-managed funded accounts are a significant part of its plan. Ms. Zhang is encouraging growth in Enterprise Annuity Pensions (similar to our 401(k) plans) and Individual Account Pensions (similar to IRAs). She hopes that these two savings vehicles combined will, in future, meet half of retiree income needs.

The fund industry executives at the lunch suggested that there were 4 aspects of the U.S. system that might be relevant to China:

  • The problems with pay-as-you-go. Tax-funded retirement systems — such as Social Security and China’s Basic Pension — become tougher and tougher to support financially as populations age and the number of retirees relative to the number of workers increases. If that’s an issue in the United States today, it’s an even bigger problem in China, where the one-child policy has led to a rapidly aging society. China will need to pay close attention to its pension benefit schedule to ensure that it remains affordable.
  • Encouraging participation in employer-sponsored programs. Automatic enrollment features have made it easy for workers to contribute to a 401(k) — requiring them to act (by exercising an opt-out) only if they don’t want to be in the plan. Matching contributions and tax breaks make it attractive for workers to contribute. China should look at both default options and incentives to raise participation rates. Better still, they should make participation — by both employers and workers — mandatory, as it is in Australia. However, going beyond an opt-out to a mandatory system is a tough political challenge in both the United States and China. The softer approach has been only moderately successful in the United States, where fully half of workers — many of them lower-income — are still not covered by a pension plan at work.
  • Moving among plans. China currently has a myriad of retirement plans with different requirements — much like the United State. This presents difficulties as the Chinese labor market becomes more national. The rollover IRA has made it easy for savers to move assets from one type of plan to another. China might consider establishing a similar mechanism — both as a convenience to its citizens and as a way to slowly increase consistency among plans.
  • Education is key. If the savings program will be voluntary, then individuals will need lots of help figuring how much they need to save to meet their income goals — which in turn means that education has to be an essential component of a privately-managed system. Similarly, if savers can make their own investment decisions, they’ll need advice on how best to do that — or access to investment vehicles like balanced funds and target date funds that relieve them of some of the burden. Right now, investment choice is constrained in China, though Ms. Zhang’s department is considering changes to that policy.

Lots for Chinese policymakers to consider — though they’re in good company. If the lunch discussion highlighted anything, it’s that the U.S. retirement system is also a work in progress.

  1. August 4, 2011 12:00 pm

    I would like to wish the Chinese the best of luck. The size and scope of this endeavor is mind-numbing. Their state-capitalism control and willingness to learn from our mistakes can only help. I am dubious because of the minimum threshold of information (knowledge comes later) would have to be created and disseminated to a populations that unfortunately may not have education levels capable of understanding. “Markets” are not a known quantity to many of the 1.3. Keep in mind the level of financial literacy (or lack thereof) we have here in the U.S.

    However, if achieved it would unlock the legendary (but very purposeful) savings of their citizenry. Their rate of internal consumption could skyrocket.

    • Theresa Hamacher, CFA, NICSA President permalink
      August 8, 2011 9:12 am

      I think you have it exactly right — in terms of both the challenges and the potential rewards. Thanks for your comment.

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