China laid out a policy framework Thursday for launching its own version of the U.S.’ individual retirement account (IRA), a popular tool for promoting private pensions.
As of mid-2020, 37.3% of U.S. households (about 47.9 million) had set up IRAs. Because of differences between the two countries’ income tax systems and other factors, China’s private pension system will have difficulty reaching this scale. Whether the Chinese version of the IRA can contribute to the long-term healthy development of the capital market and boost retirement savings for individuals will depend on whether investment institutions can improve the rate of returns on pension investments and whether relevant government departments can improve the system’s design.
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Five Things to Know About China’s Private Pension System
The framework designed by the State Council provides a clear path for developing the third pillar of China’s “three-pillar” pension system, the development of which is an important policy goal for China.
The country has been working on it for a while. In 2018, China launched a one-year pilot program for an individual tax-deferred private pension program in Shanghai, East China’s Fujian province and the Suzhou Industrial Park in the city of the same name in Jiangsu province.
The pilot didn’t get a lot of participants, a sign of its limited attractiveness. Most experts agreed that the program, which tied limited tax benefits to pension investment products, was weighed down by a cumbersome process and lack of personal choice in choosing investments.
The State Council didn’t provide details of tax benefits of its planned private pension system, but they are expected to be similar to those of the pilot. The system will be rolled out nationwide. More importantly, it will adopt an account-based model, which is more in line with international standards, rather than the product-based approach used in the pilot.
In a product-based pension system, people looking to save for their retirement can do so by putting money into specially designed investment products that have been granted certain tax benefits. In an account-based pension system, it is the account itself that allows savers to reap the tax benefits. Account holders can use the money they deposit to invest in qualified products of their own choosing.
According to the State Council, the account-based system will involve two accounts. The first, called an “information account,” links account holders with the tax authorities to make sure they pay their due to the government. The second is a “fund management account,” which holders use for paying their pension contributions, collecting earnings from their investments, and paying their personal income taxes.
Compared with a product-based system, an account-based system is easier to manage and provides account holders with more options, which can make it fairer and give it more appeal. With their individual fund accounts — which are limited to one per person — participants in the private pension program can take advantage of tax benefits, access the records of their investments, and invest in any eligible pension product, avoiding double taxation.
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I have two suggestions for improving the design of the private pension system. First, the system should encourage more people to participate. As private pensions involve complex issues such as taxation, they may be difficult for ordinary people to understand, making them less willing to participate. Based on the experience of other countries, China’s private pension system can adopt an automatic enrollment mechanism and a default product mechanism. An automatic enrollment mechanism works by automatically enrolling those eligible in this pension system, from which they can opt out within a set period of time. A default product mechanism, or Qualified Default Investment Alternative, would then invest their money in eligible products if account holders didn’t do so themselves.
Second, policymakers should connect the private pension system with the second pillar of the country’s pension system — employer-sponsored pension plans. This can be done by sharing information between the two pillars and increasing tax benefits for participants who aren’t covered by the second pillar. From a fiscal perspective, the second and third pillars are essentially the same, both using tax benefits to incentivize participants to save for retirement.
Wang Dehua is a research fellow at the National Academy of Economic Strategy under the Chinese Academy of Social Sciences.
The article has been edited for length and clarity.
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