1. Overview
Under the Employee Retirement Benefit Security Act, a retirement pension plan is a system designed to help ensure employees’ financial security after retirement. Under this system, the employer accumulates funds for employees’ retirement benefits with an external financial institution, and employees receive their retirement benefits from the financial institution in the form of either a pension or a lump-sum payment upon retirement.
The main types of retirement pension plans that an employer may establish for its employees are the Defined Benefit Retirement Pension Plan (“DB Plan”) and the Defined Contribution Retirement Pension Plan (“DC Plan”).
2. Key Features
A. Establishment of a Retirement Pension Plan
Employers are generally required to establish either a DB Plan or a DC Plan for the payment of retirement benefits to their employees. Where no retirement pension plan has been established, the employer is deemed by law to have established a statutory retirement allowance system.
Unlike a retirement pension plan, the statutory retirement allowance system does not require an employer to fund employees’ retirement benefits in advance with an external financial institution. Accordingly, the Korean government encourages employers to adopt retirement pension plans. In addition, while accounting provisions recognized by an employer for retirement benefit obligations under the statutory retirement allowance system are currently not deductible for Korean corporate income tax purposes, contributions made to an external financial institution under a retirement pension plan may be deductible, subject to applicable statutory requirements and limitations.
B. Types of Retirement Pension Plans
(1) DB Plan
A DB Plan is a retirement pension plan under which the amount of retirement benefits to be received by an employee upon retirement is determined in advance. Accordingly, the employer is required to make contributions to an external financial institution to fund the retirement benefits, and the amount ultimately borne by the employer may vary depending on the investment performance of the plan assets.
Under a DB Plan, the retirement benefit payable to an employee upon retirement must be at least equivalent to 30 days of average wages for each year of continuous service. In addition, in order to secure the employer’s ability to pay retirement benefits, the employer must maintain plan assets of at least the statutory minimum funding level, which is generally equal to 100% of the standard reserve liability as of the end of each fiscal year.
(2) DC Plan
A DC Plan is a retirement pension plan under which the amount of contributions to be made by the employer is determined in advance. Employees directly select how the contributions made by the employer are invested, and the amount of retirement benefits ultimately received by employees may therefore vary depending on investment performance. In other words, once the employer has duly made the required statutory contributions, the investment gains and losses on the accumulated funds generally accrue to the employee.
An employer that establishes a DC Plan is required to make contributions to an external financial institution at least once a year in an amount equivalent to at least one-twelfth of each employee’s total annual wages.
3. Conclusion
The key difference between a DB Plan and a DC Plan is the allocation of investment risk. Under a DB Plan, the employer bears the investment risk associated with the plan assets, whereas under a DC Plan, employees determine how their accumulated funds are invested and bear the resulting investment risks and returns.
Accordingly, employers should select the appropriate type of retirement pension plan after taking into account various factors, including their workforce structure, compensation system, financial burden, and the degree of investment choice to be provided to employees.
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