The government’s latest review of the public pension finance underlines the bleak reality of the pension system under the pressure of a rapidly aging and declining population. It estimates the payout level for a model household will decline by 20 percent in real value in the next roughly 30 years. The level of pension benefits paid to retirees in proportion to the income of the working-age population could fall even further if economic growth falters or plunges into negative territory.
Public interest in the health of the pension system spiked after a report by a Financial Services Agency panel noted in June that a model household of retirees who rely on pension payouts as their source of income will face a shortage of ¥20 million to cover their daily expenses if they live to 95. Apparently trying to contain any negative impact on the ruling coalition in the upcoming Upper House election, the government played down the report as “misleading,” even refusing to accept it as an official document.
However, it has already been made clear that under Japan’s pay-as-you-go pension system, in which the costs of benefits to retirees are covered by premiums paid by the working-age population, curbing the level of payouts to future retirees will be inevitable as the working population shrinks and the elderly ranks expand. The 2004 reform of the pension system mandated that the payouts will be adjusted in accordance with the demographic changes to keep the pension system sustainable.
The outcome of the latest public pension review by the Health, Labor and Welfare Ministry, carried out every five years, should serve as a reminder of the stark reality of the pension system and its challenges, and as a trigger to move discussions forward on what can be done to stabilize the system and minimize the cuts to payouts so that public pension can credibly support retired people.
The pension replacement rate, a key indicator of the payout level, gives the proportion of retirees’ benefits to the average after-tax income of the working generation. In fiscal 2019, a model household of a single-income couple whose breadwinner had paid into the pension plan for corporate workers for 40 years gets ¥220,000 in monthly benefits when they start receiving the payouts at age 65 — or 61.7 percent of the average after-tax income of the working generation. Under a standard scenario assuming an annual real-term economic growth of 0.4 percent, the replacement rate is now estimated to go down to 50.8 percent in 2047.
That will be barely above the government’s target of keeping the pension replacement rate above 50 percent. However, the figure dips below 50 percent under three of the six scenarios considered in the pension review that assumes either lower or negative growth in the coming decades. Under a scenario based on a minus 0.5 percent annual growth, the replacement rate is forecast to dip below 40 percent in the early 2050s.
The decline will be even steeper for self-employed workers or part-time workers who only subscribe to the mandatory national pension program, which constitutes the basic portion of the pension system. The replacement rate for such pensioners is projected to fall from 36.4 percent today to 26.2 percent in 2047 — a roughly 30 percent decline.
The situation will be even more dire for people who subscribed to the pension plan for only brief periods due to economic reasons. As irregular workers such as part-timers and term-contract workers account for 40 percent of the nation’s workforce today, extra support for people who expect to receive only low pension benefits will be an urgent policy challenge.
As highlighted by the pension review, higher economic growth and greater labor participation hold the key to sustaining the level of pension payouts. The projected pension replacement rate was in fact slightly improved from 50.6 percent in the previous review in 2014. Part of the improvement was attributed to the fact that the number of people who pay pension premiums into the system rose by over 2 million more than forecast — due to the greater participation of women and elderly workers in the labor market. A change to the system that expanded the coverage of corporate pension program for part-time workers also added to the increase.
In the latest review, the labor ministry disclosed other estimates of the pension finance based on several optional reforms — such as further expanding the scope of coverage of the corporate pension program to enable more part-time workers to join, extending the period during which people pay into the system from the current 40 years to 45 years, and giving people the option of starting to receive pension benefits at a more advanced age (at added monthly rates) — and noted that all such options will be effective in sustaining the pension payout levels.
The level of pension payouts will have to be pared to sustain the system under the rapidly aging population, and people need to make additional self-help efforts to cover their expenses in retirement. But there are measures that can possibly shore up the payout levels. Discussions should proceed on what practical steps can be taken to stabilize the system as much as possible.