Traditionally, Chinese workers have relied on two pillars of income in retirement — the basic state pension and employer-sponsored plans open to employees in certain sectors.

However, in late 2022, the Chinese government poured some concrete into the mould of a third pillar, unveiling the details of a previously announced private pension scheme. Under the new rules, employees are entitled to make voluntary contributions of up to 12,000 yuan (around $2,400) per year to private pension funds, which can then be used to purchase a range of financial products.

The pilot project, which launches in 36 cities but is expected to roll out nationwide after its one-year term, also allows participants to deduct contributions from their annual taxable income, while the usual 7.5 per cent tax on withdrawals is reduced to three per cent.

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Jia Wang, interim director of the University of Alberta’s China Institute, says the new scheme will look familiar to Canadians with a registered retirement savings plan. “This is something that many other countries — including Canada — have enjoyed for many years, but it’s definitely a major change to the Chinese pension system.”

A third pillar

The development of a third pillar in the Chinese pension industry has had a long, stop-start history, but the urgency to implement a private scheme has increased as a result of the country’s current demographic crunch, says Wang.

“China has a vast aging population and, as the saying goes, the country is getting old before it’s getting rich.”

Last year, Chinese citizens over the age of 65 accounted for 14.2 per cent of the nation’s inhabitants, moving the country out of the World Bank’s category of “aging” populations (those where the proportion of over-65s is between seven and 14 per cent) and into the group of nations with “aged” populations.

China’s private pension scheme by the numbers

12,000 yuan — The annual contribution limit for China’s new private pension option, equivalent to about $2,400

36 — The number of cities taking part in China’s pilot project

25 years — The length of time it took for over-65s to move from 7% to 14% of China’s population

115 years — The length of time it took for France to make the same transition

850,000 — The drop in China’s population in 2022, the first annual decline since 1961

Sources: The World Bank, China’s National Bureau of Statistics

Many western countries are further along the line in terms of the maturation of their population, but few have made the journey at such speed. By the World Bank’s standards, China spent just 25 years with an “aging” population. In comparison, the U.S. completed the same transition in the last century over the course of 69 years, while France took 115 years.

Read: CPPIB head says China and Canada face similar pension challenges

The scale of the problem was thrown into even sharper relief with the release of the most recent set of data from China’s National Bureau of Statistics, which revealed that, during the span of 2022, the country’s population had shrunk by almost a million people to 1.41 billion — the first annual decline since 1961. Meanwhile, China’s gross domestic product grew by just three per cent over the same period — the economy’s worst annual performance since the 1970s, with the single exception of the coronavirus pandemic-ravaged 2020.

Despite the recent loosening of China’s famed one-child policy, the country is struggling to replace retirees with working-age citizens. As a result, the two established pillars of the traditional pension system are beginning to feel the pressure.

According to projections from the Chinese Academy of Social Sciences, total expenditures from the state pension are on track to outstrip contributions by 2028 and the whole fund could run dry by 2035 without changes to its terms, which set the normal retirement age for men at 60, women in white-collar jobs at 55 and female blue-collar workers at 50.

Accumulated assets in the second pillar — made up of defined contribution-style annuity schemes for various groups of civil servants and employees of state-owned enterprises — have grown over the last decade, but only a small segment of the Chinese working population is covered by these plans.

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As awareness grows of the new third-pillar option, Wang expects the Chinese population to buy in to the idea. “Generally, people are very much into managing their finances. One of the key characteristics of the Chinese culture is to be prepared for the future and save up for rainy days.”

A major step forward

Ellen Yin, manager of human resources and payroll services at Shanghai-based professional services firm Dezan Shira & Associates, describes the private scheme’s launch as a major step forward for China’s pension industry.

“We see that, especially middle-income groups, are interested in private pension products and their associated individual income tax exemptions. However, there is also considerable interest among the elderly who are retiring in the coming years.”

On the other hand, while Yanjun Pan, a Singapore-based analyst at Cerulli Associates Inc., says the third-pillar pilot is a good start, she remains unconvinced about its transformational potential. “The government is paying much more attention and they will launch more and more measures in the following months to refine the private pension scheme, but currently, I think the intensity is not enough.”

Read: Government benefit cuts, longevity among global trends affecting retirement readiness

For example, only a small proportion of the Chinese population — around 10 per cent, concentrated in urban areas — actually earns enough money annually to cross the 60,000-yuan threshold at which any income tax is payable, she notes. Even fewer earn enough to make the new incentives worthwhile, after accounting for the three per cent tax payable on benefits paid from the pension fund after retirement. “You can see this is not very attractive for low-income people, but in the future . . . maybe they will lower or remove the deferred tax or they will give some more cash incentives,” she adds.

However, the third-pillar scheme may prove considerably more attractive for foreign asset managers looking to establish themselves in the Chinese market, according to Joanne Peng, a research analyst at Cerulli, who says the Chinese financial industry has become increasingly open to foreign investment in recent years.

Although the private pension scheme is in the early stages of development, a recent report from Manulife Investment Management (Canada) Inc. estimated the total value of the third-pillar market size could jump to more than US$1 trillion by 2025. “In my opinion, [foreign managers] should be optimizing their local investment and research teams so they can select strategies that meet the needs of the local market,” says Peng.

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As ever, Wang says geopolitical factors could complicate the fortunes of non-Chinese asset managers operating in the country. “The Canada-China relationship is still pretty fraught, but hopefully it will improve somewhat. China is always a complicated case; the massive population and quickly-changing demography poses a lot of challenges, but it also creates a lot of opportunities. It’s a market you can’t ignore.”

Michael McKiernan is a freelance writer.