China Expat Pensions

The People’s Republic of China is ruled by the Communist Party of China and endorses a socialist market economy. The political system is partially decentralized. Regional leaders possess a certain amount of autonomy.

Central legislation is not always equally implemented on regional level. Which is relevant for the exact legal and fiscal position of Expats who fall within the realm of Chinese jurisdiction.

I. Prelude

The public pension system in China includes an urban and a rural system.

The latter was specifically designed for rural areas and differs considerably from the system in place in urban areas. Pension participation is voluntary and operational matters are left to local governments. Benefits are far less generous compared with the urban pension system and participation in the rural system is very limited.

The urban pension system was officially launched in 1997 with the announcement of a revised pension policy. While pensions were provided by state owned enterprises in the previous system, a social insurance system took over. The reform started at the provincial level with a view to expanding it to the national level.

II. Structure

China has a Three Pillar Pension System:

• Pillar 1: A basic State Pension.
• Pillar2: A mandatory employee contribution to an occupational plan.
• Pillar 3: Private pensions and assets.
• Contrary to many countries, there is no real Pillar 3 Private Pension with tax benefits.
• Pillar 1 remains the most important and fast developing Pillar until now.

III. Developments

There have been recent developments demonstrating that both government and the public are paying greater attention to the pension system:

• Encouraging foreign entry into the pension management industry.
• The admission of the ninth pension insurer applicant.
• New approval of pension annuities plans and mutual funds.
• All three pension pillars continue to register growth.
• The local public pension funds deal with their worsening deficit. More provinces are reporting growing deficits and need to ask for subsidies.
• More provinces have asked the National Council for Social Security Fund (NCSSF) to manage their investments.

Pillar 1 is expected to remain the largest and most important Pillar. Due to aging, more individuals will draw capital from their pension accounts. The Public Pension Fund (PPF) and NCSSF combined already account for half of the country’s pension assets and have a much wider coverage than the other two pillars.

I. Structure

The basic pension pays 1% of the average of the indexed individual wage and the province wide average earnings for each year of coverage. There is a minimum of 15 years of contributions.

The pension in payment is indexed to a mix of wages and prices, which has been about 10% in recent years. The modelling assumes 50% indexation to wages.

II. The National Social Security Fund (NSSF)

The NSSF is not part of the pension system. Its function is to build up capital for public pension deficits resulting from future demographic development.

The NSSF was founded in 2000 and is currently in the accumulation phase. It is managed by the National Council of the Social Security Fund.

It is unclear when payments will start. Some think that this will start when the fund reaches assets of at least EUR 97.2 billion (RMB 1 trillion). Others suggest it will start as of 2030 when the demographic situation will likely begin to deteriorate.

The funding of the NSSF has four sources:

• Fiscal transfers from the central government budget;
• Proceeds from the listing of state owned enterprises;
• Lottery proceeds;
• Investment income.

The NSSF's investment policy is based on the priorities of asset security and liquidity. Thus regulations determine that deposits and government bonds combined must amount to at least 50% of assets. At least 10% must be invested in deposits alone. The maximum limit for corporate bonds is 10% and the combined limit for shares and mutual funds is 40%.

In 2003 the NSSF began outsourcing some of its assets. As of 2005 five national and/or joint ventures were selected to manage NSSF assets. In the future the central government's contribution to "refill" pillar 1B will be managed by the NSSF. The initial amount is EUR 972.1 million (RMB 10 billion).

This comprises of individual funded Defined Contribution accounts.

In addition to the north eastern provinces a further eight provinces have funded individual account systems. In other cases the accounts are largely notional and are credited with a notional interest rate.

Employees pay 8% of wages to the individual account system. The accumulated balance in the fund or the notional account is converted into a stream of pension payments at the time of retirement by dividing the balance by a government determined annuity factor. Which depends on the individual retirement age and average national life expectancy.

In all provinces, these annuity factors for males/females for monthly benefits are:

• Age     :   40      45        50        55        60        65       70
• Factor : 233    216      195      170      139      101      56

The modelling results are based on a funded Defined Contribution (DC) system.

I. Progress

In 1997 the division between Pillar 1/2/3 was introduced. As of then the growth of Pillar 3 has been modest in comparison to Pillar 1. Which is understandable.

Recently Pillar 3 registered not much growth but the sector continues to attract new entrants regarding Tax Deferred Annuities Plans and Mutual Funds.

Regarding the Tax Deferred Annuities Plans most providers introduced their products in 2018 resulting in not much recent growths. There are now rounded 50 product versions by 20 providers.

Regarding Mutual Funds rounded 60 products have been introduced. Pension funds offered by Fund Management Companies still do not enjoy any tax benefits. With their track record and product awareness there might be a revival of interest once those tax benefits do exist.

II. Future

Like the enterprise annuities scheme, the tax incentive provided for pension annuities products appears to have been insufficient for the scheme to take off.

Experience from enterprise annuities products shows that for a new scheme to reach critical mass, tax benefits are not enough and have to be combined with other incentives:

• A fine and constant investment return track record;
• Investor education;
• Detailed disclosure;
• Long term planning;
• 24/7 internet portal;
• Regulatory oversight.

The first distinction to be made is the difference between an international and local contract.

In case of an international contract from for example a Dutch Holding company, rather strict Dutch civil and fiscal pension law is applicable.

Whereas a local Chinese contract is dictated by entirely different and much more decentralized Chinese pension law.

I. Legal Basis

Expats with a Chinese contract fall within the realm of the Chinese pension system.

In 1997 the division of public, corporate and private pensions was introduced. As the funding of the public pensions is increasingly difficult, it is for the corporate and individual sector to help fill the cap. In 2004 the Enterprise Annuity Law for the voluntary occupational pension system was introduced. It provided a legal basis for government advocated voluntary corporate pensions.

The percentage of international corporations which operate in China and offer a pension grant is substantially lower than in fully developed markets as Europe, U.S. and Australia.

II. Enterprise Annuity Law

The law created the Enterprise Annuity Funds. The already existing Legacy Funds were company funds that were managed by local social security agencies. China intends to hand management over to the private sector.

Group pension insurance contracts and trusts are the third and fourth possibility for employers to provide their employees with a voluntary pension scheme.

III. Enterprise Annuity Fund

This voluntary fund is established as an internal or external trust. These plans use a trust model but rely on separate Enterprise Annuity specific regulations for the trust aspects. Therefore they are not equal to the (Chinese) trust in general.

The internal trustee is known as the Pension Council. It is similar to the trust system in the UK. At least one-third of trustee members should be employee representatives. The trustee is obliged to outsource administration, asset management and custody services to other institutions that are licensed to operate these businesses.

The external trustee is known as the Professional Trustee. It is executed by financial institutions with no representations requirements. The trustee is allowed to provide administrative and asset management services but not custody.

If a company prefers an external trustee, best practices suggest the need for an internal Pension Committee to oversee the trustee and communications towards participants. The latter appears to be vital for the success of the program.

IV. Enterprise Annuities

They are voluntary occupational plans that are fully funded Defined Contribution individual accounts. Some regional regulations require asset managers to provide a certain level of returns. They can i.e. be compared to the US 401 (K) account. At pension age it generates an annuity or lump sum.

An employer who grants an enterprise annuity is obliged to pay premium.There is no mandatory own contribution for the employee. Even though own contributions quickly increase in prevalance and the majority of the pension plans have it incorporated.

Employer contributions are limited to 8,33% of employee salaries. The combined employer/employee contribution should not exceed 16,66% of the total wages. Many schemes have a flat premium percentage of 5%-7%.

An employer can only provide this corporate coverage if the corporation is already participating in the urban pension system, is financially sound and has collective bargaining mechanisms in place. Most schemes have been adopted by large state owned corporations.

The most relevant quantative investment restrictions are:

• At least 20% of the assets have to be invested in high liquidity money market instruments such as deposits or central bank notes.
• At least 20% should be invested in government bonds.
• Maximum of 50% of assets can be invested in term/contractual deposits, government/corporate/concertable bonds and securities.
• Maximum of 30% of assets can be invested in stocks, investment-linked insurance products and equity funds.
• Investment in equities should not exceed 20%.
• In general investments can only be made in China with its low interest rate and volatile stock market.

These restrictions have lowered the potential return on investment and thus reduce an employee’s potential old age pension. Due to financial market development and regulatory experience, the investment restrictions will probably be eased in the future.

V. Enterprise Annuities And Tax

Premium

Due to differences in regional rules a company with an Enterprise Annuity Plan receives a tax exemption of 4%-12,5% of the wages. There is no tax benefit for employee contributions.

One of the reasons for the low degree of participation might be this small tax benefit. Many other types of investments benefit anyhow from similar tax benefits. More tax relief for both employers and employees is expected in the future.

Pension Terms

Investment income and pension payments are taxed according to standard tax rates. Enterprise Annuities are therefore subject to an ETT system.

The Future Of Enterprise Annuities

The substantial differences in (tax) regulations between even urban regions hinder the implementation of the Enterprise Annuities.

Mostly large Chinese companies have opted for them whereas international and smaller companies seem to be very reserved. The desired pension reforms will only succeed if national and local government succeed in much needed regulatory harmonization.

VI. Group Pension Insurance

Group pension products are offered by Chinese and international insurers. Most offered products have a Defined Contribution nature and include investment choice for participants.

Due to previous abuses of such programs as tax shelter, there are restrictions. Furthermore the tax treatment is not favourable. As with all Non Enterprise Annuity Models, there are no specific direct corporate tax breaks available. The regulations are clear that employees must pay income tax on the contributions when they are made. Investment income and distributions are not taxable to the employee.

The best aspects of insured pension products in China are the security and services provided by insurance companies. The insurance industry is well regulated and competative.

VII. Trusts

In many countries trusts are used to implement corporate pension schemes. It provides asset independency, security for the participants and a steady framework.

In China the pure trust constellation is not that often thus used. Chinese trust law is not written with such plans in mind. Trusts do not receive the level of regulatory and public support that alternatives do. Due to scandals in the past, in China trusts do not radiate an aura of security. Therefore only a few trust companies in China implement pension schemes.

I. Mandatory Participation Expats

National legislation obligates Expats residing in China to participate in the social security system as of 2011. This within 30 days after receiving their work permit.

As only Korea and Germany have a social security treaty with China, Dutch Expats fall within the realm of the mandatory participation.

This regards 5 coverages:

• Pensions;
• Medical care;
• Work related injury;
• Unemployment;
• Maternity insurance.

II. Local Differences

It is typical for China that the mandotary participation is not implemented in all regions equally. Depending on which region it regards, employers seem to decide if they sign up their expats for participation.

It is estimated that 35% of all Expats residing in China are participating.

III. Amount Of Premium

The amount of premium is different for each region as regional rules might differ and substantially increase the premium.

In general the annual expat premium amounts to 11% of the pre tax wages with a certain maximum. The premium exposure of the employer is estimated at 35%.

IV. Pension Annuity Or Refunds

The public pension system is divided into an urban and rural system. The described public pensions refer to the urban system as most Dutch Expats reside in the city.

For Dutch Expats residing in the rural environment it is relevant that the rural pension system is voluntary, very basic and differs substantially in each region. Operational matters are left to the local government.

It appears not to be easy for an Expat who has left China to receive a pension annuity. Among other demands he has to be at least 60 years old and has to have participated during at least 15 years. Neither seems it easy to get a refund of paid premium when the Expat leaves China.

V. Participation Not Always Recommendable

Of the five coverages one has to pay for, the Expat probably only uses medical care and work related injury. As Chinese medical care is not always up to western standards and as medical bills incurred outside of China are not covered, most Expats come with insurance from home.

Regarding pensions for most Expats it is not possible to claim their pension back at the end of their residence. Unemployment insurance is pointless because if the Expat is fired, he loses his visa and has to leave the country. Furthermore it is not always clear if a participating Expat who relocates within China can effectuate his existing coverage in another region.

Many companies find it therefore not worthwhile taking local social security for their Expats.

VI. Sanctioning Of Non Compliance

It is often stated that Chinese government does not uphold this law and that there are no sanctions in case of non compliance.

It seems advisable to check regional rules on this issue. Beijing for example does have substantial penalties for both Employer and Expat in case of non compliance

VII. Desired Coverage

Expats have to decide what kind and amount of coverage they prefer for their family regarding in general disability, passing away prematurely and old age risks.

VIII. Voluntary Continuation Of Homeland Coverage

In several home countries it is possible to voluntarily continue the domestic coverage while working abroad as Expat.

It is advisable to carefully compare the offered coverage with the required premium.

I. Standard

The regular retirement age is:

• For men          : Age 60
• For women     : Age 50/55 for blue collar/white collar

II. Early Retirement

It is possible to claim a pension benefit from the age of 55 years for men and 50 years for women if the individual engaged in physical work in certain industries or posts.

III. Late Retirement

It is possible to defer pension payments until after normal pension age but the pension benefit is not valorised and thus this seems no real option.

I. Chinese Personal Income Tax On Taxable Income

Taxpayer Status	Taxable Income
Living in China less than 90 days (183 days in case of a tax treaty)	- Income sourced within China - Income paid and borne by an overseas employer is exempt
Living in China more than 90 days (183 days in case of a tax treaty) but less than one year domestic enterprise	- Income sourced within China - Income sourced outside of China is not subject to IIT, unless the taxpayer is a director/senior manager of Chinese
Living between 1-5 years in China the income is paid by a Chinese	- Income sourced within China - Income sourced outside of China where enterprise or individual
Living more than 5 years in China	- Income sourced within/outside of China as of the sixth year onwards for every full year spent in China

II. Taxation Of Workers

There is a standard income-tax allowance of CNY 42.000. Employees are allowed to deduct social insurance and housing fund contributions to calculate taxable income.

III. Taxation Of Worker’s Income

Individual Income Tax Rates (applicable to income from wages and pensions).

Grade             Monthly Taxable Income                                                      Tax rate

• 1          Less than         CNY   1.500                                                        3        %
• 2          Between          CNY   1.500     and      CNY   4.500                 10        %
• 3          Between          CNY   4.500     and      CNY   9.000                 20        %
• 4          Between          CNY   9.000     and      CNY 35.000                 25        %
• 5          Between          CNY 35.000     and      CNY 55.000                 30        %
• 6          Between          CNY 55.000     and      CNY 80.000                 35        %
• 7          More than       CNY 80.000                                                       45        %

IV. Social Security Contributions Payable By Workers

Under the revised system, employers contribute a maximum of 20% of earnings to cover the basic pension.

The occupational pension is financed by an 8% contribution from employees. These contributions are capped at three times the local average wage. The social security contributions to individual accounts are exempt from income taxes.

V. Taxation Of Pensioners

There is no additional tax relief for pensioners.

VI. Social Security Contributions Payable By Pensioners

Pensioners do not pay any social security contributions.

I. In General

Expats often have pension claims from several countries and plans.

If an Expat receives a pension pay-out from a Chinese plan and retires in another country, than it is advisable to check if there is a double tax treaty between both countries in order to prevent double taxation.

China has tax relief treaties and agreements with 101 countries. Among others with the Netherlands, U.K. and U.S.

If there is no such treaty, the Expat can only look for unilater national rules in order to prevent or mitigate double taxation.

II. Double Tax Treaty China/The Netherlands

2014

In 2014 a new tax treaty and a protocol between China and the Netherlands entered into force. It applies to income received by residents of either State as of January 1, 2015.

It regards national and local personal income tax issues in order to prevent double taxation.

We will now sumarize the for Dutch Expats in group context most relevant parts of the treaty.

Resident

The Expat is according to the treaty in general tax resident of China and liable to its taxation, if the Expat has his residence or place of management in China.

In case this would result in double taxation, the country which scores the highest on applicable ‘home base/centre of vital interest/habitual abode/nationality’ is entitled to tax.

Income From Employment

The Expat who resides in China will be taxed in China. To the extent that work has been performed in the Netherlands, the latter may tax these wages.

However, the Expat will only be taxed in China regarding work done in the Netherlands if:

1) The Expat does not reside in the Netherlands for more than 183 days in a fiscal year;

2) The related wages are not paid on behalf of an employer who resides in the Netherlands;

3) The related wages are not borne by a permanent establishment or fixed base of the employer in the Netherlands.

Tax Relief

When an Expat resides in China and he also pays Dutch taxes regarding his Dutch wages, these taxes may be credited against the Chinese tax imposed on the Expat. The credit shall not exceed the amount of Chinese tax on that income computed acording to Chinese tax law

‘Voluntary’ Implementation Of Homeland Rates

Some foreign based companies implement on a non governmental bases and therefore voluntarily the homeland tax rate. Besides the probably higher rates and withholding, it is advisable to beforehand look at all pension implications.

Chinese customers increasingly understand that they will need to take more personal responsibility for their pension plans. Their participation will bring profound changes to the industry relating to Pillar 2/3.

To make this happen more stringent consumer protection regulations are expected to be put in place. Distributors, product manufacturers and other contenders for Chinese retail’s pension money are expected to upgrade their client onboarding process.

These companies will also have to offer more personalised products and service modes to satisfy Chinese consumers.

Furthermore a more robust infrastructure is needed to operationalise these changes and development, requiring more investment into process, people, and technology.

Finally it can be expected that due to the increased demand and required better and more products, there will be a fierce competition in the near future between providers in this huge market!