How do freelancers pay for pension contributions?

Key Questions#

How are contributions and calculations made in the mainland pension system?
Why are retirement pensions in the system so high?
How should one contribute to pensions?

How are contributions and calculations made in the mainland pension system?#

Three Pillars of Pension#

Public Pension: Government-led. For example, urban employees and rural residents' pensions.
Occupational Pension: Initiated by the unit, operated by commercial institutions. For example, enterprise annuities and occupational annuities;
Personal Pension: Purchased and saved by individuals, provided by commercial institutions. For example, individual tax-deferred insurance and non-tax-benefit pensions;

Three Pillars of the Pension System

Since the mainland of China is dominated by public pensions, this section mainly discusses the calculation of this part of the pension. Currently, in the mainland, the second pillar of occupational/enterprise pensions is mainly enjoyed by civil servants, institutional staff, state-owned enterprise employees, and some large private or foreign enterprise employees. The third pillar accounts for only 1.2%.

Contributions to Public Pension#

During employment, pension contributions are divided into two parts: individual and enterprise contributions, which are significantly different. Note that the values listed below are examples, and the contribution ratios vary greatly across different regions; also, flexible employment individuals are not suitable for reference.

Individual Contribution: 8% of salary, which goes into the individual account.

This can be simplified as a personal savings account; regardless of where the individual moves, the funds in this account will not change. Of course, policies are not like smart contracts; even if the funds belong to the individual account, there is no guarantee they won't be used for other purposes.

Enterprise Contribution: No more than 20% of salary, which goes into the pooled account.

Basic pension insurance is implemented at the provincial level, and the economic development levels and the ratio of contributing employees to retirees vary across regions, leading to significant differences in contribution ratios. For example, in the 2012 social security interpretation, there was a statement: Shenzhen has a large employed population and few retirees, so the contribution ratio for employers is 10% of the total salary of contributing employees; Liaoning, being an old industrial base, has many retirees and has implemented individual accounts, so the contribution ratio for employers exceeds 20%. By 2023, the contribution ratio for employers in Shenzhen has increased to 14%, while in Liaoning, it has decreased to 16%. What happened between this rise and fall? This is another question worth exploring. For instance, the reason for Liaoning's reduction in the employer contribution ratio in 2019 was mainly to alleviate the burden of social security contributions on enterprises, to create a better business environment, and to allow more previously non-contributing units to participate in contributions. So, has the pension paid by Liaoning decreased? If not, where does this money come from? This will not be discussed in depth here.

Calculation of Public Pension#

Once contributions are made, one can receive pensions. The total retirement pension = individual account pension + pooled account pension.

Individual Account Pension = Individual Account Balance \div Number of Payment Months

The number of payment months can be directly referenced from the Number of Payment Months Table on Baidu Baike.

Pooled Account Pension = \frac{Average Monthly Salary at Retirement Location (1 + Average Contribution Index)}{2} \times Years of Contribution \times 1\%

Understanding the above two formulas is best done with practical case calculations; it is recommended to watch Teacher Li Yongle's video. Additionally, funeral expenses and bereavement payments are also related to the above social security contributions, which vary by city; this will not be discussed in depth, but simply put, if one passes away, the absolute value is unlikely to incur a loss, and for the relatives receiving it, it could even be a profitable business (misunderstanding). However, if a person is no longer alive, why consider whether there is a loss?

How to Understand the Pooled Account and Pay-As-You-Go System?#

The enterprise contribution part is allocated to the pooled account, managed by the local government. The pay-as-you-go system means that the portion of the retirement pension received by current retirees from the pooled account is paid by the contributions of currently employed individuals. In simple terms, the social security contributions that the company currently pays for you are used to support local elderly people, and when you grow old, you will also rely on future local enterprises to pay social security for employees.

Looking again at the calculation formula for the pooled account above, the core influencing factor here is the average monthly salary at the retirement location. The higher the average salary at the retirement location, the more pension one will receive. If you graduate and work in a high-income big city, paying social security locally each month, but when you grow old, you move your household registration back to a small city, then under the pay-as-you-go system, this part of social security contribution can be considered a significant loss. The happy square dance aunties in Beijing, Shanghai, Guangzhou, and Shenzhen should thank you for carrying the burden for them. From this perspective, if young adults work in first-tier cities, it is best to choose to retire in those cities. If you do not like living in first-tier cities, your physical presence may not be there, but your social security must be.

Why are retirement pensions in the system so high?#

It is said that the retirement pensions of civil servants and institutional staff are high; just how high? The following chart shows that the pension replacement rate has been declining since 1999 and is currently only about 42%. According to online sampling surveys, the replacement rate for civil servants and institutional staff may be between 70%-90%, far exceeding the societal average of 42%. If the chart below includes this high replacement rate, then the pensions for social workers would be even lower.

Data Source: Wind, National Bureau of Statistics, Huachuang Securities

The reason civil servants and institutional staff have such high retirement pensions is due to receiving full salaries and high contribution ratios for public pensions, as well as the accumulation of additional occupational annuities by the unit and individuals.

What is the Dual Track System?#

The dual track system mainly involves the public pension portion for civil servants and institutional staff. Before understanding the dual track system, let’s look at a story from Zhihu (author: Lin Zhonglaogui). To prevent future censorship, the story is copied here:

It is said to be a social security case from an American car factory in the 1990s.
Mr. Martin Ford opened a car manufacturing plant, hiring 6,000 young workers and 100 supervisors.
One day, Ford held a staff meeting and said: You young people don’t save money, what will you do when you get old? Now I have planned it for you: starting this month, 20% of your salary will be deducted, and I will open a financial account for you to save and increase value, so when you get old, you can take your retirement pension from this account.
From then on, the 6,000 workers only received 80% of their monthly salary, but the 100 supervisors did not have any deductions and still received 100% of their salary.
Five years passed, and a supervisor named "Red" turned 60, and another supervisor named "Jennifer" turned 55. Ford processed their retirement paperwork that day: from now on, they would receive 8,000 in retirement pension from the workers' pension account.
When the workers learned that "Red" and "Jennifer" would take retirement pensions from their accounts, they exploded and rushed to talk to Ford:
Worker Jack first asked: Mr. Ford, we are not retired yet, how can the money be used for Red and them?
Old Ford replied: This is called "Yesterday and today," which means in Chinese, "Drink today while you can." They were once part of the company, so it is reasonable for them to take the money.
Worker Mike said: The problem is that the supervisors never contributed money in the first place...?
Old Ford replied: This is called "Yours is mine," meaning "What is yours is mine, and what is mine is still mine." The supervisors not contributing does not affect their ability to take money from it...
Worker Johnny asked: What is this "Yesterday and today," "Yours is mine"? We have never heard of it!
Old Ford said: This was a new factory rule collectively established at last year's supervisors' meeting.
Worker Vivian said: We only take 4,000 at work, and after the 20% deduction, we only get 3,200, but Red and Jennifer can take 8,000 in retirement, that’s too unfair!
Old Ford said: The supervisors contribute greatly to the company; without them, the company might have gone bankrupt, and you would have lost your jobs... It is reasonable for them to take 8,000 in retirement.
Vivian pressed: So when we workers retire, can we also get 8,000 a month?
Old Ford replied: You think too much~~~ You only contribute 800 a month, and after 40 years, getting 900 should not be a problem...
Worker Benjamin said: Old Ford, I studied law at MIT; you promised to invest the money to increase value and pay retirement pensions to workers. Now you unilaterally establish "Yesterday and today" and "Yours is mine," allowing retired supervisors who never contributed to take our money; this is typical unilateral breach of contract... We can even sue you for fraud...
Ford took a sip from his goji berry cup and said: The supervisors' meeting is the highest management body of the company and has the right to establish and modify any factory rules; this is all legal procedure.
Worker John said: Old Ford, I am a finance graduate from the Royal Swedish Academy of Music: I will be honest: if this continues, in a few years, the pension account will be emptied by the retired supervisors, and when we retire, let alone 900, we might not get a single cent...
Old Ford lit a 555 cigarette and blew a smoke ring, saying: First of all, the account cannot be empty; I will appropriately increase your deduction rate to ensure that retired supervisors can receive their 8,000 pension on time and in full.
As for your workers' pension issue, the supervisors' team has carefully studied the "Son and grandson forever" strategy, which means in Chinese, "Children and grandchildren will never end." Specifically, when your children grow up, they will continue to work in the factory, and my son "Martin Ford II" will collect their money to pay for your pensions; doesn’t that solve the problem?
The workers were collectively furious: Isn’t this just a trick? After all this talk, it turns out that our pension contributions are just to support the retired supervisors. And for our own pensions, you push the responsibility onto our next generation. In the end, our pensions will rely on our own children to fill the gap? Isn’t this essentially what the Chinese saying describes as "raising children to prevent old age"?
Ford threw away his cigarette and said: One generation can only do the work of one generation. I invented this system to ensure that supervisors have support in their old age; I have no regrets.
Franklin said: Mr. Ford, don’t you know that half of our 6,000 workers are still unmarried, likely single, and those who are married dare not have many children? The next generation's population will significantly decrease. Where will your Ford II collect money to fill the gap?
Ford said: I have already designed the system for you. If you don’t marry and don’t have children, then I will say it upfront: if my son cannot collect money and cannot pay pensions, you can only blame yourselves...
Worker Obanew said: Mr. Ford, my dad is 68 this year and has no pension; he is currently working on a farm in Wisconsin growing ginseng, and my mom is 61 and also has no pension; she is currently cleaning at Mr. Trump's hotel... Originally, I agreed to contribute to the pension as a form of savings. But now, I really cannot accept that my contributions are used to support others' pensions, so I have decided not to contribute anymore. In the future, I will give 20% of my salary to support my parents and fulfill my filial duty...
Obanew's statement resonated with the workers; everyone announced they would no longer contribute to pensions and would not trouble Mr. Martin Ford to manage the accounts...
Mr. Ford, in a fit of rage, said: What? You are rebelling! If you don’t contribute to pensions now, how will I pay the supervisors their retirement pensions? While working for me, you must honestly contribute to pensions.....

Before 2014, civil servants and institutional staff did not have to pay social security; all contributions were covered by the government, and pensions were paid at the highest contribution rate. Retired staff only needed to spend their pensions. Starting in 2014, the dual track system began to be abolished, with a 10-year transition period. Theoretically, from 2024 onwards, civil servants and institutional staff will have the same social security contribution and payment rules as social workers for the public pension portion, but they will still enjoy the occupational annuity portion.

Occupational Annuities and Enterprise Annuities#

As mentioned earlier, China's pension system consists of three pillars. The first pillar is the government-led basic pension insurance fund, which had a cumulative surplus of 6.4 trillion yuan in 2021, accounting for 45.8%; the second pillar consists of enterprise annuities and occupational annuities initiated by enterprises and institutions, totaling 4.4 trillion yuan, accounting for 31.5%. In 2021, the investment operation scale of enterprise annuities and occupational annuities was 2.6 trillion yuan and 1.8 trillion yuan, respectively (left side of the chart below). The proportion of employees participating in enterprise annuities was only 6.2% of the total urban employed population that year. Such a low participation rate accounts for 31.5% of retirement funds, so this group will enjoy relatively much higher pensions.

Pension Structure in China and the United States

Occupational annuities are only available to civil servants and institutional staff, while enterprise annuities are often paid by large enterprises, such as some state-owned and foreign enterprises. These units generally contribute at a full salary rate, while most private enterprise employees have lower contribution rates and do not contribute based on full salaries, sometimes even contributing based on minimum wages, leading to significant differences in retirement pensions.

How should one contribute to pensions?#

Where to work and pay social security? At what salary and at what rate should social security be paid? For many people, these are not even matters of choice; they can only follow the social job demands and company contribution standards. However, for those with bargaining power in the workplace and the ability to choose cities and positions (freelancers, digital nomads, etc.), it is worth considering taking responsibility for their long-term lives.

Sustainability of Pensions?#

First, let’s look at the comparison of pension reserves between China and the United States. The data in the table below is calculated from the comparative data of the Ministry of Human Resources and Social Security, ICI, and CCEF mentioned above. It can be seen that the main source of pensions in the United States no longer relies on the first pillar and generally enjoys pensions from the second and third pillars. On average, there is already a pension reserve of $127,700 per person, assuming one can live for another 15 years after retirement, it seems one can live quite well.

Average Pension in China and the United States

Now let’s look at the situation in China, where the average pension reserve is less than 10,000 yuan. For over 80% of employees in private enterprises in China, one can only look at the public pension portion (the first pillar), meaning that the average amount received is theoretically even less. Let’s assume 10,000 yuan, and if one lives for only 10 years after retirement, with an annual pension of 1,000 yuan, it is difficult to meet basic living needs in most areas. However, to meet the basic living needs of retired elderly people, the current government is actually paying pensions that exceed its payment capacity.

According to predictions from the Academy of Social Sciences, the basic pension insurance fund for urban employees will peak at 6.99 trillion yuan in 2027 and then rapidly decline, exhausting all funds by 2035. The chart below shows the situation in 2021, where the overall public pension portion heavily relies on fiscal subsidies.

2021 Basic Pension Revenue and Expenditure Surplus

Will pensions not be paid?#

From the above mathematical game, it seems that pensions may not be paid. Logically, the pay-as-you-go system will also be difficult to sustain under the trend of declining population in China. But don’t forget the last line of defense for pensions: fiscal subsidies. At this point, we need to ask: Are fiscal subsidies unlimited? This turns the issue into a political one. Theoretically, pensions are paid in legal currency, and the right to issue legal currency is in the hands of the government, which can print money indefinitely. However, mass printing of money also brings many issues. Should we print money to pay pensions? At this point, the logic of thinking needs to shift to the primary goal of governance: maintaining governing authority. Pensions involve the most basic livelihood of the people; stopping pension payments will undoubtedly threaten governance stability, so it is a high priority. Additionally, it is worth mentioning that in the matter of printing money, priority is very important. The purchasing power of those who first receive the newly issued currency will initially not be affected by inflation caused by money printing, while subsequent asset prices will be driven up by money printing. Therefore, if you can get the new money first and purchase scarce assets, that’s a significant advantage. Money cannot be printed indiscriminately, and pensions must be paid, which will ultimately lead the government to constantly pursue a balance between governance stability and money printing. In simple terms, as long as the government retains its governing authority, relying on pensions is unlikely to lead to starvation, but do not expect a quality life. If your retirement pension is far above the standard of not starving, then be cautious of the potential for wealth redistribution in the pursuit of governance stability.

How to contribute to pensions when there is a choice?#

In a scenario where personal investment capabilities can consistently outpace inflation, one should try not to contribute to pensions and invest all the money oneself. However, most people may not have the ability to consistently outpace inflation in their investments and will have to pay a basic social security contribution. Therefore, it is advisable to choose to work in cities with high average salaries and pay social security at the minimum wage and minimum rate, which may be the most advantageous contribution method. Use the extra money to accumulate scarce assets, such as quality equity assets, Bitcoin, etc. When you reach 100 years old, you can calculate that it is likely to yield a higher return than contributing fully to pensions. Finally, the above views are based on the assumption of policy continuity; change is the fundamental nature of the world, and the future is uncertain. Ultimately, pensions need to be implemented to better cope with changes in the world.

Zhemin