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?#

The Three Pillars of Pension#

Public Pension: Government-led. For example, urban workers' and rural residents' pensions.
Occupational Pension: Initiated by the employer, 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;

The 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 Pensions#

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

Individual Contribution: 8% of salary, this part belongs to the individual account.

This can be simplified to understand as an individual's 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 funds belonging to the individual account may be repurposed.

Employer Contribution: No more than 20% of salary, this part belongs to the pooled account.

Basic pension insurance is implemented at the provincial level, and the economic development levels and the ratio of contributing employees to retired individuals vary across regions, leading to significant differences in contribution rates. For example, there is a statement in the 2012 social security interpretation: Shenzhen has a large employed population and few retirees, so the contribution rate for employers is 10% of the total salary of contributing employees; Liaoning, being an old industrial base with many retirees, has a contribution rate exceeding 20% . By 2023, the contribution rate for employers in Shenzhen has increased to 14%, while in Liaoning, it has decreased to 16%. What has happened between this rise and fall? This is another question worth exploring. For instance, the reason for Liaoning's reduction in employer contribution rates 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 Pensions#

Once contributions are made, pensions can be collected. 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 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 in conjunction 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. In summary, if one passes away, the absolute value will likely not result in a loss, and for the beneficiaries, it could even be a profitable business (misunderstanding). However, if a person is no longer alive, why consider profit or loss?

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

The employer 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. Simply put, the social security contributions made by companies now are used to support the elderly in the area, and when you grow old, you will also rely on future contributions from local companies to support your retirement.

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 retirement pension one receives. If you graduate and work in a high-income big city, paying social security there each month, but later move your household registration back to a small city when you are old, then under the pay-as-you-go system, this part of social security contributions can be considered a significant loss. The happy square-dancing 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 should remain.

Why are retirement pensions in the system so high?#

It is said that the retirement pensions of civil servants and institutional staff are high; how high exactly? The following chart shows that the pension replacement rate has been declining since 1999, currently at around 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 high retirement pensions for civil servants and institutional staff are due to the full salary and high contribution rates of 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 a plan for you: starting this month, I will deduct 20% of your salary, and I will help you open a financial account to save it uniformly, preserving and increasing its value, so that when you get old, you can withdraw 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 large sum of money was saved in the account.
At the beginning of the month, supervisor "Red" turned 60, and another supervisor "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 each month.
When the workers learned that "Red" and "Jennifer" were going to withdraw retirement pensions from their account, they exploded and rushed to talk to Ford:
Worker Jack was the first to ask: Mr. Ford, we haven’t retired yet; how can the money be used for Red and the others' pensions?
Old Ford replied: This is called "Yesterday and today," which is similar to the Chinese saying "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 didn’t contribute any money at all...?
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" about? We’ve never heard of it?
Old Ford said: This was collectively established as a new factory rule at last year's supervisors' meeting.
Worker Vivian said: We only take 4,000 at work, and after deducting 20%, we only get 3,200, but Red and Jennifer can retire and take 8,000; that’s too unfair!
Old Ford said: Supervisors contribute greatly to the company; without them, the company might have gone bankrupt long ago, and you would have been unemployed... 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; after 40 years, getting 900 should be no problem...
Worker Benjamin said: Old Ford, I studied law at MIT; you promised to invest the money and provide retirement pensions for the workers. Now you unilaterally establish "Yesterday and today" and "Yours is mine," allowing supervisors who never contributed to take our money; this is a typical unilateral breach of contract... We could even sue you for fraud...
Ford took a sip from his goji cup and said: The supervisors' meeting is the highest management body of the company and has the right to formulate and modify any factory rules; this is all legal.
Worker John said: Old Ford, I am a finance graduate from the Royal Swedish Academy of Music: Let me be honest: if this continues, in a few years, the pension account will be emptied by the retired supervisors, and when we retire, don’t even think about getting 900; you might not get a single cent...
Old Ford took a 555 cigarette, blew a smoke ring, and said: First of all, the account cannot go bankrupt; I will appropriately increase your deduction rate to ensure that retired supervisors can receive 8,000 in pensions on time and in full.
As for your workers' pension issue, the supervisors' team has carefully studied the "Son and grandson forever" strategy, which is similar to the Chinese saying "Children and grandchildren will never end," specifically meaning that 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 collectively became furious: Isn’t this just a way to take advantage of us? After all this talk, it turns out that our pension contributions are just to support the retired supervisors. And our own pensions, you’re passing the buck to our next generation. In the end, our pensions will still rely on our 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 can rely on their old age; I have a clear conscience.
Franklin said: Mr. Ford, don’t you know that half of our 6,000 workers are still unmarried and likely to remain single? Even those who are married dare not have many children; the next generation will significantly decrease. Where will your Ford II go to collect money to fill the gap then?
Ford said: I have already designed the system for you. If you don’t get married and don’t have children, then I’ll say it upfront: if my son can’t collect money and can’t 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. 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 can’t accept that my contributions are being used to support others' pensions, so I’ve decided not to contribute anymore. From now on, I will give 20% of my salary to my parents for their retirement, fulfilling my filial duty...
Obanew's statement resonated with the workers; everyone announced they would stop contributing to pensions and wouldn’t bother Mr. Martin Ford to manage the accounts anymore...
Mr. Ford, in a fit of rage, said: What? You’re rebelling against me! If you don’t contribute to pensions now, how will I pay the supervisors their retirement pensions? If you work 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 distributed 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 distribution rules as social workers, 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 and operation scale of enterprise annuities and occupational annuities were 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 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 contributed 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 may not even contribute based on full salaries, sometimes only the minimum wage, leading to significant disparities in retirement pensions.

How should one contribute to pensions?#

Where to work and contribute to social security? At what salary and what contribution rate? For many people, these are not even matters of choice; they can only follow the demands of the job market and the company's contribution standards. However, for those with bargaining power in the workplace and the ability to choose cities and positions (such as freelancers, digital nomads, etc.), it is worth considering how to take 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 from the Ministry of Human Resources and Social Security, ICI, and CCEF. It can be seen that the main sources of pensions in the United States no longer rely on the first pillar and generally enjoy pensions sourced 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.

Per Capita 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. Taking 10,000 yuan as an example, if one lives for only 10 years after retirement, with an annual pension of 1,000 yuan, it is very 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 Chinese Academy of Social Sciences, the basic pension insurance fund for urban workers will peak at 6.99 trillion yuan in 2027 and then decline rapidly, exhausting all funds by 2035. The following chart shows the situation in 2021, where the overall public pension portion heavily relies on fiscal subsidies.

2021 Basic Pension Revenue and Expenditure Balance

Will pensions be unable to be paid?#

From the mathematical game above, it seems that pensions may not be paid out. Logically, the pay-as-you-go system will also struggle to sustain itself 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 currency lies with the government, which can print money indefinitely. However, mass printing of money 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 governance authority. Pensions involve the most basic livelihood of the people; cutting off pension payments will undoubtedly threaten governance stability, thus it is a high priority. It is worth mentioning that in the matter of printing money, priority is very important. The purchasing power of those who receive newly issued currency first 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 new money first and purchase scarce assets, that’s a significant advantage. Money cannot be printed indiscriminately, and pensions must be paid, ultimately leading the government to continuously pursue a balance between governance stability and money printing. In simple terms, as long as the government retains its governance authority, relying on pensions is unlikely to lead to starvation, but don’t expect a quality life. If your retirement pension is far above the standard for 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 scenarios where personal investment capabilities can continuously outperform inflation, one should try to avoid contributing to pensions as much as possible and invest all the money oneself. However, most people may not have the ability to consistently outperform inflation in investments and may still have to contribute a basic amount to social security. Therefore, it is advisable to choose to work in cities with high average salaries and contribute to social security at the minimum wage and minimum rate, which may be the most advantageous way to contribute. Use the extra money to accumulate scarce assets, such as high-quality equity assets, Bitcoin, etc. When you reach a hundred years old, you can calculate that it is likely to yield higher returns than contributing fully to pensions. Finally, the above views are based on the assumption of policy continuity; change is the underlying reality of the world, and in the future, no one can be certain. Ultimately, retirement needs to be implemented to better cope with changes in the world.

Zhemin