They are instead a form of insurance
I was getting ready to talk to a client yesterday when I had a thought: state or defined benefit pensions are a kind of insurance, not an investment like many people assume.
A defined benefit pension promises you a specific amount of money, unlike a defined contribution pension (like iDeCo) that will give you different results based on market returns.
Even I fell into this trap, analysing the benefits of going back and topping up partial payments to kokumin nenkin in terms of the expected investment return.
In some ways it may be best to think about defined benefit pensions by looking at something very similar: an annuity.
There are different types of annuities. Generally speaking, you should avoid variable annuities (complex, high/opaque fees/no guaranteed payouts) and instead go for simple annuities.
A simple annuity is a financial product that allows you to purchase a lifetime income from an insurance company. The company will use its actuaries to calculate your expected lifespan and adjust rates so that they can make a profit.
Generally speaking, the following options make annuities more expensive:
1. if they are index-linked (go up with inflation)
2. the younger you are when they start
3. if they start immediately
4. if they can be transferred to your spouse
The main disadvantage of an annuity over investing yourself is that if you die earlier than expected the insurance company keeps the money.
The advantage is that (as long as the insurer remains in business) you will never run out of money or end up destitute.
Current annuity rates in the UK seem to be about 4% for a 55-year old and up to 7% for a 75-year old.
Compared to this national pension schemes seem like a pretty good deal. For kokumin nenkin, you pay 16,000 yen a month for forty years, and the government then pays you 65,000 yen a month for the rest of your life. Your total contribution is approximately 7.7 million yen. You would 'make it back' in just under ten years. To put it another way, to buy an equivalent annuity in the UK would cost you almost twice as much.
The purpose of a defined benefit pension is not to maximise your investment returns, but rather to insure yourself against outliving your investments or your ability to manage them. Ideally it should create a bare minimum income floor that protects you from poverty. You can then use other investments to add a bit of comfort and luxury to your life.
If you are a resident of Japan and not currently paying into the Japanese pension scheme, it might be worth reconsidering that decision, particularly if you are not going to receive any other kind of defined benefit pension.
What do you think? Do you have plans to buy an annuity? Are you paying into any pension schemes?