Japan proposal on contribution limits could hurt

Japan's regulators are moving to put "fairer" contribution limits for corporate defined contribution plans in place this year but analysts warn their proposed changes could just as easily shrink Japan's DC market as expand it.

Along the way, some of Japan's biggest corporate plan sponsors could be forced to restructure the mix of DC and defined benefit retirement plans they offer to employees.

At issue are current rules that mandate across-the-board reductions in DC contribution ceilings for companies that also offer defined benefit plans.

In contrast to the U.S. 401(k) system, where regular deductions from employees' paychecks powers growth, companies are the main contributors to Japan's corporate DC asset pool, which has grown to more than ¥12 trillion ($112.9 billion) since the country put its DC framework in place almost 20 years ago.

DB plans, meanwhile, remain the core of Japan's corporate retirement system with ¥63 trillion in assets — roughly five times the size of DC.

Under prevailing rules, companies offering only a DC plan can contribute up to ¥55,000 monthly, or just over $500, to employees' accounts. For companies offering a DB plan as well, that ceiling is cut in half — to ¥27,500.

Japan's Ministry of Health, Labor and Welfare is arguing now that slashing monthly DC contribution limits by ¥27,500 is unfair for companies whose estimated DB contributions come in well below that amount, noted Junichiro Goto, Tokyo-based managing director, multiasset business development, with AllianceBernstein Japan Ltd.

The ministry is calling for those companies' DC ceilings to be raised, flexibly, to allow total contributions for a sponsor's DB and DC plans of ¥55,000, Mr. Goto said.

By way of example, under the proposed change, a company paying only ¥5,000 a month per employee into its DB plan could contribute up to ¥50,000 a month to participants' DC accounts — far in excess of the ¥27,500 permitted under current rules.

At present, companies face no limits in making contributions to their DB plans and the push to generate a hypothetical, per-employee DB figure is only relevant in the context of the current proposal to come up with company-specific DC contribution limits.

Still, some market participants expressed concern that those hypothetical, per-employee DB figures could lay the groundwork for regulators to impose contribution limits on DB plans in the future. A ministry spokesman couldn't immediately be reached for comment.

Analysts say while Japan's DC contribution limits are worthy of review, the focus should be on encouraging as sharp a pickup in inflows to employee DC accounts as possible, whether from corporate sponsors or employees.

At ¥660,000, or roughly $6,300 a year, Japan's DC contribution limits are a fraction of the up to $57,000 in combined contributions employees and employers can make to U.S. DC accounts, noted Haruka Urata, Tokyo-based head of DC proposition and thought leadership with Fidelity Investments (Japan) Ltd.

Those low contributions are the main obstacle keeping Japan's DC industry from graduating to much faster-paced growth from the steady gains of the past decade, Mr. Urata noted in an August report outlining potential reforms for Japan's defined contribution system.

The report suggested government concerns about lost revenues from expanding DC incentives could be overstated. Added incentives would allow companies to further weight their retirement programs toward DC from DB — a potentially tax-neutral shift from the government's perspective, Mr. Urata contended.

In addition, he called for lifting the prohibition on after-tax contributions to DC plans for both employers and employees.

As of March 31, 2019, Japanese corporate DC assets came to ¥12.5 trillion, or 17% of total corporate retirement assets — up from 12% of the total for the year ended March 31, 2012, Mr. Urata's data showed.

Japanese corporate DC assets almost doubled over the past six years, nearly more than three times the growth rate for Japanese corporate DB assets.

If boosting corporate DC contributions is a central goal for Japan's retirement industry, the ministry's July proposal, titled "In consideration of setting a fairer DC contribution limit," offers uncertain prospects.

Japan's DC contribution limits currently are "rather complex and very difficult to understand," with no common formula capable of neatly bridging the corporate and individual DC plans they cover, noted Akiko Nomura, a Tokyo-based managing director with the Nomura Institute of Capital Markets Research.

And without better data on the corporate DB and DC contributions being made now by companies sponsoring both types of retirement plans, it's tough to get a good sense of who's suffering, and to what extent, from that one-size-fits-all, 50% reduction in DC contribution limits, Ms. Nomura said.

The proposal suggests there'll be far more winners than losers from taking DB outlays into account when setting DC contribution limits.

A document outlining the proposal showed 91.7% of the ministry's tally of 11,038 defined benefit plans making estimated monthly DB contributions of less than ¥27,500, leaving room for more than 9 out of 10 companies to boost DC contributions.

Still, some remain skeptical.

The ministry's documents show fewer than 15% of companies that currently offer only a DC plan — and which therefore have the ability to contribute up to ¥55,000 a month to member accounts — are putting in more than ¥30,000 a month, noted Kunio Nakashima, a senior research fellow with Tokyo-based NLI Research Institute.

If that's any guide, "even if the Ministry of Health, Labor and Welfare's proposal comes to be realized, it is unlikely that corporate contributions will increase," he said.

A pension executive at Japan's Ministry of Health, Labor and Welfare didn't respond to queries on what proportion of the 91.7% of companies making monthly DB contributions of less than ¥27,500 are currently making the maximum DC contribution of ¥27,500.

But if the upside for DC asset growth is limited, some warn of more potential downside.

The flexibility the ministry is looking to introduce can cut both ways, forcing companies with high estimated DB contributions to reduce their DC or DB contributions to stay below that combined monthly limit of ¥55,000, said AllianceBernstein's Mr. Goto.

Analysts say while there's no definitive list, the remaining 8.3%, or more than 900 companies, on the ministry's DB sponsor list with estimated monthly DB contributions in excess of ¥27,500 likely includes many of Japan's biggest companies with generous retirement plans.

The government should "move carefully" because those companies will face the choice of shrinking or closing their DC plans or reducing allocations to their DB plans, according to arguments presented by the Trust Companies Association of Japan at an Aug. 26 hearing of the Corporate Pension/Individual Pension subcommittee of the Social Security Council.

Under the new plan, "we would have to close up our DC plan, because our DB plan uses up the whole ¥55,000" allotment, said a human resources executive with a global Japanese company, who declined to be named, calling that prospect "a big problem right now."

Roughly 600,000 DC participants, or 15% of the 4 million total working for companies offering both DC and DB plans, could see either weaker growth for their corporate DC accounts or their accounts being shut down entirely under the new paradigm, the Trust Companies Association of Japan warned at the Aug. 26 subcommittee meeting, according to a report on those proceedings by Sumitomo Mitsui Trust and Banking.

NLI Research Institute's Mr. Nakashima noted that calls for "transitional measures" allowing firms making heavy DB contributions to continue contributing to their DC plans for a period of time could still find their way into the final proposal, likely to be hammered out as early as October.

Still, Mr. Nakashima said, in his personal view, if the Ministry of Finance rejects those calls, the steady growth of Japan's defined contribution assets could reverse.

Others, however, believe the DC market could prove resilient in an environment where big plan sponsors are forced to make hard choices between their DB and DC plans.

Companies may well come under pressure to redesign or restructure their retirement programs but shutting down their DC plans is unlikely to be a popular choice, said Junior Thomas, a Tokyo-based consultant and actuary with Mercer's pension consulting team.

With companies globally looking to minimize DB-related liabilities on their balance sheets, a more likely option could involve companies freezing their DB plan, with future accruals focused instead on DC plans and lump-sum payouts at retirement, he said.

If legislation incorporating the ministry's proposal is approved, the new DC contribution limit arrangements would go into effect in October 2022.