CONTENTS
- 1. Executive Retirement Benefit Limit | The Importance of Classified Taxation of Retirement Income and Its Tax Advantages
- 2. Executive Retirement Benefit Limit | Standards for Recognizing Corporate Expenses Based on the Articles of Incorporation and Payment Regulations
- - Provisions Limiting the Multiplier by Year Following Amendments to the Income Tax Act
- 3. Executive Retirement Benefit Limit | Managing Tax Risks When the Limit Is Exceeded and Obtaining Professional Assistance
- - Calculating the Executive Retirement Benefit Limit and a Win-Win Design Structure
- - The Need for a Corporate Attorney
1. Executive Retirement Benefit Limit | The Importance of Classified Taxation of Retirement Income and Its Tax Advantages
The following examines a company's response strategy for setting executive retirement benefit limits and preventing tax risks.
For executives who have dedicated themselves to a company and produced results, retirement pay carries meaning beyond mere salary.
Many executives dream of "financial freedom" after retirement, but if they do not account for the proportion of taxes in the amount actually received, they may face difficulty securing substantial assets.
The core concept here is the executive retirement benefit limit.
Generally, an executive's income is classified into earned income (salary and bonuses), dividend income, and retirement income.
Of these, the most advantageous item for tax purposes is, by some margin, retirement income.
Earned income and dividend income are subject to comprehensive taxation, under which they are aggregated with other income and taxed at progressive rates that can reach up to 49.5% (including local income tax) depending on the income bracket.
By contrast, retirement income is subject to "classified taxation," under which it is taxed separately rather than aggregated with other income.
In addition, because retirement income is income accumulated over a long period and received in a lump sum at the time of retirement, a "annualization and de-annualization" method of calculation is applied.
Under this method, the retirement income is divided by the years of service to apply the tax rate, then multiplied again by the years of service, which lowers the tax base and, as a result, brings the income into a lower tax rate bracket.
Accordingly, from a company's perspective, making the fullest use of the executive retirement benefit limit within the range permitted by law is the most effective tax planning strategy for increasing the executive's net amount received.
Under the Corporate Income Tax Act and the Income Tax Act, it refers to the legal ceiling on the portion of the amount an executive receives upon retirement that may be recognized as "retirement income."
Any amount paid in excess of this limit may be treated not as retirement income but as "earned income," to which a far higher tax rate may apply.
2. Executive Retirement Benefit Limit | Standards for Recognizing Corporate Expenses Based on the Articles of Incorporation and Payment Regulations
For a corporation to have the retirement pay it pays to an executive recognized as an expense (deductible expense), it must comply with the executive retirement benefit limit set under the Corporate Income Tax Act.
If a company pays an excessive amount without a legal basis, the tax authorities may not only decline to recognize it as an expense but also treat it as an improper outflow of corporate funds and impose strict sanctions.
Under the Corporate Income Tax Act, as a rule, an executive's retirement pay must be paid according to the amount set in the corporation's articles of incorporation or according to the "executive retirement pay payment regulations" delegated by the articles of incorporation.
If no such separate regulation exists, under Article 44 of the Enforcement Decree of the Corporate Income Tax Act, only an amount equal to "10% of total wages for the one year preceding retirement" multiplied by the years of service is recognized as an expense.
Any amount exceeding this is treated as a non-deductible expense and subject to corporate income tax, and for the executive concerned it is aggregated as earned income, increasing the income tax burden.
Accordingly, company representatives and executives should carefully examine whether their company's current articles of incorporation contain a clear provision on the executive retirement benefit limit, and whether that provision reflects the latest changes in the law.
The mere existence of a relevant provision does not resolve all risks.
Where the following circumstances arise, the expense treatment may be denied during a tax audit.
Where an excessively favorable multiplier is set for a particular executive only
Where different payment rates are applied to different executives without an objective standard
Where the payment regulation is abruptly amended immediately before an executive's retirement
Where due procedures, such as a resolution of the general meeting of shareholders or the board of directors, are not followed
Even if a company wishes to set generous retirement pay to reward an executive's efforts in the course of its operations, disregarding these legal procedures and considerations of fairness may instead result in imposing a heavy tax burden on the executive.
Provisions Limiting the Multiplier by Year Following Amendments to the Income Tax Act
In the past, if a high multiplier (for example, five times or ten times) was set in the articles of incorporation, the entire amount could be recognized as retirement income.
However, as cases of abusing this to take corporate funds out at a low tax rate increased, the government amended the Income Tax Act and progressively tightened the executive retirement benefit limit.
At present, the applicable multiplier differs depending on the period of service, so care is required in the calculation.
The portion of the total retirement pay received by an executive that is recognized as retirement income under the Income Tax Act is calculated by dividing it into the following three periods and aggregating them.
First, the period of service on or before December 31, 2011.
Retirement pay for this period may be recognized as retirement income in the full amount set in the articles of incorporation or payment regulations in effect at that time.
If no separate regulation existed, the statutory limit (10%) applies.
Second, the period of service from January 1, 2012, through December 31, 2019.
From this point, a multiplier limit under the Income Tax Act was introduced, and only up to three times the amount of 10% of the average annual total wages for the three years preceding retirement, multiplied by the years of service, is recognized as retirement income.
Third, the period of service on or after January 1, 2020.
Through amendment of the law, the limit was further reduced, and at present only up to two times is recognized as retirement income under the same method of calculation.
In addition, because the retirement income limit under the Income Tax Act is determined by the average wages for the three years preceding retirement, adjusting the annual salary level in advance can serve as a tax saving strategy.
| Classification by Period of Service | Multiplier Recognized as Retirement Income | Remarks |
| On or before December 31, 2011 | Full amount of the stipulated multiplier recognized | A basis in the articles of incorporation or delegated regulations is required |
| 2012 through December 31, 2019 | 10% of average annual total wages × years of service × 3 times | Limit under the Income Tax Act introduced |
| On or after January 1, 2020 | 10% of average annual total wages × years of service × 2 times | Limit reduced (2 times applied) |
As shown, the executive retirement benefit limit must be calculated proportionally by period of service, which makes it highly complex in practice.
In particular, any amount exceeding the limit is taxed on the executive individually as "earned income" through aggregation, even if it has been recognized as an expense by the corporation.
This consequently leads to increased health insurance premiums and a heavier comprehensive income tax burden, which may disrupt the executive's substantial retirement asset planning.
3. Executive Retirement Benefit Limit | Managing Tax Risks When the Limit Is Exceeded and Obtaining Professional Assistance
From a company's perspective, it is not impossible to pay an executive retirement pay exceeding the limit.
However, the company must clearly recognize that the excess portion is not recognized as an expense under the Corporate Income Tax Act and is taxed as earned income for the executive.
If a high multiplier is applied arbitrarily without considering tax risks, substantial incidental costs may arise, including the collection of corporate income tax and an underreporting penalty.
Care is also required when, after receiving retirement pay, an executive seeks to transfer it to an Individual Retirement Pension (IRP) and receive it as a pension.
An amount within the executive retirement benefit limit under the Income Tax Act may receive a reduction of 30 to 40% of the retirement income tax upon pension receipt, but an amount that exceeds the retirement benefit limit and is treated as earned income cannot receive any such reduction, nor can it benefit from the tax deferral available through a pension account.
Ultimately, the key to successful executive retirement planning is to accurately calculate the executive retirement benefit limit permitted by law and to establish regulations under which both the company and the executive can benefit (win-win) within that limit.
If you are in any of the following situations, a legal review should be undertaken.
Calculating the Executive Retirement Benefit Limit and a Win-Win Design Structure
| Category | Key Content | Effect for the Company | Effect for the Executive |
|---|---|---|---|
| ① Statutory Limit Structure | The deductible expense limit under the Corporate Income Tax Act is within the range of (average salary for the 3 years preceding retirement × 1/10 × years of service × 3 times) | Blocks the risk of non-deduction of the excess portion | Retirement income tax may apply to the full amount |
| ② Reorganizing the Articles and Regulations | Specify the payment multiplier and calculation standards in the articles of incorporation and the executive retirement pay payment regulations | Secures a basis for payment in a tax audit | Enables predictable retirement planning |
| ③ Simulating a Compensation Increase | Calculate the increase in retirement pay in advance before raising an executive's salary | Prevents an excessive burden of retirement reserves | Establishes a reasonable compensation adjustment strategy |
| ④ Managing the Risk of Excess Payment | The excess over the limit is non-deductible and taxed as earned income | Prevents the collection of corporate income tax and penalties | Prevents the loss of retirement income reduction benefits |
| ⑤ IRP Transfer Strategy | Transferring only the amount within the limit to a pension account allows a reduction of retirement income tax | A tax saving structure without tax risk | A tax rate reduction benefit upon pension receipt |
| ⑥ Requirement of a Shareholders' Resolution | Under commercial law, payment of compensation and retirement pay requires a resolution of the general meeting of shareholders | Blocks the risk of invalid payment and occupational breach of trust | Prevents future disputes |
| ⑦ Business Succession or Corporate Conversion Situations | Establish a strategy to reorganize executive retirement pay before succession | Prevents a tax burden during the succession process | Enables adjustment of the tax burden between generations |
| ⑧ Documentation for Responding to a Tax Audit | Retain the basis of calculation, the average salary calculation table, and the minutes of the board of directors and general meeting of shareholders | Reduces the risk of collection by securing supporting materials | Enables a response to a taxation disposition |
The Need for a Corporate Attorney
If you are concerned about tax and legal disputes related to the executive retirement benefit limit in the course of a company's important decision-making, establishing a careful strategy from the early stage is the only way to prevent asset loss.
For an executive's lifetime of contribution to be lost to taxes due to a deficiency in the regulations is a significant loss for the company as well.
To secure both the executive's stable retirement and the corporation's financial soundness, the assistance of professionals well versed in the relevant laws can be important.
At Daeryun, attorneys handling corporate matters, attorneys handling tax matters, and certified tax accountants work together and can help prevent corporate risks.
Daeryun Law Firm 🔗Schedule a Consultation with a Corporate Attorney. We recommend that you review your company's articles of incorporation and design a retirement pay payment structure within the legal limit.
