Korean retail investors flock to government bonds as interest rates rise

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The South Korean government will be introducing a government bond for personal investment in the first half of 2024. The government will guarantee the savings product’s principal and investors do not need to worry about losing their investment unless Korea falls into a default crisis.

Government bonds are available in 10-year or 20-year maturities. It assumes holding to maturity, and investors need to invest long until maturity to benefit from separate taxation, additional interest rates, and compound interest rates.

Individual investors can open a dedicated Treasury bond account with a financial institution and choose between 10-year and 20-year products for investment. Unlike regular coupon bonds that pay interest every six months, Treasury bonds for personal investment are compounded, meaning the investors receive principal and interest in a lump sum at maturity and cannot receive interest before the product matures.

The interest rate offered to retail investors on Treasury bills is determined by the prevailing market interest rate, with the government basing the coupon rate on the winning bid rate of the same maturity government bond issued in the previous month. For example, a 20-year Treasury bill issued in July next year will have the same interest rate as the 20-year Treasury bill bid in June, with the market rate for Treasuries practically setting the coupon rate.

Investors who hold the bonds to maturity are also entitled to additional interest rates. They receive compounded interest based on the coupon rate plus the markup. For example, an investor buying a 20-year Treasury bond for personal investment with a 3.5 percent coupon rate will see a return after 20 years of 99 percent pre-tax and 84 percent post-tax. This means an investor who invests 100 million won will receive 184 million won after taxes.

If an employee saving for retirement buys a 20-year bond for 500,000 won every month from the age of 40 through 59, he or she will receive about 1 million won before taxes and 920,000 won after taxes every month for 20 years from the age of 60. This is based on compounding the principal at a rate of 3.5 percent per year, with no additional interest applied. Depending on the level of the markup, the return could be even higher, and the additional interest rate is yet to be finalized. In terms of taxation, those holding the product to maturity will be eligible for separate taxation on interest income at a 14 percent rate for a total purchase of up to 200 million won. With the maximum tax rate at 49.5 percent under the current tax system, the tax savings from holding to maturity are greater for investors in higher tax brackets.

Those who cannot afford to hold to maturity can also sell the bonds before the term ends. However, they must hold the bond for at least one year and no tax breaks, additional interest rates, or compounded interest rates will be provided. The principal is guaranteed, but simple interest will be applied on top of the coupon rate.

The government initially considered applying a rate lower than the coupon rate for selling before maturity before deciding to keep the coupon rate.

As the conditions for selling before maturity have been significantly relaxed since the product launch was first discussed, analysts say that the liquidity issue, cited as one of the biggest drawbacks of government bonds for personal investment, has been partially resolved.

Unlike regular government bonds, those for personal investment cannot be transferred through sale or purchase. However, there are exceptions for inheritance, bequest, and forced execution between individuals, with investors who die before maturity able to pass them on to their spouse or children. “A year or two ago, retail investors were interested in corporate bonds with higher interest rates than government bonds, but rising interest rates are driving up demand for government bonds as well,” according to Park Joo-han, head of the fixed income team at Samsung Securities Co. “The biggest advantage of these government bonds for individual investors is the tax exemption for investments of up to 200 million won at maturity.”