Contributed by: Warriortan
As Singaporeans and residents working here, I am sure you are familiar with CPF (Central Provident Fund), our “pension, “retirement benefits” etc. If you are not, I think it is worthwhile for you to spend time to learn more about it.
I know for many of you, the statutory retirement age is still decades away and hence, since you feel you “can’t do anything about it”, it is the last thing in your mind. I used to have that line of thoughts until recently.
I had neglected the “power of compounding interest”. I have lost years to take advantage of it. The “power of compounding interest” needs time to work its magic and it will bring the most benefits when you start to make it work for you when you are young.
I have done some research lately on how CPF works as a retirement tool. I thought of sharing my own learning, insights and actions that I have taken with you so that you can consider and maybe find something that are relevant to you to help make your CPF works harder for you.
1. Contributions to Your CPF and Breakdown to the various Accounts
As most of you are aware, your and your employer’s CPF contributions go into the 3 accounts and in the following ratios. Note, the ratios change when you reach 35, 45 and 50 years old. The contribution ceiling is $ 6000 per month.
2. Other useful CPF information to know:
(A) Interest Rates
(a) Current interest rate for Ordinary Account (OA) is 2.5%, Special Account (SA) and Medisave Account (MA) are 4.0%
(b) On top of that, Singapore government will provide an extra 1% interest paid on the first $60,000 of a member’s combined balances (with max up to $20,000 from the Ordinary Account)
(c) The interest rate on Ordinary Account monies is reviewed quarterly. OA monies earn either the legislated minimum interest of 2.5% per annum, or the 3-month average of major local banks’ interest rates, whichever is higher.
(d) SA and MA monies earn either the current floor interest rate of 4% per annum or the 12-month average yield of 10-year Singapore Government Securities (10YSGS) plus 1%, whichever is higher. For the moment, the government has kept the 4% as the computed rate of 3.08% is lower than the current floor interest rate. There is no guarantee that the Singapore government will always maintain the 4%.
(B) Medisave Account Ceiling
The MA ceiling is set at $52,000 on 1 January 2017 for all CPF members. Amounts above this ceiling will flow to your Special Account to boost your monthly payouts. This applies regardless of your age.
The ceiling for 2016 was $48,500. So, for 2017, it has increased by 7.2%.
As life expectancy and healthcare costs rise, younger cohorts of CPF members will need more Medisave for their healthcare expenses in old age. The MA ceiling will therefore be adjusted yearly in January to keep pace with the growth in Medisave use by the elderly. Each cohort’s MA (BHS) will be fixed when they turn 65 years old, and this amount will not change for the rest of their lives.
(C) Special / Retirement Accounts
There have been significant changes to the Special Account / Retirement Account in the last few years. It has now been restructured to provide flexibility and options to how you can use the fund in your Special Account (after age 55) which then has an impact to your Retirement Account (after age 65).
In 1/1/2017, the full retirement sum (FRS) has been increased to $ 166,000 in line with inflation. In the last few years, the FRS has increased between the range of 3-4% per year.
So, what is BRS, FRS and ERS? This is a decision you have to make at age 55. You can opt for either one of them and then withdraw the differences between what you have in your special account and retirement sum that you opt for.
What is the implication of the choice between BRS, FRS and ERS?
(a) It determines the amount of monthly payout you will get from age 65 onwards. If you opt for BFS, FRS or ERS, the monthly payout will be $700 – $750, $1,280 – $1,380 and $1,860 – $2,000 respectively.
(b) It determines how much money you can take out at age 55
(c) It determines how much you will leave behind to your love ones as your estate. You may leave more if choose BRS than FRS / ERS.
(D) Investment Schemes using CPF money
You can invest your CPF savings under the CPF Investment Scheme – OA (CPFIS-OA) after setting aside $20,000 in your OA. Likewise for CPF Investment Scheme – SA (CPFIS-SA), you will need to set aside $40,000 in your SA.
In addition, you can only invest your OA savings up to 35% and 10% of your investible savings in stock and gold respectively, also known as the stock and gold limits.
3. Realisations & Actions I took (in case you are not aware like I was earlier)
(A) The cost of using your CPF money is expensive
I believe many of us have used our CPF money to purchase our first property and maybe more if you had already repaid the loan of your first property. For the first property, it was probably the best decision then because our income wasn’t high and our available free cash was limited. Using our CPF money to pay part of the downpayment and/or reduce the loan quantum helped to make that particular property affordable to us.
However, by now, many of you will have already discovered that this usage of CPF money for property loan is expensive. If you look into your CPF statement, you will have realised that the accumulated interest for the “loan” you took from your CPF money has now snowballed to a big sum. Ouch!
Let me illustrate this using an example.
Assuming that you have $100,00 in OA at start of zero year and the interest rate for the next 10 years is 2.5% pa. After the 10th years, your OA will have grown to $128,000. A handsome gain of $28,000, given by the government to you 🙂 … again demonstrating the power of compounding interest.
But if you had used the $100,000 for downpayment or reduced the property loan at onset, then at the end of the 10th year, you would have to return $128,000 (not $100,00) to CPF – the principal and accumulated interest. You will actually be $28,000 poorer because you didn’t get the interest from the government and you will be an additional $28,000 less net free cash. OMG !!!
So, unless the interest for your property loan is super high or you can get a very high yield investment for your cash, it is an expensive cost.
Actions I took:
(1) Stop using my CPF for the monthly loan repayment
(2) Reduce the principal of “my loan” of my CPF money at regular interval to minimise the accumulated interest. I am doing this progressively because of the huge lump sum required and just in case, there maybe an opportunity to get a better deal for my cash.
(B) Most investments can’t beat the CPF Special Account Interest Rate and the Ordinary Account Interest Rate when corrected for Risk
The 4% interest rate on the Special Account is an extremely attractive rate especially when you consider that its risk free. Even the latest Singapore Saving Bond cannot afford the same interest rate. Although the interest rate is not fixed, I do see “political” challenges for the government to adjust it downwards below 4% at least not within the foreseeable future if the 12-month average yield of 10-year Singapore Government Securities (10YSGS) plus 1% continues to stay below 4%.
While the interest rate on the Ordinary Account is easier to beat, for the same reason as why we should avoid using this for property loan if you can afford and considering that there would be transaction fees in external investments and they are risk free, a 2.5% risk free interest rate is quite attractive.
Actions I took:
(1) I sold all my investments that used funds from my OA and SA so that the funds are returned to CPF to earn the 2.5% and 4.0% interest rate respectively.
(2) Over a series of a few years, I top up my Special Account with cash until the amount reached the ceiling. $166,000 is the current ceiling and you cannot top up further with cash or Ordinary Account when you reach it. I did not top it up with Ordinary Account as I think the 2.5% is attractive. Furthermore, topping it up by cash will allow you to deduct the contribution from your taxable income.
(3) After my SA reached the ceiling, I went to top up my Medisave whenever there is a gap to its ceiling so that the amount meant for Medisave from monthly contribution will automatically go to Special Account to earn 4.0% yield. This is one minor way to accelerate a growth in Special Account when you can’t do so directly anymore.
4. What do I hope to gain at the end by doing all these?
All that I am doing is to accelerate my Special Account to reach the Enhancement Retirement Sum (ERS) – currently $249,000 at age 65. I hope to get a “passive income” of $2000 a month to get by with day-to-day living without the need to lower my quality of living too drastically.
I hope to earn more interests from the government rather than self financing my own loans and losing out that interests. With more free cash flow, I can invest them to gain more income.
I hope to get a peace of mind in that I have a pot of money in a risk-free environment that gives me a decent returns and a modest monthly payout after I retire. With this peace of mind, I can perhaps venture into more risky investments to gain a better return. And if I do that correctly, I should get a better yields overall and accelerate my route towards finance freedom.
I hope this article is useful to you to prompt you to think about how you can potentially make your CPF works harder for you. As I mentioned before, what suits me may not suits you. Evaluate your current environment, your investment needs and what you feel comfortable, that peace of mind beats everything else.
There are many articles done by bloggers on this topic. So, if you are interested, you can read them to get alternative views. Any comments from you are most welcome.
Take care and have a good weekend!!!