Is CPF broken?

As election day approaches closer, a topic that always gets media publicity (not the mainstream media) is CPF.

Most parties would generally have a plan to fix and make CPF better.

But first, we need to understand how CPF works currently.

Disclaimer: This is not political. It is my unbias, honest opinion on CPF. If there are misstatement of facts, it is an honest mistake and not intended to cause any political, social or public harm or unrest.

How Does CPF Work Currently?

CPF is a mandatory social security scheme that enables Singaporeans or permanent residents to set aside funds for retirement. Since then, the CPF scheme extends to cover housing, education, healthcare and investment needs.

In short, it tries to help us prepare financially for the big things in life.

Your CPF is divided into three accounts:

• Ordinary Account (OA) – used for housing, education, investment or retirement
• Special Account (SA) – specifically for retirement
• Medisave Account (MA) – specifically for paying hospitalization and health insurance with a lot of constraints and limitation

IIf you are employed, CPF mandates companies to top up an additional per cent (17% if you are below age 55) on top of 20% of your salary (up to the first $6,000).

For the self-employed, you may contribute to your CPF for tax relief. You are, however, mandated to contribute to your Medisave Account.

Throughout your working years, you will contribute to CPF and earn special interests rate set by the CPF board.

Once you have reached 55, you may withdraw all up to a specified maximum amount.

You will still have to set aside a minimum amount known as a basic retirement sum or full retirement sum. That amount will become your annuity (CPF life) which will give you fixed payouts from age 65 until your death.

Indeed, it is complicated – rules on contribution, allocation, usage, withdrawal, interests etc.

No wonder we are always confused about it.

Let us take a closer look at the proposals to make CPF better.

Higher Withdrawals

You can only withdraw a maximum of $5,000 if your CPF retirement account has less than the *full retirement sum.

*Or the basic retirement sum if you have a property whose lease is not expiring before you reach 95 years old.

$5,000 in today’s term is not a lot. And the retiree has to wait until age 65 to receive his or her first payout from CPF life.

Here are the proposals on improving CPF from a few parties:

• Progress Singapore Party – increase withdrawal cap to $50,000 at age 55
• Red Dot United – withdraw everything at retirement age
• Singapore Democratic Party – withdraw everything at age 55 – abolish retirement sum scheme

People should have the freedom to do what they want with their money. I understand that.

A retirement plan should cover you financially until your death.

That is why people came up with the 4% rule to guide you on how much you can withdraw to last for your entire retirement. There is a risk of depleting your source of income during retirement especially if you live longer than planned.

The government created CPF life for that purpose of eliminating that risk – to provide income that will last you until death.

Longevity Risk And Annuities

With life expectancy on the rise, retirees face a new risk – longevity risk which is the possibility of your retirement funds running out before you die.

An annuity is a contract between you and an insurance company in which you will receive regular disbursements for a fixed term in exchange for a lump sum payment.

CPF life is an annuity. It will pay a regular sum to you monthly until your death in exchange for the lump sum in your CPF (the full retirement sum).

Sure, the government can please people and allow them to withdraw more (or all) of their CPF.

If they have a retirement plan and know how to extend their savings to last their retirement, then all is well.

But if they spent all their money and fortunately (or unfortunately) live much longer than they anticipated, they might face financial issues. They may be forced to go back to work to support themselves.

Whether the government should continue to be our nanny and help decide what is best for us – I will not comment on that.

My point here is: don’t focus on the short term (withdrawing all your monies) but on the longer-term – how to make your money last through retirement.

Better Returns on CPF

A few other proposals concerning CPF are on improving the returns in our CPF.

• Worker’s party – introduce special dividends paid out to the CPF Special Account from the Government Investment Corporation (GIC)
• Singapore People’s Party – make government investment returns transparent. Distribute additional returns as a bonus.
• Red Dot United – provide better interest rates for incentivizing staggered withdrawals

In theory, I support these proposals. However, I doubt its feasibility.

High Interest Rates Must Come From Somewhere

Currently, CPF OA returns 2.5% interest risk-free while CPF SA returns 4% interest risk-free.

While bank interest rates have been dropping to near zero, CPF OA has been maintaining 2.5%. This big spread is rather generous of them. For the CPF SA rates, on the other hand, have been kept at 4% while ten-year government securities have been below 1%.

The extra interest of 2.5% and 4% have to come from somewhere, and it cannot be achieved by investing in safer securities. Therefore, GIC must invest in riskier securities to be able to provide a 2.5% and 4% interest.

The problem with riskier securities is that the returns will vary and there is a risk of losing your capital. Any additional returns have to be kept by them because these additional returns act as buffers to maintain your initial capital as well as paying out interest when times are bad.

There will be trade-offs if we push for a bonus dividend. Either we have to accept a lower fixed interest rate, a variable interest rate or allow possible losses of capital.

However, I do feel that we should have more transparency on the performance.

Using CPF As An Emergency Fund

There are also proposals on making CPF money more accessible:

• Singapore People’s Party – allow partial withdrawal based on compassionate grounds – case by case basis
• Red Dot United – enable people to borrow from their CPF during uncertain times.

I think some flexibility is better as personal situations vary from individual to individual. If you cannot even survive for the next few months, why also plan for retirement?

However, instead of always relying on CPF as a fallback, we should also address this problem with other means.

There are times when you face a financial crisis because of a lack of preparation or financial literacy. Maybe you did not create an emergency fund, did not buy enough insurance or took on too many debts too aggressively. Then, the solution is to improve your financial literacy, build good money habits and make a plan.

If you face a financial crisis because of systematic poverty – then it should be addressed by reducing inequality. Policy makers should strive to create policies such as comprehensive medical insurance for all, raising the minimum wage, a universal basic income (freedom dividend?) or more safety nets etc. Or they should remove of policies that increase the income gap – tax relief etc.

Ideally, CPF should be mainly used for retirement. It should not be an emergency fund. Whenever possible.

CPF for FIRE

FIRE here means Financial Independence Retire Early (FIRE). It is a popular movement where one pursues early retirement by achieving financial independence via frugal living and investing. 

There was a proposal to allow us to retire earlier at age 60.

• Worker’s Party – lower CPF payout age eligibility and CPF life payout age to 60

For the government’s standpoint, encouraging people to retire early is not in its best interest, especially for an ageing population where the working class is shrinking with time.

Helping early retirement places more burden on the working class to support an ever-increasing group of retirees. Neither is it good for GDP – you need people to continue working to produce goods and services.

Another point is how an annuity works. There will be trade-offs when you increase the duration of the annuity payout, i.e. start the payouts at an earlier age. 

You will have to accumulate more, e.g. increase the full retirement sum amount, and your payout amounts will be much lesser. It is a policy which benefits the wealthier or financial savvy ones. 

For the average person, it means your full retirement sum will be further increased, and your CPF life payouts will further decrease.

Conclusion

CPF elicits an emotional response from the people. That may be the reason why they bring it up from time to time.

The main advantage (and the main disadvantage) of CPF is its inflexibility. It forces you to regularly contribute to your retirement from an early age with severe restrictions on its usage and withdrawal, which is possibly the best way to plan for retirement.

However, it is by no means perfect. Its inflexibility also causes CPF to be useless in specific emergencies or significant life changes. Neither is CPF a silver bullet that solves all retirement problems.

The other possible solution to retirement is increasing financial literacy. That is where we try our best to share information on how to prepare for retirement.

Nevertheless, I do believe there are many other issues on inequality, accountability, free speech and transparency that politicians should bring up. And CPF should not be the top of the list.

What is essential is political awareness and participation from the people, especially the young.

The best thing we could do is to educate ourselves and go out and vote. Every vote matters.

So, make your vote count.

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