CPF Simplified

Have you ever heard a phrase like this: 

“I don’t reed bonds in my portfolio because I have CPF, which is like a bond. Therefore I invest in a 100% equity portfolio.”?

Is CPF a bond or behaves like a bond?

In short, the Central Provident Fund or CPF is a government-managed system designed to help Singaporean and permanent residents plan and set aside money for their future, namely, retirement.

It has, however, evolved into a very complicated scheme.

Hence, I would like to explain CPF in simple terms and propose that CPF is more of an insurance product than a bond.

We will start by looking at CPF at the various milestones:

• Before the age of 55
• At the age of 55
• At the age of 65

Before 55: A Fixed Deposit Account

A fixed deposit account pays a higher interest compared to a regular savings account. 

That higher interest comes with a price – your money is locked up with the bank for a pre-determined amount of time. You do not have the flexibility to withdraw your money whenever you want without losing interest.

Likewise, CPF before the age of 55 is like that. Think of it as an extreme form of fixed deposit.

Features of this ‘fixed deposit’ known as CPF:

1. You cannot withdraw* any amount before 55. All contributions are irreversible.
2. More attractive interest rates (2.5%~5%).
3. The government guarantees your CPF monies – you will not lose any money. 

*For the sake of simplicity, we will not mention the various types of accounts in CPF which may allow you to use the CPF monies for specific purposes.

At Age 55: Mechanics of Investment-Linked Insurance Policies

Investment-linked insurance policies (ILPs) have two components – life insurance coverage and investments. 

Unlike regular insurance premiums, the premiums for an ILP goes into buying units of funds or sub-funds of your choice. These are your investments.

The insurer will then sell some units of your investments to pay for your insurance and other charges. You could withdraw whatever remains of your investment after paying the insurance charges. The insurance charges are sunk costs – you cannot get those back.

I am not saying that CPF also has both an investment and an insurance component (It does, but I don’t want to complicate things here). I am, however pointing out that CPF uses the same mechanics as ILPs:

1. Your CPF monies are your “investments”.
2. At age 55, you have to ‘sell’ your ‘investments” (CPF monies), setting aside a sum known as the retirement sum, which is like your insurance premium.
3. Whatever leftover after paying your ‘premium’ is available for you to withdraw. 

Just like your ILP where you cannot keep your investments and refuse to pay the insurance charges, you have no option but to set aside the retirement sum or whatever is in your account if you don’t have the full retirement sum. 

After 55: A Savings Account

Once you have set aside the retirement sum after age 55, your CPF account transforms into a high-yield savings account.

Now you are free to withdraw whatever monies left in your CPF. If you choose to keep the money where it is, you will enjoy high interest from your CPF accounts.

Under specific conditions, you may even withdraw a portion of your retirement sum (think of it as getting rebates from your insurance premiums).

In my opinion, this is the best part of CPF. But you will have to wait till 55 for it.

After 65: Annuity

Remember the insurance charges you had set aside at the age of 55? Well, that insurance charges, a.k.a retirement sum, is the premium paid for a special kind of insurance called an annuity.

An annuity is an insurance that pays a regular and constant stream of monthly income until you die. That is what CPF LIFE is.

The more premiums you pay, the higher the monthly payout. 

There is a possibility that you might outlive your retirement savings and run out of money at old age.

Annuity serves to mitigate that risk (longevity risk) as you will be guaranteed an income until you die.

Conclusion

So as you can see, CPF can be simplified into three stages:

1. Before 55: CPF is a fixed deposit account
2. After 55: CPF becomes a savings account for the remaining amount after setting aside the retirement sum.
3. After 65: The retirement sum set aside at age 55 becomes an annuity. (Your CPF remains a savings account as long as it has something in there)

I am grossing oversimplifying – I left out all the different accounts, different interest rates and rules and restrictions for using each account. I did this to help you understand what kind of product CPF is.

The raison d’etre of bonds is for investment – to grow your capital. There are always risks involved in investing in bonds, even though they carry much less risk than equity. 

CPF, on the other hand, distilled down to its essence, is fundamentally about safety. It is always about wealth preservation – high interest rates, annuity and other safety nets like housing, medical expenses and insurance. It is about reducing risks to zero.

The philosophy of CPF is so much different from Bonds, although they do share similar characteristics.

Hence, I feel that CPF is more like an insurance product rather than as a bond.

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