What I learnt about CPF Life

CPF Life is a black box.  It is a financial annuity plan, but there is no term sheet to really explain the workings of it.  I asked friends and very few of them were capable of answering basic questions of the scheme. Websites are no big help either.  In one recent article written by NTUC Income, it concludes that doing a quick search online “may leave some even more confused”.  I have come to believe that if this product was offered by any other financial institution in Singapore, it would be taken to task by MAS for mis-selling.  But because this is a compulsory government scheme and it is guaranteed by government, one can make a logical assumption that the scheme is not only fair, but far more “efficient”.  It has the largest pool of subscribers, avoids adverse selection and since there is no middle man or distribution agent, it must be cheaper to run, and should be the “best” in the market.  But I was curious to understand more.  I thus made two separate trips to speak to CPF officers to try and make some sense of it.  I got partial insights.

The intentions of CPF Life are both virtuous and correct.  Singapore, by and large, is a society that insists that the financial needs for life is a personal responsibility, even in retirement.  The state should not and cannot be relied on to meet each individual citizen’s basic needs. So one should save for it.  CPF Life is akin to the progressive idea of a UBS – Universal Basic Salary – only that it is personally funded from savings that is made compulsory pre-retirement.  After 65, CPF Life allows every citizen to get an amount in his golden years, no matter how small, to get by.  This does not exclude society helping out the poor.  As a mechanism, the Government and CPF Life should help those that cannot even reach the Basic Retirement Sum (BRS), given that this amount is far too small to live on. 

CPF Life has multiple scenarios to cater to different people in different circumstances, which leads to confusion.  For this entry, I use my own position to give an insight into how the scheme works.  On my 55^th birthday, a Retirement Account (RA) will be set up to lock away a tidy sum of money for my later years.  To fund this, CPF will first empty my Special Account to zero and then withdraw as much as it needs to from my Ordinary Account till the RA reaches the Full Retirement Sum (FRS) amount. The Medisave Account (MA) remains untouched. As of today, the FRS Amount is $186,000.  All this happens automatically on my birthday.  From 55 up to the age of 65, I can choose to top up my Retirement Account to the Enhanced Retirement Sum (ERS) at any time.  This is capped at 1.5x the FRS.  So in this example, as my FRS is $186,000, the ERS at 2021 is $279,000, a top up of an additional $93,000 at maximum.  

The RA earns a high risk free rate of 4+% interest (its 4+% as there are different tiers of interest payments) for the ten years between 55 and 65.  This is substantially higher than anything you can find elsewhere in the market.  As an illustration, the FRS amount of $186,000 would grow to become $278,000, while the ERS amount of $279,000 would grow to $417,000 - over ten years. But remember this is money that you cannot touch.  You certainly never see it back in a lump sum.  You only see it coming back in the form of enhanced monthly payments after 65.  So the question is, is it worth topping up? 

To answer this question, I calculated what the payback period is.  I relied on the CPF calculator found on the CPF website.  Under FRS I will receive $1530/month.  Under ERS I will receive $2230/month.  So for an initial additional outlay of $93,000 on my 55^th birthday I stand to receive an additional $700/month from my 65^th birthday onwards for life.  If I calculate a straight payback period, I will get the entire $93000 back in 93000/700 = 133 months, or about 11 years or at 76 years of age.  But perhaps it is more correct to not use $93,000 but $139,000 as the starting amount, which is $93,000 + Interest accrued at age 65.  Now my payback period is longer.  It is now 198 months or 16.5 years.  I will break even at 81.5 years of age.  Now if I take the final step and discount the stream of payments from 65 onwards, using 2% as the discount rate ($1 today is not the same as $1 when I am 80 years old), I will only attain the Present Value of $139,000 in 20 years or at 85 years of age. In short, my payback period is at life expectancy.

These numbers are all back of the envelope, but they are not far off.  This exercise shows a little of how the CPF Life scheme is run.  There is no free lunch in this annuity scheme (except during the initial period where an enhanced interest rate of 4% accrues to the RA).  For the money that is transferred to the fund manager (termed as the Lifelong Income Fund), payback will be around life expectancy, which in Singapore is today 83.5, and tomorrow possibly 85 or 86. As breakeven is attained at life expectancy, the fund needs to find “extra” money to pay the annuity for those who live longer than life expectancy. [If one passes before life expectancy, CPF Life will return the "unused" portion of the RA, although the calculation of this is not disclosed.] This must come from two ways.  First, it must come from the fund retaining a portion of the initial premium as a “fee” for joining the scheme at 65.  This is fair, and I suspect this is under 5% of the initial amount, although once again, I have been unsuccessful to learn what this amount exactly is.  Second, it must come from the fund manager beating the discount rate of 2% which I have assumed in this example.  Given that a sizeable amount of money that is locked up for a long duration, this should not be a problem for the fund manager even when investing in safe assets.  The amount should be sufficient to offset those centenarians amongst us, and pay for the overheads for running the scheme.

So back to the question. Is it worth topping up?  The RA is a forced and safe savings plan.  For those who are bad with money – the spendthrift, the gamblers, those susceptible to the duplicitous charms of foreign or local women or men, those completely reluctant or unable to make risky investments – the act of locking up the extra cash in the RA is not a bad one.  It will come back to you in one way or another over time, in a fair way.  But for those who fall outside this category, it may be worth thinking of how to build a personal RA outside the CPF.  With your personal RA, you can decide to draw an annuity or adjust the capital base at any time.  And this also means that the sum can grow even after a certain age.  It is entirely flexible.  So if you have excess cash, form two RAs.  Treat CPF Life as your fixed base, and your personal RA as your flexible base.