By Ryan Ong
Confused about which retirement planning method is right for you? We break down the pros and cons of the 5 most popular ones in Singapore.
As a leading financial hub, there is no end to the number of retirement plans available in Singapore. However, no single product is suited to everyone, and it can be confusing when you have thousands of options to choose from.
Here, we discuss the five most common retirement planning methods in Singapore, along with their pros and cons:
1. Get an Insurance Policy or Endowment Plan
Insurance policies don't just provide coverage for accidents and death; many of them also have a savings component. In other words, the insurance policy both provides protection, and also grows your money.
Two common forms of this are endowment insurance, and Investment Linked Policies (ILPs). A qualified financial advisor can give you the exact details of each product (of which there are literally thousands in the market), but we can make a ballpark prediction of the returns.
Most endowment products will project returns of 3% – 5% per annum, while the (riskier) ILPs often project returns of 7% – 9% per annum. However, it's important to note that these returns are not absolutely guaranteed.
Pros of Using Insurance Policies
The biggest advantage of using an insurance policy for your retirement fund is that it's "hands off". You just pay your premium every month, and the subsequent investments are managed by the insurer. There is no need to track the market yourself, or make decisions on how your money is invested.
The second advantage of insurance is protection. You do need to be insured for health and accidents, so you are going to buy a policy anyway. You may as well also get money from the policy, rather than just protection.
The third advantage is that, if you're not a particularly disciplined saver, having a policy paid by GIRO "forces" you to set aside money. We don't mean this literally (you can cancel a policy or let it lapse), but when you automate the payments, you tend not to think about it and are not tempted to spend the money.
Cons of Using Insurance Policies
One criticism about insurance policies is that a large chunk of premium payments go toward distribution costs. That is, the money goes toward the agent's commissions, and toward the marketing and operational costs of the insurer. These costs eat into the returns of the policy, which might otherwise be higher.
As each policy is different, it is impossible for us to tell you exactly how much of the returns are taken up by distribution costs. You will need to know how to work this out yourself by comparing the projected payout to the total premiums paid. This is another problem with insurance: as the product is complex, some people are not financially savvy enough to grasp how much they're really paying.
(For details on how to calculate this, follow us on Facebook; we have an expert on hand who can explain it in a separate article).
The third problem is that returns from insurance policies depend on how well the insurer fares in the market. If you are part of an "unlucky batch", who held a policy at a time when the insurer hit a rough patch, your projected returns may end up being below the rate of inflation (around 3%). This can mean a disappointing retirement.
If you struggle with personal finance and investing, you can let a Financial Advisor take over for you. However, you do have to be aware that you paying for this privilege: not only are you entrusting someone else with your retirement, you are paying them significant sums via your premiums in order to do so.
2. Use Your CPF Special Account
One way to build a large retirement sum is to transfer your CPF Ordinary Account (CPF OA) funds to your CPF Special Account (CPF SA). The CPF OA grows at up to 3.5% whereas the SA grows at up to 5%.
The CPF OA is low with regard to the general inflation rate. Ideally, a retirement fund should beat Singapore's core inflation by 2%. This means you want interest of around 5% per annum.
However, the SA gives returns of up to 5% per annum, regardless of market conditions. As such, one strategy is to constantly transfer your OA to your SA, to build a large retirement fund.
Pros of Using Your CPF SA
The main advantage is that CPF SA is guaranteed. Regardless of how well or poorly the market fares, you will get the promised rate.
The second advantage is that your CPF is absolutely secure. A person's CPF savings are protected from creditors (however, this does not apply to CPF monies that you receive from a CPF member who has passed away).
Cons of Using Your CPF SA
The most obvious drawback is that you cannot withdraw the CPF money, until you are at least 55 (and still have set aside the Full Retirement Sum, S$166,000, for your retirement account).
The second problem is your housing. Because the CPF OA is used to pay for your house, you will have to be prepared to pay in cash instead of via the CPF. This means making the initial down payment, as well as servicing the monthly mortgage, right out of your own bank account.
3. Invest in Property
There are two ways Singaporeans tend to do this. The first is to count on the resale value of their flat. The other way is to purchase a second property, rent it out, and count on a good resale price.
Property investments are popular in Singapore as well as many other Asian cultures; the concept of property ownership carries a sense of prestige and permanence. The general assumption is that there was always be a demand for housing, and less availability of it as the population grows.
Pros of Property Investment
A successful property investment is a cash generating asset. This is when the rental income from the property exceeds the monthly loan repayments – it means the house basically pays for itself, and contributes money to you every month; even better, it could also make you money if it's resold at a higher price. A successful property investment is the closest you will get to free money.
Another advantage of property investment is that, if you choose not to resell, it can be passed to your children (there is no inheritance tax in Singapore). This can give them a big headstart in life, as they will not need to worry about providing housing for themselves.
A property can also be collateral for a loan (a second mortgage, which we will discuss in a future article). Loans backed by property are among the cheapest loans available, as there is already an asset that guarantees the lender will be repaid.
Cons of Property Investment
There is no guarantee that a property can be sold for a profit. The property market, like any other, is prone to fluctuations. In 2016 for example, many properties sold for million dollar losses. As such, property investments are not as "risk-free" as many sellers like to claim.
The other problem with property is that interest rates for home loans can rise, such as they have in 2016 and 2017. This means the monthly repayments can exceed the rental income, and the property will turn into a liability that costs you money.
In the event that a property becomes a liability, it is also an illiquid asset. You cannot just "cancel" your property investment as you can with an insurance policy. It can take many months to sell a house, during which you will be saddled with loan repayments and property taxes.
The final issue with property is the cost. Property investments are capital intensive. A S$1 million condo, for example, requires a minimum down payment of S$50,000 in cash (5% of the total amount borrowed), and another S$150,000 in cash or CPF (15% of the total amount borrowed). You cannot borrow the entire cost of the house from the bank.
4. Invest in Index Funds, Actively Managed Mutual Funds, or Other Equities
Most Singaporeans do not pick stocks on their own, and we strongly advise you not to do so unless you know what you're doing! Please do not read a few books on stocks and then base your whole retirement plan on what you've gleaned.
Most Singaporeans will invest via an index fund or some form of managed fund. In the case of the former, management fees are low, but performance depends on the underlying benchmark. For example, the Straits Times Index Funds (ST Index Funds) deliver returns based on the performance of the overall ST Index, which can go up or down.
For actively managed funds, the aim of the fund is often to outperform the market. If the fund uses the ST index as a benchmark, for example, and the ST index delivers returns of 6%, the fund might deliver returns of 6.2%. If the ST index delivers negative 1.8%, the fund might deliver negative 1.7%.
The idea is that the fund managers, who actively reallocate the assets in the fund, are able to get you better than average returns with your money. However, funds are not managed for free, and you pay for it with a cut of your returns.
Pros of Stock Investment
Stock investments are highly liquid. Even though some funds have rules about when you can sell off your assets, it is generally easy to switch between funds or sell off your assets within a matter of days. This is different from putting your money in the bank or in your CPF, in which you may not be able to withdraw it for a long time.
Stocks have the potential to outperform many other kinds of investment. This is because stocks represent a share in a business, and there is no theoretical limit to how much a business can grow. Many of the early investors in Google, or in Apple when it struggled in the 1990s, became sudden multi-millionaires when these companies took off.
Cons of Stock Investment
Stock investments are risky, as the value of businesses fluctuates all the time. You do run the risk that you will get back less than you invested (capital loss), which could destroy your retirement plan. It's usually a good idea to invest in something else besides just stocks.
The other problem of stock investments is knowledge. You do need to be able to tell which funds are worth buying into, and also when to leave an underperforming fund. This can be difficult if you have no grasp of the financials involved.
With regard to managed funds, stocks also have the same problem as insurance policies: a large part of your money goes toward paying for the management (with funds, this is expressed as the Total Expense Ratio or TER). Indexed funds, however, have very low management fees, as they only track the market rather than try to beat it.
5. Keep Your Money in Fixed Deposits
This is the slow and painful way: put portions of your monthly pay into fixed deposits, and wait until you retire to spend it. It's an old school method, which is "airtight" but delivers returns too low to beat inflation.
Fixed deposits pay a certain interest rate (usually below 1% per annum), and release the money to you at a given time (often 5 to 10 years). You will be unable to access the money in the meantime, at least not without incurring some form of penalty.
Pros of Fixed Deposits
Fixed deposits are as secure as your money can possible be, next to the CPF. Many people have some money in fixed deposits – speak to a wealth manager about the right amount for you. In general, the older you are the more you would want to leave in fixed deposits (as you get older, your priority is protection rather than growing your wealth).
Fixed deposits are very simple products that anyone can understand. Simply find the bank offering the highest rate for fixed deposits, and give them the money.
Cons of Fixed Deposits
You cannot rely purely on fixed deposits for retirement, especially if you are young (in your 20s). With the exception of private banks for very rich people, or rare promotional offers, the interest rate on a fixed deposit will be below 1%. This is insufficient to cope with inflation.
The other problem with fixed deposits is inflexibility. You cannot withdraw the money before the deposit matures. If you do, you will often lose all the accumulated interest.
Speak to a financial advisor to find the right portion of your portfolio to put in fixed deposits.
The article is first published in SingSaver.com.sg.