If you are a Singaporean and want to take charge of your retirement savings, then read on.
Back when Mr Roy Nerng stirred up some noise, asking the government to return our CPF money, it has stirred up a national conversation about the adequacy and how functional our CPF is when it relates to our retirement needs.
A CPF Advisory Committee was formed to advise on how to improve the CPF in this regards.
In previous CPF Advisory Committee proposals, they made proposals to simplify the plans to CPF Standard and CPF Basic, however some details were not released.
Today the committee released:
- A CPF Life Escalating Plan
- An alternative CPF Lifetime Retirement Investment Scheme (LRIS)
In this article, I will take a look at how different are the cash flow of the 3 different CPF Life Plan, if I were to retire next year how would my retirement wealth de-accumulation plan be. I will also share my thoughts why LRIS looks to be good, but it will not take off.
CPF Life Escalating Plan
Recall that in previous updates, we know that when we want to start withdrawing our CPF Life, be it 65 at its earliest, or when you delay to get a bigger annual cash flow, we have 2 options.
*The figures above are based on CPF LIFE Standard Plan payouts computed as of 2016.
The 2 options are CPF Standard and Basic.
The difference between these 2 are the bequest levels and cash flow payout per year. If you choose Standard, your payout is higher than Basic, but you have a smaller bequest (which is what you will leave to your next generation when you passed away)
If you choose Basic, your payout is smaller than Standard, but you have a bigger bequest.
How much payout you received for Standard or Basic depends on the minimum sum you hit at age 55 onwards, when you transfer the sum from your CPF OA and CPF SA to the CPF Retirement Account (RA).
The minimum sum goes up over the years, and currently the Basic Retirement Sum is at $80,500. This is the sum if you chose to pledge your home.
If you do not pledge, your minimum sum is $161,000 currently.
You can further boost your payout, if you put in one more chunk under Enhanced up to $241,000 currently.
You can further boost your payout, if you delay your withdrawal from age 65 to any year between 66 to 70 years old.
Keeping up with inflation
The committee introduces CPF Escalating which is a plan to boost your monthly payout annually by 2%.
Why introduce this?
This is because many folks are complaining the current CPF Life Annuity do not keep up with inflation.
So this escalating plan pay out goes up by 2% yearly.
However, there is always a give and take. For the Escalating plan the downside is that the initial payout is smaller than Basic and Standard.
Comparing the 3 plans in terms of Payout
Let us take it with the example that Kyith is 55 years old and CPF transfers $80,500 from his CPF OA and CPF SA to his CPF Retirement Account.
This sum is $80,500 because Kyith decides to pledge his 4 room flat to make up the 50% current minimum sum of $161,000.
Currently CPF RA will grow at 5% per year. This will reach perhaps $131,126 when Kyith is 65 years old. However, do note that this sum is a projection, and CPF currently do not reveal how much the CPF RA for Kyith's portion grows to.
When Kyith receives his monthly payout at age 65 years old, depending on which plan he chooses, the payout to 100 years old (should Kyith lives that long) is as follows:
CPF Escalating Monthly or Annual payout is less than Standard and Basic.
However, if Kyith lives long enough to 78 and 72 years old respectively, CPF Escalating Monthly and Annual payout will be higher.
Here is another illustration.
If we are computing based on 10 year payout, overtime the Escalating plan pays out more on absolute amount.
If we discount inflation over the time frame, the value accumulated in the last decade is worth less than the previous decade and so on.
The present value of the stream of payout of the Escalating plan is higher than that of Standard and Basic today, if Kyith is 65 years old.
Comparing Yield on Initial 'Investment'
It will be difficult to gauge whether Singaporeans are getting a good return or a poor one by talking about cash flow.
However, if we view the annual payout yield over the initial amount, we can get a very good idea.
The above table shows the yield on initial investment of $131,126, which is the amount in RA of $80,500 accumulated at 5% from 55 years old to 65 years old.
The Escalating plan shows some good return yield as we stay alive longer.
Do note that, instead of comparing, appreciate that all the yield for the 3 plans are rather high and backed by the insurer, which in this case is CPF.
You can compare against the list of high yield dividend stocks in Singapore currently, and you will realize the returns of this 'investment' is average.
However, the difference is that, the investment risk of this CPF Life is transferred to CPF, while in the case of these dividend stocks, you bear the risk of poor dividend stock selection.
Why pegged to 2% and not inflation?
It would be better if the rate is pegged to positive inflation. This would mean that should we have a hyper inflation of 10% in one year, the annuity payout goes up by 10%. If there is -5% deflation, the annuity payout stays at current.
The board deems that inflation fluctuates and it will be better to take an average and keep it as such.
We do am aware that in Singapore the past 10 to 15 year inflation averages 2%. Hard to believe for some, but I did a computation not too long ago and there is some truth to that.
Even First REIT (Dividend Yield 6.5%), which pegged their rental escalation of their Indonesian hospital at CPI capped at 2%, uses 2% based on the past 10 year inflation reading.
Is the 2% Escalation Permanent?
According to what was revealed, this 2% follows the long term inflation rate, which is subjected to change. So they will be reviewing this figure and changing accordingly.
My Preferred Retirement Plan
Given if I am retiring next year, and can choose which of these 3 CPF Life Plans, my thought process will be this:
- How does this affect my overall wealth de-accumulation plan?
- Which is the best option to fit the de-accumulation plan
The first thing to recognize is that the CPF Life is only a part of my overall wealth plan. You have to accumulate out of CPF Life.
The CPF Life takes care of my Monthly or Annual Survival Expenses (here is how to derive your survival expenses). The Wealth Machine's Annual and Monthly cash flow takes care of the good to have things in retirement.
I would choose the Escalating CPF Life plan for the reason that:
- all 3 CPF Plan's monthly distribution are close to my survival expenses of $1700/mth – $2000/mth. Or rather, on a monthly basis there is not much difference in absolute dollar terms
- escalating at least provide some inflation link compare to no
- the bequests to next generation would come from the Wealth Machine so CPF Life takes care of the survival needs and that is its purpose
The cash flow from the wealth machine will fluctuate due to stock market volatility, and I would have to be conservative in withdrawing from it when markets are down (67 to 68 years old in this example)
However, the predictability and transfer of investment risk of the CPF Life ensures that my survival expenses are met even in bad times.
CPF Lifetime Retirement Investment Scheme
What was kept in suspense is how do we boost the returns of our CPF to increase the sum built up?
Even with this announcement, there was much details NOT revealed.
I suppose there are much evaluation still taking place.
What is revealed is that there is this new Lifetime Retirement Investment Scheme (LRIS).
This will be an alternative to our CPFIS, which we use to invest in CPF approved unit trusts, stocks, insurance endowments and gold.
The objective is to:
- Grow the amount
- By taking more risks
- For people who lacked the know-how
- For people who lacked the time
Under LRIS, there will not be an avalanche of unit trusts.
There will be:
- A single administrator
- Few selected funds
- Passively Managed
- Investors are discouraged from churning, or frequent switching of investments
- As there is 1 administrator the annual expense cost for the investor may be brought down from the traditional 1.5% to 2% down to lower than 0.5%
More advantage than disadvantage
Many Singaporean's are not clear about passively managed funds. They are also not well versed in what makes the most impact to building wealth with funds.
So they would not understand what is the impact of this plan and how this will be a better option.
It is likely they will implement a portfolio of index funds. These are going to be low-cost passively managed.
The illustration provided by Straits Times, gave a hint of what are the limited funds provided by the single administrator.
I hope the returns are enticing to you.
The plan is generally good, because to sustain-ably money by buying and holding a portfolio of funds :
- You need to keep costs low. Your returns is unpredictable but your cost of 1.5% to 2% for unit trusts is definitely loss to you. And the power of compounding occurs on the costs as well.
- Passive is better than one Managed by a manager because it has been proven that it is difficult to beat the benchmark. Even if a fund manager can for 1 year, it is difficult to repeat the result over 10 years. Fund managers have a tough task and many under perform the index (which is what CPF is recommending under this scheme)
- You need to hold it for long. But not many can do it because we overestimate our abilities and make stupid behavioral mistakes. Think of these funds as a very long 20-30 year bond. You can earn that 5.3% to 7.4% annual compounded returns, but in the middle of this 20-30 year bond, the value of your holdings will be very volatile, going up and going negative.
Why Cost Matters in Investing
To illustrate #1, at a 7% compounded return, you would turn $10,000 into $76,122 in 30 years. But if your cost is 2%, you will lose $32,903 to costs and only get $43,219 at year 30.
If you are able to keep your costs at 0.75% instead, you will lose only $14,482 and earned $61,640.
The cost compound more drastically over time.
Why portfolio churning is a problem in Investing
To illustrate that we are really bad in making investment decisions, Dalbar did a study on what the average investor achieve in terms of their unit trust sales, redemption and exchanges in USA.
You will observe that during this 20 year period, almost every asset class did well, but one of the worse performer is us, the average investor.
We are just so bad at managing money that we only take in a fraction of the returns.
It would be better if we meddle less.
My opinion of LRIS
My original concern was that this will stop me from making active contribution to the stocks that I currently held. Turns out that this will be a separate scheme targeting the people who fit the original criteria.
While I like everything about it, the pick up of this will be slow to non-existent.
This is because Singaporeans like capital protection, and when they learn that they are likely to lose money from this, they would be turned off.
That projected higher compounding return will pale against the great capital guarantee return of 4% on the CPF SA.
Despite what they say about wanting higher returns, they want higher returns but also capital guarantee.
In other words, they want a free lunch.
The CPF is already complicated enough and introducing one more side scheme, is not going to help.
People do not believe that they are poor investors, and they believe they can generate better returns through stocks then the puny pathetic returns of funds.
Perhaps we need a 10 year gestation period, where these few selected funds show good compounding returns to convinced people of their benefits.
We also need the CPF to not provide that guarantee 2.5% and 4% in CPF OA and SA, to force people to look for alternative.
This article first appeared on www.investmentmoats.com
(note: the BRS/FRS/ERS and CPF LIFE figures in this article are based on 2016 information. The figures are adjusted every January. Please click for the latest figures for the former and latter)