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Tea with Klein: CPF, SRS and HDB housing loans.

Sunday, April 6, 2014

I received a couple of emails from a reader this weekend and I want to share them here because I like sharing high quality content, especially those which are thought provoking and inspiring.


Hi AK,

I read this post:
http://singaporeanstocksinvestor.blogspot.sg/2010/10/do-you-want-to-be-richer.html

If u never mention about the OA transfer to SA account and get the compounded interest, I wouldn't have thought about it. Thanks.

Hopefully, I can meet the minimum sum with this when I retire and float the money out so I can have money to spend between 55 to 62 else it's going to be tough working in my old age.

On using the medisave to pay for integrated shield plan, I finally found someone who shares the same view cause when I told my collegues and friends about it, they just shrugged it off. In fact, I got laughed at a bit. Well, that's life. (See:
http://singaporeanstocksinvestor.blogspot.sg/2013/12/how-to-get-free-medical-insurance-in.html)

I like this quote u have as well:


"Find your strengths and build on them."

AND

Hi AK,

Thank you for taking the time to read and reply my mails again.
 
Well, transferring to the SA, I feel is really a good idea that is if I cannot make the 35% investible grow more than 4% per annum. Even if I can grow it at 4% what about my other 65% that's running at 20k @ 3.5% the rest at 2.5%? That's a lot of growth I need to cover. So, by transferring to SA, my risk-free rate becomes 4% rather than 2.5%.
 
I am 34. So, about 21 years later, I need to make sure I can meet the minimum sum. I am not too good at finance stuff so maybe some of my calculations are wrong. I just find finance a bit hard to learn. (Right after I saw your article, I moved it all to SA. There is much I need to learn and not many people will teach.)
 
Yes, I agree with u about using the system to beat the system. One example is when u talk about SRS. Though there is a 5% penalty but for a safe investor that can get a 3-4% dividend he can recover the cost in about 1 to 2 years. Thereafter, if he chooses, he can take it out. So, that's at least 3.5% savings in tax and a slight capital gain. But sadly people really want cash in the bank and regard the taxes they pay to IRAS as a small sum.
 
I really do not understand how saving $420 a year in taxes is not an incentive for them. Of course, if they did contribute to the SRS, they must not take the money out of their SRS accounts when they still have income or else they might jump to the next tax bracket or simply just pay more tax.
 
To me, the tax savings is like 4 months of free internet n hp bills.
 
In fact, this is how I see it:
 
1. CPF minimum sum, at age 65 drawable (in the form of CPF Life). So, that covers my late life. Gives about $1,200 pay-out per month, I think.
 
2. SRS, so that I can cover my journey from age 62 to 72. So, say I don't work, I can withdraw $20,000 non-taxable + personal relief $1,500-$2,000, that makes $22,000 total tax free. There's supposed to be a 50% tax rebate. So, I think maybe $40k tax free? Not sure how to calculate this though.
 
This is, of course, a bit of an idealism as I don't think I can save $220,000 in 20 years. Old cow cannot pull cart. so I think if I spend within my means with some occassional entertainment, that's ok.
 
When I see the folks working at menial jobs at an advanced age, my heart sinks a bit. They really don't look happy, some of them. Did a general survey at my workplace. It seems most people think they will not end up working after 60+ as a cleaner etc. I have my doubts and goverments around the world don't have a solution at all.
 
So, I think I better plan ahead. Better to be labelled a scrooge than to be screwed.
 
Of course, as one's situation gets better, going on long tours and stuff would be good. In short, make sure one is on firm ground before thinking about having fun.
 
 
The 1.5%/year difference in interest rate compounded monthly gives me 35 cents more per $1 after 20 years. That is like 35% more compared to if I put it into the OA and I beat the inflation by 1% even though I don't believe inflation is 3% given the price increases. I have a personal inflation index based on what I spend on.
 
Secondly, I think even if people do own HDB flats, they should not be too concerned about paying back too fast because people do fear about holding debt. But what I think most of the people around me don't realise is paying back the HDB too early they are doing themselves a disservice. Why?
 
1. There is insurance on the HDB flat. So, if one party happens to die, the loan is repaid. So, if there are dependents like kids they will get less cash compared if they didn't pay the HDB back so fast.
 
2. Every dollar given back to HDB, that dollar will not help them earn any interest.
 
3. The interest on housing loans runs on reducing balance while the interest on OA runs on simple interest. So, even if the HDB loan is 0.1 percent higher it still doesn't make sense to pay too much because the interest accumulated would outrun the savings on a lower CPF loan.
 
4. The fear of the hdb repossessing the flat is a bit irrational. If by some stroke of bad luck there is job loss or illness in the family resulting in skipping payments, I mean this can be negotiated or rather put it simply if they have more money in the bank they can wriggle through the situation but if they paid it all to HDB then I don't think they can get it back. However, if it was because of debtors, then, of course, the above would not be a good choice for them.
 
The weird thing is after explaining to friends about this, I do not know why they still want to pay their loan back as fast as possible.
 
 
If you have any ideas or experience which you would like to share with readers here in ASSI, please feel free to email to me at ak71@sillypore.com. I would be more than happy to share high quality content here in my blog. Like I always say, I don't know everything. :)

Related posts:
1. SRS - A brief analysis.
2. Build a bigger retirement fund: CPF-SA.
3. Dirty CPF-HDB scheme to trick Singaporeans?

9 comments:

Ray said...

great exchange of ideas. thanks for sharing. the only worry i have is if moving money into oa, if i ever need to use cpf to buy a second flat i cant use those money, right?

AK71 said...

Hi Ray,

If you have the intention of buying an investment property, then, you have to be careful with transferring funds from OA to SA.

If you have no desire to become a landlord, then, the choice is easier. :)

Yong Ho said...

Nice sharing!

As for the idea of working and planning towards a comfortable retirement/semi-retirement, i am all for it and it reminds me of a quote from Game of Thrones (TV series):

"If you're going to be a cripple, it's better to be a rich cripple."
~Tyrion

raymond350 said...

Hi AK71, regarding your 3rd point on not paying HDB loan quickly, I don't really follow, can elaborate?

Also for your 2nd point, although every dollar paid won't earn you interest, but it saves you on the loan interest right?

Lastly, I think OA interest is not simple interest, but compounded annually. Found this site detailing it: http://sti-stocksinfo.blogspot.sg/2009/08/calculating-cpf-interests.html

AK71 said...

Hi Raymond,

This is a guest blog put together with emails I received from a reader, Klein. I hope he will see your comment and reply to your questions. :)

AK71 said...

Hi Raymond,

While waiting for Klein to reply, I will offer my own POV.

I think that Klein has his own line of reasoning for not repaying HDB home loans too quickly. Points 1 and 4 are simple enough to understand.

I can see how point 2 would make sense in certain instances. If we could get a housing loan with rather low rates (like the POSB HDB home loan which I blogged about before), then, it makes sense. Or if we could make sure that our CPF money is able to earn higher returns, then, it would also make sense.

However, following Klein's reasoning takes a bit more hard thinking. HDB home loan interest rate is 2.6% while CPF-OA interest rate is 2.5% but this is compounded like you rightly pointed out.

So, let us say that we had an outstanding HDB loan of $100,000 but chose to pay it off at one go instead of paying it off over a 10 year period. The interest payment saved on the reducing balance as Klein has rightly pointed out is $13,670. Use an amortising calculator to calculate this.

If we had not paid off the loan in a lump sum, over a 10 year period, that $100,000 earning 2.5% per annum compounded would earn $28,008.42 in interest income. :)

klein7767 said...

To raymond350:
on the 3rd point ak71 has explained.
The idea is simply this
CPF does run on compound interest
but yr housing loan runs on a reducing balance which simply means over time u pay less interest but pay more of yr principal(the amount u borrowed)

so
outstanding HDB loan of $100,000 u save 13,670
cpf 100,000 u earn 28,008.42
so 28000-13700=14300
if u choose to use the cpf option you would have been 14,300 dollars better off

or think of it this way compound interest runs on a increasing exponential type of function while
reducing balance runs a decreasing function.
http://loanstreet.com.my/learning-centre/interest-calculation-reducing-balance-flat-interest
they have a graph here that shows it.
i kind of have the concept but when it comes to calculation i may not be accurate so do verify

essentially it can be any lump sum amount the longer u can compound the higher yr returns.

2nd part
Also for your 2nd point, although every dollar paid won't earn you interest, but it saves you on the loan interest right?

ok this part goes like this. today u give the hdb yr $1 its gone much like an expense. but if u keep that one dollar and put it in cpf and let it keep growing that's yr investment.

or think of it this way if u were running a business would you use yr money to buy more goods and hopefully sell it then thereafter pay yr supplier using some of the extra profit.

or u can take it that u put in a high interest account after that use the principal + interest to pay yr employee but still get to pocket that interest even if its just a bit of interest

here for us its just the initial downpayment that works in yr favour
even though u think yr paying more interest yr actually arent because interest in our mind is calculated in the same manner but in reality its not. (another slip i have is does the difference in repayment installment that would also compound in the cpf make a signifcant difference to the points above)

of course u pay less downpayment yr monthly repayments go up for the same loan period however if u use the loan calculator it has been shown the interest is less than what u could earn with the cpf option.

the key i think is how comfortable u are the amount of debt u want to hold. u can do it in terms of percentages like how much u want to pay the downpayment etc

A comforting point is i think with the hdb if in the event one cannot pay up i dont think they will evict the family so that's why i suggested the above method.

there's also another another way besides moving to SA so at least u get yr money back and the same method has 3 variations of it. Depending on how far u want to push it.

in my opinion the loan can be thought of as a form of insurance one can design for one's family.

that's about all i could think of but i havent found the time to write those numbers out. the cpf website is abit unintuitive for me though.

have a good nite

raymond350 said...

Hi, did a spreadsheet of the calculation https://docs.google.com/spreadsheets/d/1MKNCb9I1pLCsXtfHebMypgbbwDN1K5jPFiV1Mkexuq4/edit?usp=sharing Don't know if its error-proof, but the calculation shows that even with the initial full payment, you could still accumulate the $28K in CPF interest. All being equal, it will be worthwhile to repay the interest slowly, because I think if you pay upfront in one shot, you would have to pay back a larger accrued interest if you were to sell it in the future?

AK71 said...

Hi Raymond,

Thanks for sharing this. :)

You have brought up a good point about accrued interest payable to the CPF (if/when the flat is sold). The water has just become a bit murkier. ;p

I am going to leave this to those who are more enlightened in such issues to comment. -.-"

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