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Tea with LS: The Pros and Cons of topping up the CPF-SA.

Monday, April 6, 2015

LS left a very good comment on the CPF recently in my blog and I suggested that a guest blog could be next and here we have the maiden guest blog:

Just want to share with you some of my thoughts on the CPF cash top up to SA. Please note that we are talking about CPF cash top up, not transfer of OA to SA.

I know you have being recommending readers to do cash top up to SA early as this will greatly assist them in achieving their Minimum sum(MS) in the future. While this advice is mathematically sound, does it applies equally to all? Is there any cons involved in such a plan? Let’s us look at some of the pros and cons.

Pros

1) You can enjoy up to $7000 in tax relief per calendar year. The amount of tax relief you get is the amount you contribute to OA/SA, up to S$7000. How much saving do you get from this?  If you are earning more than $80k, the tax rate after the first $80k is 11.5%. Which mean you get a one-time saving of $805 from the $7000 top up. That is a very respectable amount for a one time saving fee. Average Singaporean will be earning between S$40-80k so the tax rate is only 7% which work out to be a one-time saving of $490. Still a decent amount. This clearly works better for the higher income earners but the lesser income earners do get quite a bit of saving too.

2) You get free 4% interest (not accounting in the additional 1% interest for first S$40k in SA) from the government. Who do not like free money from the government? Lol. Contributing S$7000 yearly into SA for the first 10 years and leave it to roll for another 15 years will nett you around S$87k in interest alone after 25 years. That is decent return with a contribution of S$70k of your own. S$87k free money after 25 years, risk free J

3) It can also act as a risk free bond portion in your overall portfolio. This will reduce the overall volatile in your portfolio since the SA will not be affected in times of a crash.




Cons

1) While SA is earning us an interest rate of 4%, there are also other options that is earning more than 4% though not risk free. STI ETF (stock code ES3) is having an average return of 8.55%(inclusion of dividends) since inception from April 2002. Rate of returns does matters especially over a long period of time.

2) Opportunities cost. While transferring S$7000 cash per year might means confirmed 4% compounding and one-time tax saving, you will also lose opportunities to invest in cheap bargains if they do come your way (example like OCBC at S$9 last year and Keppel at S$8 this year). We can always alleviate this 4% loss by putting our money in some high yield saving accounts like OCBC 360 account which earns 3.05% with some terms and condition. (Interest will soon be changed with more details yet to be announced) These high yield accounts provide lesser returns but with no lock up of funds until age of 55. Feel like a good alternative comparing to 4% return but no flexibility in withdrawing of funds at your convenient timing. 

3) Lastly, to enjoy the fruit of the accumulated SA, we have to wait until the draw down age which is 64 in 2015, 65 in 2018 (hopefully no more adjustment to a later age though I highly doubt it) or a portion of the fruits at the age of 55 if you have excess of MS. How you will enjoy your fruit of labour is through the policy of CPF Life. You will enjoy life long monthly pay out with the amount depending on how much you have accumulated and which plan you select. What is not widely known is that the monthly payment is not fixed and will be adjusted depending on the money left in the overall pool that everyone contributes in. The solvency of the fund could be affected by many factors. Mr. Wilfred Ling had sent a post to Straits Times and MOM replied. What we are given is just a verbal assurance that CPF Life scheme is designed to be sustainable. But if they are sure, why do they feel the need to include in the non-payment in the case of insolvency in the bill? Isn’t this like preparing a back door exit and they are not as sure as they want us to believed? So is contributing guaranteed cold hard cash of S$7000 into SA really risk free? Could that money be better used investing somewhere so it will still be available if something do happen to CPF or Singapore?
  
Above are just my thoughts and I am just another common man in the streets with limited knowledge. Read everything with a huge pinch of salt and disregard any portion that you find distasteful.

Also feel free to advise me if I am misguided :P

Thanks for sharing, LS. Appreciate it. :)

Related post:

16 comments:

Toma said...

Hello AK,

What does LS mean by "monthly payment is not fixed and will be adjusted depending on the money left in the overall pool that everyone contributes in" and "non-payment in the case of insolvency"?

P.S. You blog like you do not have work! Haha

AK71 said...

Hi Toma,

This is LS' guest blog. I will let him reply to your comment. :)

I only work a few hours a day. I have been semi-retired for a while now. ;)

Lim LS said...
This comment has been removed by the author.
Lim LS said...

Hi Toma,

Please see the quote from CPF website

http://mycpf.cpf.gov.sg/Members/CPFSchemes/CPF_LIFE.htm

"While stable, the monthly payouts are not fixed. The payout amount will be reviewed annually and we may adjust your payout due to changes in life expectancy rates, investment income and transactions which affect your RA balance. This will ensure that the CPF LIFE annuity fund is sustainable in the long run."

What this means is although you might be getting S$1000 per month from CPF Life this year, there is a possibility of the monthly payout dropping to S$800 or even S$500 in the next year. All this will depend on the solvency of the CPF Life annuity fund. The solvency of the fund can be affected by many factors like longer than expected life expectancy, insufficient investment returns by CPF, etc. These are things that we totally have no control over and we can only hold faith that CPF Life will deliver...


In the case of non-payment, please see the quote from our CPF Act(Chapter 36)Section27N(7)

http://statutes.agc.gov.sg/aol/search/display/view.w3p;ident=9b58b3e1-b9f9-4457-ae11-bc1387d8cde1;page=0;query=DocId%3A%22f1b7803c-71dd-4732-b7f0-231fef8142ca%22%20Status%3Apublished%20Depth%3A0;rec=0

(7) "Notwithstanding anything in this Part or the relevant regulations, the Board shall not make any payment under this Part unless the Lifelong Income Fund is solvent."

With this included in the CPF act, they are allowed not to make monthly payment if they deem the CPF annuity fund is insolvent.

While they verbally promised the CPF Life scheme is designed to be sustainable, their insertion of this clause speaks otherwise. We should not only hear what they say, but also see what they do, in order to fully evaluate the situation.

I just quoted the facts from the relevant government agencies. It is up to the readers to come up with their own conclusion and decide on the best course of action.

Cheers.

P.S. If there is any mis-quote, please do advise me.

P.S.S Lazy AK.... I got more work than I bargained for...

AK71 said...

Hi LS,

Sumimasen. LOL.

Bloggers don't just blog. They have to reply to readers' comments also. Comes with the territory lah. ;p

Lim LS said...

Deleted away the 3rd comment since it was a repeated comment. I thought the comment did not went through so I retype.

Sorry for the inconvenience caused.

AK71 said...

Hi LS,

No problem. I would have deleted one of them but they were slightly different from one another. So, I let them be. ;)

Toma said...

Hello AK and LS,

Thanks for taking time out to reply and for the helpful information. Appreciate it!

So as per stated in the clause, does this mean that as long as the CPF annuity fund is insolvent, it will not matter no matter how much we have in our CPF accounts (For e.g. 200k)?

AK71 said...

Hi Toma,

Well, if an entity is insolvent, it means it won't be able to meet its financial obligations.

Personally, I rather doubt that it would happen. If it should happen, I think annuities run by private financial outfits might not fare better. -.-"

Lim LS said...

Hi Toma,

With so much of changes to CPF these recent years, it is hard for me to keep up. For clarification of details, it is better to seek advice from CPF Board.

The only thing we know from the official information is that the pay out is not fixed and they do have a clause for non-payment in case of insolvency. What will actually happen in the future, nobody can really predict...

It is just like nobody can guess what will be the drawdown age after 25 years (my guess is 75 ;p) and what will be the Minimum Sum after 25 years (AK guess is $337k based on 3% inflation ;p). Or how CPF will actually evolved after 25 years...

As such, make your plans accordingly and do not put all your eggs in one basket. This is the only advice I can offer at this moment...

Cheers.

Serendib said...

Excellent post - very balanced and objective. The way I see it, CPF Life is basically taking risk on how the government policies will play out from now until we retire - imho very similar to the risk we take on land/property prices. On points 1 and 2 under "cons" these are really down to asset allocation - if you need/want more equity exposure in your portfolio then top-up is not for you. Treat CPF-SA as a "bond" as you say.

Lim LS said...

Hi Serendib,

Thanks for the compliment.

Yes, "investing" cash in CPF Life has risk which is something I hope to highlight. The risk is higher especially for those who still have many years before 55. During this period to 55, many things could happen. Draw down date could be further delayed, pay out amount could be adjusted downwards, or even the policy could be changed drastically. What is worse is that you have total no control over it and you are lock in until 55. Unlike land/property, you can choose to unload if things do not start looking good.

Another good point you brought up is asset allocation. In all good portfolio strategy, asset allocation is one of the most important thing to consider. You want to spread the risk and not get too much weightage in one area. Imagine we are already tied up in CPF for over S$100k in OA/SA, and if our cash/equity component is only S$30-50k, is it advisable to continue to increase weightage at the CPF component by doing more cash top up? While CPF can be considered as a bond component, but we must also take note of the terms and conditions attached to it (no redemption till 55, controlled pay out at much later age which can be changed anytime, no fixed pay out, etc).

So, if your overall portfolio is big and the CPF portion is only a small portion, investing more cash to it do make some sense. But if CPF is already your biggest portion in your portfolio, I feel it is somewhat risky to contribute more cash as this will create a too lopsided portfolio.

Just see too many touts of CPF being risk free. Wanted to show the readers the other side of the coin and advise them to look at the much bigger picture (asset allocation of the overall portfolio). As per my last comment, do not put all the eggs in one basket.

Cheers.

bluelite said...

yup agree too we shouldn't over commit topping up of SA as this will reduces one's liquidity.
CPFOA can be a warchest for property investment as well in times of property crashes...hoho

Serendib said...

hi LS,
yes we all tend to think CPF is "risk-free" (in fact i think you used that term in your post too!), but we have to be aware of the policy risk. The CPF system is mostly good, but it can be made better. I like some of the advisory panel's recommendations, which include providing guidance in advance on future increases in Min Sum (oops, Basic Retirement Sum!).

Anyway I think the new "risk-free" rate will be that provided by the Singapore Savings Bond.. looks like a real free lunch!

Jaded Jeremy said...

" Well, if an entity is insolvent, it means it won't be able to meet its financial obligations.

Personally, I rather doubt that it would happen. If it should happen, I think annuities run by private financial outfits might not fare better. -.-" "

AK71, this is not entirely true because unlike private insurer, CPF Board cannot pick and choose (via underwriting) who they want to offer CPF Life to. In general, I'll expect private insurer to have better risk annuity portofolio than CPF Board.

AK71 said...

Hi Jeremy,

That statement was made based on my understanding that the CPF buys special bonds issued and guaranteed by the Singapore government. These are AAA rated sovereign bonds.

If Singapore should go kaput, then, the CPF would too. So, for my statement to hold water, Singapore should have a very low or no chance of going kaput. I guess there is an element of subjectivity here. ;p

Thanks for weighing in on the matter. A valid point on how the CPF cannot choose who gets covered and who doesn't, definitely. :)

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