If you read the Singapore newspapers or follow social media, you won’t have missed the ongoing controversy about the merits or otherwise of the Central Provident Fund (CPF) scheme. The CPF attempts to serve many objectives, but in this article I will look at just one – the provision of a guaranteed income in retirement.
First some statistics. According to the annual HSBC survey ('The Future of Retirement'), four out of five Singaporeans are afraid of running out of money and not having enough to live on day to day1. And on average, people expect to live 17 years in retirement, but their savings to run out in nine years2.
Traditionally, if you are worried about running out of money in retirement, the standard solution is an annuity. An annuity is not an investment product, it is a 'risk management' product – an insurance against living a long life.
The simplest form of annuity pays you a fixed monthly income for life, in return for a lump sum premium payment to the provider. The payout rate – the percentage of your premium paid to you annually – will depend chiefly on life expectancy statistics and the returns available from the bond market. If life expectancies rise, or bond yields fall, then annuity rates fall too.
For a basic annuity, no further payouts are made when you die. That means if you pass away in early retirement, then your annuity has destroyed capital (i.e. nothing is left to pass on to the next generation). However, if you live a long time, your annuity can be very good value – ensuring an income well beyond what your retirement pot could have provided if kept as cash.
The Singapore CPF Life scheme is a kind of annuity funded by your CPF. In general terms, at age 55 a portion of your CPF fund is set aside to provide a monthly income that commences at age 65 (or later if you choose, in return for higher payouts).
Being a long-time Singapore Permanent Resident, UK national, and 50-year-old financial adviser, I thought I'd use my own situation to compare the Singapore CPF Life scheme with the prevailing system in the UK. Several aspects of the Singapore CPF scheme (and incidentally also the Hong Kong MPF) have been modelled on the UK pension system, so the comparison is relevant.
Tax-efficient money going into your pension pot
Compulsory contributions to CPF relating to employment in Singapore are not taxable. Your employer's contribution to your CPF is a tax-free payment. So for instance if your marginal tax rate is 15%, then you are 'saving' $150 extra for every $1,000 going into your CPF. This is a similar situation to the UK (ignoring the mechanics of the tax system).
In my case, because of the way the financial advisory industry is regulated in Singapore, I am considered self-employed and have no compulsory CPF contributions except for Medisave. I am allowed to make voluntary contributions to my Ordinary and Special Accounts (up to a limit). And I have chosen to do so. Why? Well, in the same way as above, voluntary CPF contributions for the self-employed are tax-efficient – such contributions reduce my tax bill at my marginal rate. But there is much more that persuades me to save into my CPF; read on.
How does the Singapore CPF Life payout rate compare with UK annuities?
Let's start by looking at the best UK annuity rates available in the market right now. As at 11 November 2016, the Financial Times reports that a lump sum of £100,000 would buy an annual annuity income of £4,8273, at a fixed level and with no guarantees or further payouts after death. (The figure is the same for men and women, because a European ruling prevents discrimination by gender.)
This is a payout rate of about 4.8%. But, if I die early, then the £100,000 is gone and nothing remains to pass on to my children. Furthermore, if I have bought the annuity using my UK pension assets, then the income is taxable at my marginal rate (less allowances). If I have other sources of income in retirement, then very likely I will end up paying tax on my annuity. For example, a retired person in UK who has used up his personal allowance would pay 20% tax (basic rate) on his annuity income – i.e. a net payout rate of just over 3.8%.
Let's now look at the Singapore CPF Life
In their document 'CPF Retirement Booklet'4, the CPF administration gives the following example, for a man aged 55 today and setting aside the Basic Retirement Sum of SG$80,500.
Set aside today: $80,500
Value of set aside after 10 years' growth: $125,000 (a growth rate of around 4.5% p.a.)
Monthly payout for life commencing age 65: $660-720
If we use the lowest monthly income figure of $660, that’s $7,920 per annum; i.e. a payout rate of 6.3%. That’s 1.5% better than the equivalent figure for the best available annuity in the UK (4.8%), or about 2.5% better if UK basic rate tax is due. The CPF Life payout rate is also as good or better than rates across numerous other countries including Australia, Netherlands, USA, and Canada.
Furthermore, Singapore CPF Life payouts are not taxable, which is an important difference when comparing with other nations where retirement annuity income is not tax-exempt.
Singapore CPF Life is not for profit
Refer back to my description of an annuity as a kind of insurance against a long life. On an individual case-by-case basis, sometimes the provider makes a profit (early death) and sometimes not (a very long life in retirement). But overall the provider must make a commercially viable margin on annuity business.
CPF Life is different because it is state-provided and not a commercial enterprise. So, if you die early, then what happens to your CPF money set aside for your CPF Life scheme? It is yours to bequest to your family as you choose.
Moreover, whilst you are taking your monthly retirement income, your CPF Life fund is growing at a rate that's guaranteed by the Singapore government – currently 4% base, with an extra 1% for the first $60,000, and an additional extra 1% for the first $30,000. We’re talking about a guaranteed return from a state with a AAA credit rating. In today’s world this is a very good deal, and especially so since security and certainty of returns is so important in retirement.
Therefore, we realise that in fact the CPF is not the same as a typical retirement annuity. In addition to the element of insurance (guaranteed income for as long as you live, at a better than 6% payout rate), CPF Life can be seen as an investment product with a guaranteed return (better than 4%), with proceeds going to your heirs in event of your early demise.
It is interesting to see how the adoption of CPF Life is impacting the open market for annuities in Singapore. The Monetary Authority of Singapore (MAS) reports that in 2015 there were 68,835 individual private annuity policies in force, down from 71,408 in 2013. There were just 349 policies sold in 2015, down from 2,186 sold in 2010 and 5,144 sold in 20005.
What else could I be doing with my CPF money if they returned it?
When planning for retirement, financial advisers seek to create a sustainable income from invested funds. We do this by reference to a theoretical maximum withdrawal rate from our pension pot, to ensure we do not outlive our funds in retirement. The recommended figure is around 4%, or up to 5% depending on circumstances.
In comparison, the CPF Life guaranteed rate of 6%+ looks attractive. The only consideration is that a long life means the purchasing power of a fixed income is eroded over time by inflation. This is the reason why a newly proposed option for CPF Life is to accept an initially lower payout rate, for an income that rises annually by 2%. Anyway, I’ll make that decision in a few years when I need to!
To close my discussion, I won't involve myself in the political argument as to whether CPF overall is 'good' or 'bad'. I have looked only at CPF Life, and in the light of my own situation and retirement intentions. The facts show that the CPF Life scheme compares extremely favourably with annuity products available in other developed countries such as UK. As a tax-efficient source of guaranteed retirement income, coupled with guaranteed returns from a AAA-rated provider, CPF Life absolutely deserves a place in my retirement portfolio.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.
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Roy Walker is Associate Director and Principal Consultant at IPP Financial Advisers Pte Ltd (Expat Advisory Group). Originally a telecommunications engineer, Roy took his MBA in Finance at Imperial College London in 1992. After many years in the corporate world, Roy moved into working one-to-one with private clients. Roy sees himself as a ‘financial engineer’ and believes in paying attention to first principles and the fundamentals of financial planning.