More flexibility proposed by CPF Advisory Panel. Why I think they are good.

After a few rounds of gaining feedback from subject matter experts as well as the community through focus group, the CPF Advisory Panel, lead by Professor Tan Chorh Chuan submitted the FIRST batch of recommendations on how to improve the CPF.

Rebranding CPF Life Entry Limits

The panel provide names for the entry minimum sum for the folks who turns 55 next year. It used to be that the government explains that if you have a home and you pledge 50% of the home, you will only need to satisfy 50% of the $155k limit.

Now its re-branded as Basic and Full Retirement Sum. If you pledge your home, you will only need to satisfy $80,500 in your CPF minimum sum, which is made up of your CPF SA account and if SA is not enough, CPF OA. This is Basic Retirement Sum.

If you do not pledge your home, you will need to satisfy $161,000. This is the Full Retirement Sum.

Much clearer.  Your pay out is smaller if you opt for basic.

Your $80,500 Basic at 55 years old will grow to $119,159 in 10 years at a 4% growth rate. This will pay $650-700 per month or $7,800. The initial yield here is 6.5%.

Your $161,000 Full at 55 years old will grow to $238,319 in 10 years at a 4% growth rate. This will pay $1,200-1,300 per month or $14,400. The initial yield here is 6%.

The role of an annuity like CPF Life is to provide lifetime income. It is to shift the risk of not knowing how long you will live to the insurer. To let them bear this longevity risk. While you may think you won’t live so long, you are seeing a lot of your ah ma and ah gong all going strong even at 90 years old. Now imagine the scenario where you reach that age and run out of money.

That is the role of an annuity, to provide the minimum cash flow required to cover subsistence living at least. After my recent exploration of variable withdrawal strategies and the challenges we faced with sequence or return risks, to coming out with a viable form of wealth de-accumulation, much of the solution points to a bear minimum of an annuity to cover the basic needs before building other wealth assets on top of an annuity.

You can opt in more to CPF Life

It used to be that the $161,000 CPF minimum sum act as both the floor and the ceiling of your contribution. This is a problem for those that understands the role of annuities and their benefits in wealth de-accumulation, the would want to take advantage of this good tool.

But they were unable to do so. The proposal is for those who turned 55 years old next to be able to top up their CPF minimum sum to a ceiling of $241,000. This would allow them to enjoy a larger pay out.

Defer Pay Out to a later age

The panel realize that 40% of the folks between the age of 65 to 70 continue to receive  income from work and thus they recommend to incentivise these folks to defer their pay outs any year from age 65 to 70 years old.

For each year the start age is deferred monthly pay outs permanently increase by 6 to 7%.

This is a move that I see in USA where financial planners recommend that, if you are having trouble hitting the nest egg required for retirement, you should defer your retirement by 1 to 2 years. (This is also one of the ways that have a large impact on you fulfilling your wealth fund in my wealth formula article)

What happens is that suppose you earn a last drawn salary of $50,000. By delaying for 2 years you save up more BUT you also delay your wealth de-accumulation by 2 years. So if you save $12,000 per year and your expense is $38,000, that is a swing of $100,000 addition to your wealth fund for retirement. It will make your money last longer.

The double attack of Opt In More, Defer Pay out

If you combine the last 2 proposals, a person who top ups to $241,000 at age 55, his money will grow to $356,738 at age 65. Based on a 5.8% yield ( lesser than the yield on $161,000 just to be conservative), the annual cash flow is $20,690 or $1724 per month.

If the person defer the payout to 70 years old, or 5 years later, based on the information given, the pay out at 70 years old would be 1724*(1.06)^5 = $2307.

If both spouse is still alive, I believe $4600 is a good sum for a 70 year old retiree couple to work with.

At 65, members can opt to withdraw up to 20%  of Retirement Account

This proposal is what many are looking forward to. For those that would like to have a sum to go for Muslim Pilgrimage, opt to help a family member in need such as children’s education or HDB down payment, this is a welcome move.

The downside is that you have to bear the risk that your pay out is reduced.

Minimum sum to go up gradually

The panel did highlight that, in the past 10 years inflation have run in excess of 5% and as such there is a need to at least propose a 3% per year rise in minimum sum, so that the amount of money individuals set aside are able to keep up with inflation.

A better communication structure

The problem with the old CPF Life i felt is that its a bloody complicated mess. The original one even have so many schemes to provide flexibility and options, such as whether to leave bequests for children and when the annuity terminates.

When you have too much options, the majority of the people fail to process them properly. They freeze to make decisions and usually opt for the default.

The existing one needs one level of explanation first on when you need to hit $155,000 and when $70,000 is enough.

Such is the confusion that, even for myself, I gave up knowing more about the CPF for the first few years because its a mess.

The panel did well to break them down into 2 basic plans with an appropriate name Basic and Full. What differentiates Basic from Full are rather clear. By providing an identifiable name, it promotes clearer discussions and responses.

Summary

I felt that most of the proposal are safe, not really big changes but ultimately brings us forward in terms of what is considered a robust pension system. I am sure that there are much things not address such as the products that can be use to build wealth under the CPF.

In reality, I have some misgivings about some of the proposals. While letting people top up more to have a stronger annuitized cash flow is good, it might not be feasible for a lot of folks. The 55 year old couple would need to have $482,000 set aside to take advantage of it. Is the sum possible to achieve? Sure. Would the majority be able to build that sum? I don’t think so. Most would still have their net worth tied up in housing ( and i really hope by then they have finish paying their mortgage!) and that if there are so much noise around, it is likely most have problems even fulfilling $70,000

What was omitted was also any proposal to have the cash flow be inflation linked. I suppose most of the people have come to a conclusion that expense over time tends to be reduced, and as such there is no need to be linked to inflation. I am on the fence with this one.  Perhaps after observing your ah ma and ah gong, you might provide a different perspective to this.