CPF on FIRE is a series that takes a deeper look into Singapore’s Central Provident Fund (CPF) Scheme and see how they do or do not contribute to a financial independence journey. As each Singaporean and Singaporean PR must contribute a large chunk of their monthly income to CPF, this is a hot button topic for everybody. I’d like to dive deep and dissect it to give an objective assessment of the scheme from a financial independence and early retirement perspective.
In my first CPF-related post on how to best optimise the usage of CPF LIFE, I concluded that CPF LIFE is a great annuity plan that has a very high expected pay out which can greatly supplement our retirement income. (And that’s still true!)
However at the end of the post, I also mentioned that it is more worth it to elect for the Full Retirement Sum (FRS) and call it a day instead of going for the Enhanced Retirement Sum (ERS). I concluded that the ERS doesn’t offer as good value-per-dollar compared to the FRS based on the RA balance… but now that I think about it, that isn’t really the best way to look at this. Rather, I should have compared it to the alternative.
If instead of topping up from FRS to ERS, we instead invested the difference – which of these two options will provide a higher passive income? Well, that’s what I aim to do with this post.
In terms of TL;DR: Based on what I found as a result of writing this post, I will personally be topping up my CPF RA up to the Enhanced Retirement Sum because it is super worth it from a risk and returns standpoint. I hope I can show you how I came to that conclusion with this post.
[Update 7-May-2020] To be clear, this is an analysis from the perspective of optimising the retirement income by comparing investments and CPF LIFE which is an annuity. It does not mean that CPF LIFE is the correct product for your retirement needs from the perspective of preserving your capital – in which case, CPF LIFE (as annuity that has low residual value), would not be the optimal choice.
So let’s take a deeper look at this decision and compare topping up to ERS against investing this money to determine which one comes out on top.
Here’s how I’ll be breaking this post down:
- Important announcement!
- What does it cost to upgrade from FRS to ERS?
- How much more passive income do we get from ERS compared to FRS?
- If we invest the money ourselves instead, how much passive income would we be able to generate?
- How long would it take for the investment route to break even against the ERS?
- Final verdict & conclusion
Before that, I have an exciting announcement to make
[Update 16-May-2020] The Webinar is done! You can watch the recorded webinar here: https://endowus.com/insights/webinar-financial-independence-retire-early/ Thank you to those who were there live to ask questions and interacted with us on the stream. I hope that the content was interesting and informative to you!
The friendly folks at Endowus (not sponsored) has graciously asked me to join them as a presenter on an episode of their weekly, live, online webinar. The topic will revolve around Financial Independence in Singapore. We’ll be discussing general topics and concepts around FIRE and Financial Independence through the lens of doing so in Singapore.
For those of you who read this blog regularly, this will likely not offer anything completely new, but we’ll be answering some live audience questions so it would be awesome to interact with some of you guys if you are tuning in!
This will be my first live appearance (in voice form) so if it goes well, I can look to do more engagements like this.
If you’re interested, it will take place on Wednesday, 13th of May at 7pm to 8:30pm.
Here is the EventBrite link to the Webinar: https://www.eventbrite.sg/e/endowus-live-financial-independence-retire-early-in-singapore-tickets-103901526262
I hope to see you guys on the chat!
Now that’s out of the way, let’s dive into our ERS vs Investing analysis!
First let’s take a look at the difference between FRS and ERS
How much extra do you have to pay to upgrade from FRS to ERS?
Here are the amounts you are required to have in your RA when you turn 55 for FRS and ERS (I included the Basic Retirement Sum (BRS) as well for completeness):
|Retirement Sums||Amount Required in CPF RA|
|FRS (2x BRS)||S$181,000|
|ERS (3x BRS)||S$271,500|
As you can see, in order to upgrade FRS to ERS, you must top up the CPF RA with an equivalent of 1 BRS or S$90,500. This can be done either via transferring more funds from the CPF OA into the CPF RA or you can top up in cash.
Once you do that, you would meet the criteria for upgrading to ERS. So what do you get for topping up?
How much more in annual passive income do you get for the upgrade?
Once you have either the BRS, FRS or ERS in your CPF RA, you can elect for the CPF LIFE to begin paying the annuity payout starting from the age of 65 (10 years later) or as late as 70.
By choosing to have the CPF LIFE payout later, you can increase the monthly payout by as much as 7%. However, to keep this simple we’ll only take a look at the amount you’ll get if we elect to get our payout at the earliest date possible, which is starting at age 65.
Here’s how much payout each of the 3 different Retirement Sums provide when you turn 65:
|Retirement Sums||Monthly Payout|
|BRS||S$750 – S$810|
|FRS||S$1,390 – S$1,490|
|ERS||S$2,030 – S$2,180|
So let’s isolate how much more we’re getting by upgrading from FRS to ERS shall we? How much more do we get for adding in another S$90,500?
|Retirement Sums||Monthly Payout (Low End)||Monthly Payout (High End)|
So it looks like by upgrading from FRS to ERS, we are getting an additional S$640 on the low end and an additional S$690 on the high end of the payout compared to the FRS.
How much does this mean in terms of a Safe Withdrawal Rate?
So if you’ve been learning about FIRE or if you’ve read by other posts, you’d know that one of our favorite tools to determine how much passive income we can withdraw from our investment is the Safe Withdrawal Rate.
So let’s take a look at how much the additional S$640 and S$690 mean when compared to the S$90,500 additional funds we need to put into the Retirement Sum. If it’s higher than our baseline of 4% then we’re getting a relatively good deal!
However, we cannot just use the S$90,500 directly to calculate our withdrawal rate as that’s how much we top up our CPF RA at age 55 but we only receive our payout at age 65 – ten full years later! Instead we should see how much the S$90,500 would have become in 10 years, and then calculate the withdrawal rate based on that larger number.
If we used S$90,500 directly, then S$640 a month would equal S$7,680 per year and S$690 would equal to S$8,280 per year. This comes out to about 8.5% and 9.1% withdrawal rate respectively – which is really high! But if we calculate using how much S$90,500 would have become in 10 years, we’d have a much lower number.
So let’s do that first.
Calculating how much S$90,500 would have become in 10 years in CPF RA
Doing this is actually quite straightforward. We can simply use the annual interest rate of the CPF RA and compound the S$90,500 monthly for 10 years.
This is how interest rates in CPF RA looks like:
|Amount in CPF RA||Interest Rate|
|Above first S$60,000||4%|
Since the S$90,500 we are topping up into the CPF RA is on top of the Full Retirement Sum of S$181,000, all of the added amount would fall into the “Above first S$60,000” amount and thus gets a flat 4% interest rate.
If we compound that amount monthly at 4% p.a. over 10 years, we’d get:
Using this number to calculate the withdrawal rate now we actually have 5.69% for S$640/month and 6.14% for S$690/month – nowhere near as high as 8% or 9% but still really good if we baseline against the 4% withdrawal rate we normally use for FIRE number calculations.
That’s it then right? Case closed? Topping up to ERS is definitely better because for the amount of money, we’d get a steady income that’s equivalent to between 5.69% and 6.14% – which is clearly better than just 4%?
Not so fast! It may be true that the additional passive income you get for ERS represents a great withdrawal rate, but we’re just comparing that to the amount of money that it would become in the CPF RA under 4% interest rate.
What if instead I don’t put that S$90,500 into the CPF RA for ERS, but instead invest it outside instead to get higher returns than 4%? Isn’t it possible that it would grow to an amount that will provide better absolute passive income even when I am withdrawing just 4%?
The answer is yes, it’s definitely possible. So now let’s take a look at that scenario. How much of a return you’d need from investments outside of CPF RA for us to do better than topping up to get the ERS shall we?
How much annual passive income can we get if we invest the funds instead?
The first step we’ll need to take in order to find out the passive income we can generate from investing the funds instead is to find out how much the funds would become – if invested – after 10 years.
In order to do this, given that I don’t want to predict how well the market will perform when we all turn 55 until when we all turn 65, I’m simulating multiple possibilities.
Let’s take a look at how much S$90,500 could turn into given average nominal (including inflation) rate of returns of 5% all the way up to 9%:
Great! So now we have 5 different scenarios, all of which gives us a better portfolio value higher than if we had left it in CPF RA. Now we can actually look at how much passive income each of these scenarios will give us.
How much passive income will each portfolio produce and how does it compare to ERS?
Although all 5 investment scenarios produce better ending portfolio balance than if we had put the money into the CPF RA, the passive income that they can generate is the baseline Safe Withdrawal Rate of 4% or lower – nowhere near 5.69% and 6.14% of CPF LIFE. Therefore not all of the scenarios will produce better passive income than CPF LIFE.
Let’s take a look at each of their passive income using the 4% rate compared to the increase from ERS:
As you can see, the portfolios with returns between 5% and 7% all produce less passive income compared to even the lower end of the increase in ERS income.
At 8% average returns, we are starting to be able to generate passive income that is between the low and high end of income generated from ERS.
Then at 9% portfolio returns – keep in mind that this is an average over 10 years – we see a clear outperformance compared to ERS.
However, before we jump to any conclusions from this information, we need to keep in mind that:
- We are looking at payout for CPF LIFE payout for the Standard Plan, which does not increase to adjust for inflation over time. So for CPF LIFE Standard Plan, we will only ever get this much in payout until the day we die.
- As for the 4% Safe Withdrawal payout, it allows us to increase the withdrawal amount each year depending on the rate of inflation! This means that the amount we can withdraw from the portfolio will increase slightly over time to allow for any cost of living adjustment due to inflation.
With those 2 points in mind, eventually the passive income from the 5%, 6% and 7% portfolios will increase enough to beat the ERS income!
So when will the investment income beat the ERS income in these scenarios?
Well, there will be 2 major milestones:
- When the monthly passive income increases enough to be equivalent to the ERS income; and
- When the total income received from the portfolio withdrawal is equal to the total income received from the ERS
Of course, we’d expect #1 to come before #2. Once the monthly income beat the income from ERS, it can start to catch up with the total income.
So I modeled this out for each of the portfolio returns, increasing the passive income for each portfolio by 2% (inflation adjustment) every year and got this:
Let’s break this result down:
- 5% Return Portfolio: If your portfolio only generates 5% returns between age 55 and 65, then your portfolio will generate very small passive income at age 65. It would take between 13 and 18 years before it will generate roughly the same monthly passive income as ERS. Now if you wanted the total income from the portfolio to beat that of ERS, you’ll need between 26 and 33 years after you start withdrawing! Which will put you at between 91 and 98 years old before you break even!
- 6% Return Portfolio: For the 6% return portfolio, the situation isn’t much better. It will take between 8 and 13 years before the passive income from this portfolio to match ERS – we’d be between 73 and 78 by then. In order to beat ERS in terms of overall income received, it would take between 17 and 24 years – we’d be between 82 and 89 years old by then.
- 7% Return Portfolio: This is the more reasonable rate of return compared to the more conservative 5-6% however this also means that this portfolio is a bit more risky compared to the other 2 – i.e. more equities and less bonds. With this portfolio we’d get the same monthly passive income between 3 to 8 years after withdrawal – between age 68 and 73. We’d get more in total returns after between 8 and 16 years – between age 73 and 81. Certainly a lot more reasonable.
- 8% Return Portfolio: Now we get to something that’s really worth considering. With this level of returns on your investment – and you’d be taking a bit more risk than the other portfolios – we’d beat the low end of the ERS payout right out the gate. However, it will take almost 3 years to beat the higher end in monthly income – around age 68 – and 7 years to beat the higher end ERS income in terms of total income – around age 72.
- 9% Return Portfolio: No need to even talk about this one. If you can consistently get 9% returns per year over 10 years, you will certainly beat ERS right out the gate on both the lower and higher end. If you can do this and are willing to take this risk, then investmenting is better for you than topping up ERS.
So what’s the final verdict – should we upgrade to ERS?
Let’s look at it from a life expectancy perspective
Based on SingStat, here’s the latest life expectancy at the age of 65 for Singapore residents:
This shows that:
- For males at age 65, we are expected to live for another 19.3 years – till age 84.3
- For females, that number is slightly higher at 22.6 years – till age 87.6
So from this perspective, in order for it to make sense for us to invest the money instead of choosing to stick with ERS, we would need to generate at least a return of 7% p.a. Else ERS is going to be superior.
Of course, if our life expectancy is less than 30 years as the data seem to suggest, then it’s also possible for us to withdraw more than 4% from our portfolio since the 4% rate assumes you’d like to make sure the money lasts 30 years.
However, that is risky because of longevity risk. If we end up living longer than expected (a great thing) but we withdrew too much and we run out of money, then we’d have a hard time in our old age – so I wouldn’t advise increasing the withdrawal rate and hoping that we don’t out-live our money.
This brings us to the main benefit of CPF LIFE – risk reduction.
CPF LIFE is much lower risk whereas investing involves high risk if you want to generate the higher returns required
Now I’m not saying that CPF LIFE is “risk-free” because it isn’t. It is still affected by policy risk and the Singapore Government could potentially change the payout or the payout date.
However, given that this is a national program which affects all Singapore residents, changes will likely be gradual and we’d be informed of any changes before we get to make the decision. It’s unlikely for the government to make changes to the policy that will affect those that has already received their payout because that would seriously impact any planning that retirees has done around CPF LIFE. Any changes are likely to only affect those that have yet reached the age of 55, thus giving them time to adjust their retirement plans.
Comparatively, investing exposes the investor to the market cycle and the global economy. It’s completely possible that during the 10 years between 55 and 65, the economy takes a dive and the returns for the investor over that period ends up being negative. If that were to happen, then the investor will be much worse off than using CPF LIFE.
Also in order to attempt to get higher returns, the investor must allocate the funds to equities, but that is higher risk. Normally an investor should rebalance their portfolio to become more bond-heavy nearer retirement age, and at 55 we may have as high as 50% of our portfolio allocated to bonds, which will reduce the expected return of a portfolio in exchange for more stability.
This will not be an issue for a person utilizing CPF LIFE. The income is predictable and backed by the Singapore government.
The downside of CPF LIFE (Updated 7-May-2020)
In terms of downsides of CPF LIFE, it would not be the best choice if the intention is to preserve your capital. Once you have top up or paid into CPF LIFE for the purpose of getting the payout, that lump sum is no longer available to you. You lose the access and flexibility of using that money when and how you want. It has been converted into a relatively stable and consistent annuity payout that are paid on a schedule until you die.
Although CPF does say that there will be a bequest that – when added to your total payout – will be at least equal to or more than the amount you’ve put into CPF LIFE, they are not optimising for maximising the bequest amount. This is true even with the Basic Plan option (they still need to give you monthly payout after all.)
The primary objective of the government to design CPF LIFE in a way that optimises for ensuring that it can pay out to its members as long as they are alive and not for building an inheritance to bequest to your family. Thus, once you pass on, there may be little to no remaining value left to pass on to your dependents or family members.
Compare this to investments, if planned properly, your investment assets can be structured in ways that will produce a nest egg that can be passed onto your children or remaining family members after you pass.
If you do not need the income from CPF LIFE to live in your retirement to hedge against your longevity risk and market risk, and instead you’d like to preserve capital and build an inheritance to for your children and family, then CPF LIFE is certainly not the right choice for you.
So given all of the above analysis, I have changed my mind from my post on how to optimise CPF LIFE. In that post I wrote that the optimal use of CPF LIFE would be to get to the Full Retirement Sum. Although technically that’s still true, we don’t get a proportional increase in passive income when we top up to Enhanced Retirement Sum, however, it is still much better than if we take that funds to invest it and generate the additional income ourselves.
This is due to the fact that the ERS payout is actually quite good and it would require us to get very good returns on our investments in order to outperform ERS. Additionally the risks we’d have to take in order to generate that kind of return will actually not be worth it – especially at the age of 55.
So my personal take – from the perspective of optimising my retirement income – is to top up to Enhanced Retirement Sum to lock in that higher income payout. Then if you have money left over, you can invest that outside for additional passive income. There’s no point leaving this great guaranteed income on the table to try to do it yourself.
Of course, if you believe that you can definitely get more than 7% returns by investing, then you can take that calculated risk. For me, I know what I’ll be doing.
I hope you found this analysis useful! If you do, please do share it with others you think will benefit from this post, it will really help!
If you have any questions, do email me or comment below or get in touch with me on twitter @firepathlion!
Until next time!