Is CPF the best way to save for Singaporeans?
What options do I have?
Spend below your means, avoid debt.. These are words of wisdom that has been passed down from generation to generation and has stood the test of time. But there are so many ways to save; where should you start?
Generally, there are 3 basic ways to accumulate wealth:
- Save more
- Spend less
- Retire later
We will focus the first method: how to “Save more”. This article assumes you are a frugal person and have already adopted a disciplined budgeting approach. If you haven't, you should start now! It is never too early to start saving.
In Singapore, the most famous retirement system is none other than the CPF. Despite attracting controversy and debates over its concept of forced saving, it is still lauded as one of the best retirement schemes for the masses. Every month, a portion of your gross income will be automatically allocated to CPF, supplemented by a matching from your employer.
There are other choices like endowment plans and investment-linked insurance policies. Remember the time where you are shopping and a "financial advisor" (a.k.a insurance agent) comes to you and recommends you to sign up for a policy that guarantees you a comfortable retirement? The plan that those agents are trying to sell you are actually endowment insurance policies. These plans are viable ways to save, but it might not be for everyone.
Those who like hands-on will like to adopt a DIY style of retirement saving.
To top it all off, you have a handful of options to save for retirement. We will assess the pros and cons for each option.
- Top up your CPF
- Endowment Plans
- DIY Investing: Build up your own savings and investments
CPF Ordinary and Special Accounts
The CPF Ordinary Account is the most basic account, not just for retirement purposes, but also for housing and education.
Features of CPF accounts:
- Every month, a portion of your salary, including a matching by your employer, will be contributed to your CPF. The percentage of contribution depends on your age group.
- This CPF contribution is split proportionately into your 3 accounts: your Ordinary Account, Special Account and your Medical Account.
- The Wage Ceiling is $5,000. This means that if you earn more than $5,000 per month, your are not required to contribute to CPF for the amount after the first $5,000.
Funds in your CPF accounts earn guaranteed interest.
- Funds in your Ordinary Account earn an interest rate of 2.5% p.a.
- Funds in your Special Account and Medical Account earn an interest rate of 4% p.a.
What is unknown to most people is that the government actually has implemented an additional 1% bonus interest to encourage people to top-up their CPF accounts.
- This means that your OA can earn up to 3.5% p.a. and your SA can earn up to 5% p.a.!
- The bonus 1% interest is paid on the first $60,000 of a member’s combined balances (CPF OA + SA + Medical Account (MA)).
- The fine print: Only the first $20,000 of your OA is eligible for the bonus 1% interest. Also, the bonus 1% interest earned by your OA funds will be credited in your SA instead.
Did you know that your CPF OA is also designed to meet your housing and education needs?
Summary of your CPF Account
Endowment Insurance Plans
Endowment plans are usually marketed as savings plans that typically guarantee you a cash payout after the end of the stipulated term (known as maturity), while also offering insurance protection against death and total permanent disability.
Most people find out about these plans through the introduction from insurance agents. Insurance agents typically tout these policies as a disciplined way to save for the future, while you also enjoy the benefit of insurance protection.
For more information, the MoneySENSE financial education website offers a great insight to the different types of endowment policies. I have also prepared a nicely formatted comparison between the different insurance types.
People who want more control over their finances will find DIY Investing to be a preferred style of saving. DIY Investors tend to be ones who read up a lot on investing. Usually, you have to save up a regular amount per month (known as paying yourself first) and invest in a diversified portfolio of stocks.
Proponents of DIY Investing argue that if done properly, you will be rewarded with potentially higher yields. A greater control over your finances might also be comforting for those who are wary of letting others (even the government) manage their finances.
The best adage associated with this style of saving is: you reap what you sow. Adopting this style of saving requires not just money, but also these qualities in you:
- Grit (The ability to delay gratification)
- Discipline (To put aside a fixed amount monthly. No excuses or skipping!)
- Strong conviction (you need to have the ability to stomach large paper losses, and avoid selling at lows. An example would be the market crash of 2009 where stocks fell 54%!)
If you feel that you are up to the job, perhaps you might want to check out on the ways to invest in the stock market regularly, and know about the different styles of investing.
Which option is the best for me?
Benefits of topping up your CPF OA include:
- Flexibility. You have the option of using your OA funds to either pay for part of your house, or should you decide to leave a lump sum for retirment, you can transfer a sum to your Special Account (SA).
Alternatively, you might consider topping up your CPF SA instead due to the following reasons.
- The Special Account earns a higher interest of up to 5% p.a. That beats many of the endowment plans, investment-linked insurance plans and savings accounts out there!
No matter which account you top-up to, you stand to gain one benefit: income tax deductions. The maximum top-up amount is $7,000 per year
Case Study 1: John, 29, male
Now, let's look at John, a young professional in his 20s, who has decided to start accumulate wealth from an early age.
- Monthly income of $6,000
- John is very risk averse and remembers the panic and losses that his parents suffered in the 2008-09 financial meltdown.
- Only child in the family. He has to support his aging parents who are going to retire soon.
Probably the best choice(s) for him would be to:
- Top-up his or his parents' CPF. Contribution is limited to $14,000 per year ($7,000 for his own account + $7,000 for his parents' accounts). By doing so, he also enjoys a $14,000 tax deduction. Based on his annual income of $72,000 and the published tax rates, he enjoys a tax saving of $980 per year. Imagine being rewarded with $980 for supporting your parents!
- Sign up for an endowment plan with the goal of accumulating wealth for himself. Due to his young age, he can sign up for a longer term plan (perhaps up to 65). At the same time, the plan also provides insurance protection; since he has dependents (his parents), the insurance ensures that his parents are still provided for when there is a loss of income in the family.
The key takeaway is that you do not have to stick strictly to one form of saving; usually a hybrid of options is the best balance between your risk tolerance and goals.
Case Study 2: Bernard, 37, male
Now, we look at another aspiring (relatively) young professional.
- Monthly income of $8,000 (annual income of $90,000)
- Very frugal and disciplined; has an established habit of saving regularly
- Reads up occasionally on investments and has high risk tolerance, has dipped his toes in investing before.
- Already covered by existing term life insurance plan
- Single, no child
- Parents are retired and receiving CPF Life payouts
Based on his profile, I would recommend:
- Adopt a DIY Investing style, since he has prior experience and knowledge in investing.
- Make top-ups to his own CPF. Although he does not really need the CPF, because he is in the higher income bracket than John, he stands to get a higher tax relief than John. Topping up $14,000 leads to a tax saving of $1,610!
Since John is already covered by insurance plans, and has adopted his own style of saving, endowments plans are not necessary for him.
CPF should be viewed as a low-risk, low-return savings account. Every Singaporean should allocate part of their wealth to CPF due to its stability.
For the disciplined and patient, adopting a DIY Investing approach is probably the best way to build wealth. However, if you realize that you are unable to commit, perhaps an endowment plan is good for you as it is a "forced savings" plan that ensures that you have a minimum amount of savings.
Different people have different personalities and risk tolerances. The fact that everyone has different circumstances mean that you should not compare your savings or saving styles with others! Just because you know someone who has made it in investments in stocks and property doesn't mean that it is the best way to save for you.