Creating a Stream of Retirement Income from the CPF Ordinary Account

In our previous post How Much of My CPF Should Go Into CPF LIFE?, we argued that while the closure of the CPF Special Account may mean that there is more incentive to place more CPF savings into the CPF Retirement Account instead in order to earn the higher risk-free interest rate (up to the Enhanced Retirement Sum). However, at least some retirement savings should remain in the Ordinary Account, in order to ensure that there are still liquid funds for a rainy day. Our view is that we should allocate not more than 75% of retirement funds to the Retirement Account, and into CPF LIFE later. Regardless, this is still a very high allocation to an annuity.

At the same time, we demonstrate how a combination of CPF LIFE and the CPF Ordinary Account can create a stream of retirement income. We also show the range of safe withdrawal rates using different combinations of the two accounts (e.g. 90%-10%, 80%-20% etc.). In that earlier post, we simply assert that the CPF Ordinary Account can sustain a withdrawal rate of 3.81% for 30 years (increasing by 2% per year for inflation). How do we come up with this 3.81%? And how will this change if we decide to draw it down for 25 years instead of 30 years? Or for 35 years? This is what we will show in the following, how to create a stream of retirement income from the CPF Ordinary Account.

Harvesting a Risk-Free Asset for Income

Harvesting a Retirement Income from the CPF Ordinary Account

Creating a Stream of Retirement Income from Retirement Assets

Usually, when we talk about a Safe Withdrawal Rate (SWR), like the 4 percent rule (which incidentally doesn’t really work consistently outside of US stock and bond assets), we are talking about creating a stream of retirement income from a portfolio of risky assets. Does it make sense to apply the same concepts to risk-free assets like the CPF Ordinary Account as well?

The short answer to this is “Yes”. For example, when we put our risk-free savings in the CPF Retirement Account into CPF LIFE, we are essentially outsourcing the creation of a stream of retirement income to an annuity provider. We can also DIY this by following a sequence of withdrawals from a risk-free asset like the CPF Ordinary Account. But the question is, does it make any sense in practical terms to do so? Wouldn’t creating a stream of retirement income from risky assets be better?

Creating a stream of retirement income from risk assets is only better in the sense that there is a greater chance that there will still be a significant amount of assets remaining after the usual withdrawal horizon of 30 years. These residual assets (which in some cases can be much larger than the initial pool of assets at the start of the 30 year period) can be an inheritance for our heirs. Or, they can fund further expenses in a longer retirement period.

However, at the same time, creating a stream of retirement income from risky assets also comes wth a chance of failure, i.e. running out of money before the end of the 30 year horizon. For example, most illustrations of the 4 percent rule come with the caveat that there is a 5% chance of running out of money before the end of the 30 years. And if the withdrawal rate is higher, the chance of failure could increase to 10% or more!

This is where the stream of retirement income from risk-free assets come in. By definition, the stream of retirement income from risk-free assets has a failure rate of zero. So by combining these 2 streams of retirement income (from risky and risk-free assets), we can manage down the risk of running out of money.

Suppose at the current stock and bond market valuation levels, we work out that a 4.4% withdrawal rate from risky assets has a 7.5% chance of failure over 30 years. If we combine our retirement income streams from risky and risk-free assets such that 2/3 of the income comes from the risky asset portfolio, and 1/3 comes from the risk-free portfolio, the risk of running out of money over 30 years is now lesser at 5%! That is 2/3*7.5% + 1/3*0% = 5%. And the net withdrawal rate from the entire pool of risky and risk-free assets comes to 4.2%!

Example Combining Risky and Risk-free Streams of Retirement Income

Assets	Withdrawal Rate	Chance of Failure	Proportion in Total
Risky Assets	4.4%	7.5%	2/3
Risk-free Assets	3.8%	0.0%	1/3
Combined Portfolio	4.2%	5.0%

Hence, combining retirement incomes streams from both risky and risk-free assets can help improve the outcomes by reducing the risk of failure. Which is also why an annuity like CPF LIFE is so important for retirement financial planning, because it can help reduce the risks significantly.

But does it make sense to create streams of retirement income from 2 or more risk-free assets only? For example, by combining the CPF LIFE annuity with a DIY stream of income from the CPF Ordinary Account?

Why Creating a Stream of Retirement Income from the CPF Ordinary Account may not be Optimal

There are a couple of reasons why creating a stream of retirement income from risk-free assets may not always be optimal, especially when it accounts for a large proportion of your retirement assets. In the example above, we cited the case of combining income streams from both risky and risk-free assets to lower the risk of failure of the income streams. However, when we combine the income streams from 2 risk-free assets (e.g. CPF LIFE and CPF Ordinary Account), there is no further benefit to lowering the risk of failure, since neither asset has any risk of running out of cash over the 30 year horizon.

However, non-annuity risk-free assets do carry a very high risk of failure beyond the stipulated horizon. For example, as we show below, an income stream created from risk-free assets can last 30 years 100% of the time. This will also have a 0% chance of success beyond that horizon, since by design, it will run out through the depletion of the initial capital amount. So you’d better hope you do not outlive your withdrawal horizon in retirement!

Why is this so? This is because risk-free assets generally have very low rates of return, or yields. For instance, the CPF Ordinary is risk-free, but only yields 2.5% per annum in interest returns. If we do not plan to drawdown the capital amount over the retirement period, the withdrawal rate would be very low, just 0.5% a year in order for the principal amount to keep up with forecast inflation of 2% (which is where the bulk of the interest earnings go). Not accounting for inflation in retirement is a big no-go. While we may not be able to discern the effects of inflation from year to year in most periods, looking back now at the prices of everything from 30 years ago (i.e. 1994), it is impossible not to conclude that everything has virtually doubled in price (corresponding to an inflation rate of 2% a year on average).

In summary, relying too much on risk-free assets to generate a stream of retirement income will result in one of the three outcomes below. None of these are ideal!

There will be no principal value left at the end of the retirement horizon (applies to annuities as well)
The withdrawal rate will be too low if the aim is to preserve the inflation-adjusted value of the principal amount
The value of the principal value will shrink over time for sure due to inflation if most or all of the interest earnings is drawn down for retirement income/expenses

And the only way to avoid these non-ideal outcomes is to take on a bit of risk. That is, to combine both income streams from risky and risk-free assets for retirement expenses!

How to Create a Stream of Retirement Income from the CPF Ordinary Account

Having highlighted the risks of creating retirement income streams from risk-free assets like CPF Ordinary Account, we can get round to the business of showing how this may work in practice. Suppose we want to project how much we can withdraw from the CPF OA in an inflation adjusted manner from the age of 65 onwards. How do we go about this?

The first stage is to project how much there will be in the CPF OA at the age of 65. This will be combination of CPF contributions made every year, as well as the interest earnings at 2.5% over time. Unfortunately, this will be quite a complex calculation for those who are below the age of 55, as there are a number of changes which will affect the contribution rates, allocation rates, and even the interest rates up until the age of 65 (see here and here).

Firstly, the CPF Ordinary Wage ceiling will increase from $6,800 currently to $7,400 on 1 Jan 2025, and to $8,000 on 1 Jan 2026. This means the amount of contributions made to the CPF accounts will increase for this earning at or above these wage levels
Secondly, the CPF contribution rates will fall for those aged 55 to 60 (32.5%) and for those aged 60 to 65 (23.5%) from 1 Jan 2025
Finally, the allocation of the CPF contributions made to the Ordinary Account, Special Account and Medisave Account will also change according to age
A further complication is of course that the Special Account will be closed after the age of 55, which means that a larger allocation will be made to the Ordinary Account for those aged 55 and above

For argument’s sake, let’s suppose that after all these changes over the years, you have $200,000 in the Ordinary Account at the end of the year before you turn 65. How much can you withdraw over 30 years, accounting for inflation of 2% a year?

Fortunately, the only complication at this age is that the interest earnings on the CPF Ordinary Account need to be computed carefully. If the Retirement Account has been closed and moved to CPF LIFE (our assumption), then there is an additional 1% and 2% interest earned on the CPF OA balances, capped at $20,000. Working this out can be a little painful. But for conservatism, we can always assume that the 2.5% interest rate is applicable for the full balance instead.

How would the withdrawals and interest earnings over 30 years look like? And how would the stream of retirement income from the CPF OA look like? The next step after working out the interest earnings on the CPF Ordinary Account, is to work out how much we can withdraw every year. The initial withdrawal amount sets the tone for everything after that, as we need to increase the dollar amount from the first year by 2% every subsequent year to account for inflation. Also, we need to set the starting amount such that there is nothing left in the Ordinary Account after exactly 30 years. This can be solved using the “Solver” function in a spreadsheet, or by trial an error. The end result looks something like this:

Withdrawal from the CPF OA over 30 years

Age at end of year	CPF OA Amount	CPF OA Interest	Withdrawal for next year
64	$200,000	$5,600	$7,780
65	$197,820	$5,546	$7,936
66	$195,430	$5,486	$8,094
…	…	…	…
79	$141,038	$4,126	$10,471
80	$134,693	$3,967	$10,680
…	…	…	…
92	$37,446	$1,511	$13,280
93	$25,677	$1,099	$13,545
94	$13,230	$595	$13,816

From the table above, it is evident that the amount in the CPF OA under this withdrawal plan will fall to $0 after 30 years, so it is vital to plan ahead and put in enough safeguards to ensure you do no outlive your money if you rely on withdrawals from a risk-free asset. Also, note that over 30 years, the withdrawal amount virtually doubles, as is needed to counter the effects of inflation assumed at 2% a year.

What if you decide to take a bit of risk, and only plan for 25 years of withdrawal before going broke? This is highly risky, even though it implies that you survive until the age of 90.Simply put, while we know that median life expectancy for this aged 65 today will be around 85 years of age, it also means that you have a 50% chance of living beyond 85, and maybe 5 to 10 years more! But if you really want to go for just 25 years, here is what it looks like:

Withdrawal from the CPF OA over 25 years

Age at end of year	CPF OA Amount	CPF OA Interest	Withdrawal for next year
64	$200,000	$5,600	$9,160
65	$196,440	$5,511	$9,343
66	$192,608	$5,415	$9,530
…	…	…	…
76	$136,838	$4,021	$11,617
77	$129,242	$3,831	$11,849
…	…	…	…
87	$39,948	$1,598	$14,161
88	$27,385	$1,158	$14,444
89	$14,099	$634	$14,733

Or how about if you think you will live longer, say until the age of 100? This is what the withdrawals will look like:

Withdrawal from the CPF OA over 30 years

Age at end of year	CPF OA Amount	CPF OA Interest	Withdrawal for next year
64	$200,000	$5,600	$6,790
65	$198,810	$5,570	$6,926
66	$197,454	$5,536	$7,064
…	…	…	…
81	$152,013	$4,400	$9,508
82	$146,905	$4,273	$9,698
…	…	…	…
97	$36,146	$12,796	$12,796
98	$24,815	$1,069	$13,052
99	$12,831	$577	$13,313

Hence, in terms of the dollar amounts of withdrawal, it does make quite a bit of difference whether you prefer to withdraw over a 25, or 30 or even a 35 year horizon. This, however, does not show up to the same degree when we look at withdrawal rates instead (starting amount to be withdrawn as a percentage of the total CPF OA sum):