How Much of My CPF Should Go Into CPF LIFE?
Now that the dust over the changes to CPF LIFE and Special Account has settled, life goes back to normal. In a nutshell, the main changes announced for our retirement funding in February this year are:
- The closure of the Special Account (SA) for CPF members from the age of 55, after the Full Retirement Sum has been deducted from it into the Retirement Account (RA). This means that CPF members will no longer enjoy the risk free interest rate of 4% that is paid to the Special Account. Instead, all monies in the SA will go into the Ordinary Account (OA), with an interest rate of 2.5%.
- The maximum amount of CPF savings which can be put in the Retirement Account (and thereafter in CPF LIFE) will go up from 1.5X the Full Retirement Sum (FRS), to 2X the FRS. This is the new Enhanced Retirement Sum (ERS). For example, the FRS for CPF members reaching the age of 55 in 2025 is $213,000. Which means that the ERS will be $426,000, up from $319,500 previously. This means more can be put into the CPF LIFE annuity, and hence a higher dollar amount can be received for life from the age of 65 onwards.
These changes will obviously cause a bit of rethinking about how our retirements will be financed from 2025 onwards. For instance, a popular strategy before the changes in the CPF announced might be to put the Full Retirement Sum into the Retirement Account and thereafter into CPF LIFE, with the rest of the CPF balances in the Special Account. Thereafter, upon retirement, we can draw both the CPF LIFE payouts, as well the the annual 4% interest from the Special Account, and preserve the principal amount in the Special Account, both as a liquid emergency fund, and as a bequest upon our passing. This obviously will not work now, and the question then is how should be best allocate our funds between CPF LIFE and the Ordinary Account (which earns only 2.5% interest).
CPF LIFE – How much should go into it?
Why Do We Need an Annuity?
First off, CPF LIFE, just like Social Security in the US and most pension plans, is essentially an annuity. An annuity is a form of insurance, just like term life insurance. Only in this case, it protects us from living too long. And it does so by paying us as long as we are alive, in exchange for a lumpsum payment upfront. (A term life policy requires us to make payments as long as we are alive, in return for a lumpsum payment when we die. This is the reverse of an annuity). In the same way as we never evaluate a term life insurance policy as an investment, by comparing the return on investment, neither should we evaluate an annuity like CPF LIFE that way.
Instead, we evaluate an annuity by looking at how well it protects us, or hedges us against risk. In this case, of living beyond our financial resources. And this, it does well, being provided by the Government, which has little or no risk of not being able to make these payments to us as long as we live. Plus, the risk of living too long, beyond our financial resources, though small, is a real one, and needs hedging against. So on this score, there is no argument for not taking up an annuity like CPF LIFE, especially one which can be inflation-adjusted to a certain extent (like the CPF LIFE Escalating Plan).
So, the short answer is, Yes, we do need an annuity. And one which provides for inflation-adjustment as well, given how hard it is to cater for inflation-adjusted withdrawals from a normal investment portfolio. The next question is then, how much of our retirement financial resources should we allocate to an annuity?
How Much Should Go Into CPF LIFE?
How much should we allocate to an annuity for retirement? According to Yaari (1965), a person without a need to provide a bequest should put 100% of his/her financial resources into an annuity. This will ensure that he/she will never run out of money, no matter how long he/she lives, removing the major uncertainty of retirement.
While this may be so in theory, it is 100% wrong in practice! Unfortunately, our lives in retirement are not only exposed to longevity risk, but also other risks, such as the need to pay for emergencies, that we also have to deal with pre-retirement. As JP Morgan Asset Management (2024) points out, we may actually need twice as much in our emergency fund for retirement compared to during our economically active years. This is because, without a regular income from work, we simply need more to safeguard against such risks. Moreover, we may have other goals in retirement to meet as well. So 100% into annuities like CPF LIFE, which may be possible with the higher Enhanced Retirement Sum, is out!
But if it’s not 100% into an annuity like CPF LIFE, then how much? 90%? Or 80%? Or something less? And what factors or considerations do we need to take into account when making this decision?
Working Out Some Examples of CPF LIFE Allocation
Let;’s start with the typical problem faced by someone reaching the age of 55 in 2025 and considering how much of his/her CPF (the only source of retirement financial resources) to allocate to the Retirement Account, and thereafter to CPF LIFE. As a base case, let’s suppose the following:
Assumptions for CPF LIFE Allocation
| At Age 55 (Now) | At Age 65 (Future) | |
|---|---|---|
| Amount in Special/Retirement Account (4% interest rate*) | $213,000 | $315,440 |
| Amount in Ordinary Account (2.5% interest rate) | $246,421 | $315,440 |
Once the CPF member reaches the age of 65, how much can he/she get from CPF LIFE and from the Ordinary Account? For the CPF LIFE Escalating Plan, the CPF LIFE Estimator tells us that the expected payout starts from $1,300 per month, increasing by 2% every year thereafter. For the CPF Ordinary Account, assuming we want the account to go down to zero over 30 years (i.e. age of 95 to be safe), we can start withdrawing $1,001 per month, increasing by 2% every year as well.
Safe Withdrawal Rates (or Equivalent) from CPF LIFE, Ordinary Account and Special Account over 30 years
| CPF Account | Safe Withdrawal Rate |
|---|---|
| CPF LIFE Escalating Plan (2% increase) | 4.95% |
| CPF Ordinary Account (2% inflation Adjusted) | 3.81% |
| CPF Special Account (2% inflation Adjusted) | 4.69%* |
From the table above, it is clear that the closure of the Special Account for those over 55 years of age from 2025 onwards will result in a significantly lower (19% lower) sustainable withdrawal rate. This is a result of both the lower interest rate (2.5% vs 4.0%) as well as the cap on the balance on which the addition 1% and 2% interest is payable on ($20,000 for OA vs $30,000 for SA). If we allocate everything up to the Enhanced Retirement Sum to CPF LIFE, obviously the withdrawal rate and payouts will be higher. But this is at the cost of being able to deal with the emergency risks over the next 30 years. What if we allocated varying sums to each of the options?
Safe Withdrawal Rates and Payouts for CPF LIFE and OA Combinations (Assuming ERS)
| Allocation to CPF LIFE | Allocation to CPF OA | Withdrawal Rate | Starting Monthly Payout (increases by 2% yearly) |
|---|---|---|---|
| 100% | 0% | 4.95% | $2,602 |
| 90% | 10% | 4.84% | $2,542 |
| 80% | 20% | 4.72% | $2,483 |
| 70% | 30% | 4.61% | $2,423 |
| 60% | 40% | 4.49% | $2,363 |
| 50%* | 50% | 4.38% | $2,303 |
| 25%^ | 75% | 4.10% | $2,153 |
From the table, to enjoy the highest payouts possible, we should put our CPF into the Retirement Account, up to the Enhanced Retirement Sum. But the risk that this comes with is that we may not be able to maintain the emergency fund at 6 months’ worth of payouts. If only 10% is left in the Ordinary account, the emergency fund starts running out after about 23 years. If 20% is left in the OA, the emergency fund starts running out after 28 years of retirement.
Net, while it is possible to put up to the new Enhanced Retirement Sum (2X of the Full Retirement Sum) into the Retirement Account and thereafter into CPF LIFE, in order to preserve some funds for emergencies, it may be safer to put just 1.5X the FRS into the Retirement Sum instead.
Other Observations the Allocation to CPF LIFE vs Other Accounts
1. What is the impact of the closure of Special Account?
For reference, we can look at how this allocation and withdrawal rates looks if the Special Account is still available:
Safe Withdrawal Rates and Payouts for CPF LIFE and OA/RA Combinations (Assuming ERS)
| Allocation to CPF LIFE | Allocation to OA/RA | Withdrawal Rate (OA) | Withdrawal Rate (SA) |
|---|---|---|---|
| 100% | 0% | 4.95% | 4.95% |
| 90% | 10% | 4.84% | 4.92% |
| 80% | 20% | 4.72% | 4.90% |
| 70% | 30% | 4.61% | 4.87% |
| 60% | 40% | 4.49% | 4.85% |
| 50%* | 50% | 4.38% | 4.82% |
| 25%^ | 75% | 4.10% | 4.76% |
For higher allocations to CPF LIFE, the differences between the withdrawal rates for OA and SA are not too much. Only where the CPF member prefers to keep his/her retirement funds outside of CPF LIFE will it make a more significant difference with the closure of the Special Account.
2. Would the withdrawal rates be better if the funds were invested rather than left in the CPF Ordinary Account?
Unfortunately, the answer is no. We have seen for a portfolio of Singapore stocks and bonds, the safe withdrawal rate is unlikely to exceed 3%, which is lower than the 3.81% of the Ordinary Account. For a portfolio invested in overseas markets, such as the US, the current estimates for the safe withdrawal rate range between 3.25% to 3.5%. This is where the increase in risk resulting from investment in stocks and bonds has very different outcomes from investing in the risk-free 2.5% return of the Ordinary Account.
3. What about putting it in a dividend portfolio which can yield around 5% in dividends?
This does not necessarily lead to better outcomes than leaving the funds in the CPF Ordinary Account either. A portfolio of dividend stocks is not free from risk, and the higher the dividend rates (which boost the near term payouts) also mean that the portfolio value may not grow enough to cover future inflation over a long period.
4. What if I want to leave a bequest? Should I choose the Basic Plan or the Standard Plan for CPF LIFE?
Fundamentally, CPF LIFE is an annuity to protect/insure against longevity and financial resources running out. To try to make it also do the work of leaving a bequest is probably a bad idea, as it will just mean less payouts for yourself, and also not being able to protect yourself against inflation. Also, the amount of bequest goes down over time! Hence, it will be better to set aside a (discounted) amount for the bequest, and let it grow over time through long term investments in stocks and bonds.
Conclusions
The changes to the CPF Special Account and to the Retirement Sums have resulted in a bit of relook at how we can position our financial resources for retirement. If there are no other financial resources for retirement apart from the CPF savings, it may be better to put more than the Full Retirement Sum in to the Retirement Account at age 55, and thereafter into CPF LIFE, to enjoy the peace of mind in retirement. However, the ideal split of these savings between CPF LIFE and the Ordinary Account should not be more than 75:25.
It may come as a bit of surprise, but the CPF Ordinary Account can still serve as a good option for keeping some of your retirement funds, as it has liquidity to meet emergency needs, and earns a risk free 2.5%. Where retirement funds are scarce, this is a better choice than other risky investments in stocks and bonds.
Finally, for those with more resources over and above the CPF Enhanced Retirement Sum, the need for putting the majority of these resources into an annuity like CPF LIFE diminishes, as there are more resources to buffer against future expenditure in retirement, and for emergency needs and for bequests. As a general rule, we can conclude that the lesser resources for retirement, the greater proportion should be allocated to an annuity like CPF LIFE. The more resources, the proportion allocated to an annuity can go down, as other investments can be managed carefully to provide a source of retirement payouts instead.
References
JP Morgan Asset Management (2024) Guide to Retirement 12th Edition
Terrible attempt to paint a nice picture of CPF OA is the best option as it is risk free. What about inflation? What about A rated bonds?
Of course higher returns come with risk and it is up to individual to manage them.
“Terrible” is a rather strong choice of word to use, don’t you think? As with many other things, “risk free” is very different from “low risk”, just as for many of us “no chance of death” is not the same as “low chance of death”. For a significant proportion of people, especially the older ones and retirees, risk-free is the ideal state to be in for peace of mind. In the example shown, payouts rise by 2% a year, which alleviates a significant part of inflation risk.