Is the CPF LIFE Escalating Plan the best plan?

The CPF Board’s Annual Report for 2020 (Part 1 and Part 2) aroused quite a bit of interest around how much some members had in their CPF accounts, and how many of these lucky members there were. But for financing our retirement, the accompanying news article noted that more than 63% of the active CPF members who turned 55 in 2020 were able to put aside the Full Retirement Sum (or Basic Retirement Sum plus a property pledge). This is well up from just a few years back in 2016 when only 53% were able to do so. If saving the amounts needed for a basic retirement will no longer be an issue, the question now is: which is the best retirement option out of the 3 offered under CPF LIFE? In short, is the CPF LIFE Escalating Plan the best plan?

As we may take some time (and text!) to cover our points, here’s an outline of what we will discuss:

1. Do CPF members have enough to retire on?
2. Why is the CPF LIFE Escalating Plan the best one out of the three plans?
3. What would we like to see offered by CPF LIFE in the future?

Of course, we are not approaching CPF LIFE for the first time here on this blog. You may wish to refer to our previous posts for some of our views prior:

• CPF LIFE: A Primer on Retirement
• Is CPF LIFE a worthwhile investment?
• Should I defer the CPF LIFE payouts to age 70?
• An Update for 2020
• CPF: Important updates for 2021 you need to know
• CPF LIFE: Some Surprising Changes for 2022

Do we have enough to retire on?

Over the years, as CPF contributions (especially from employers) have been cut, and with the cost of living and healthcare rising inexorably, being able to to rely on our CPF savings for retirement has been a question on our minds. Well, no longer, or at least not for very much longer, according to the CPF Board’s Annual Report 2020 (Part 1 and Part 2). 63.6% of the active CPF members reaching the age of 55 in 2020 were able to meet the Full Retirement Sum of $186,000 (or the Basic Retirement sum of $93,000 plus a property pledge). Looking at the table from the Annex of the Annual Report for active members, this roughly corresponds to regrossed CPF balances for the 55-59 age group of at least $260,000.

CPF Balances of Active Members 2020

But if we look at the balances for all CPF members (inclusive of the ones who are not active in employment) aged 55 to 60 years old in 2020, the proportion of them with balances of at least $260,000 falls to around 41%.

CPF Balances of All Members 2020

The good news is that for those between 45 to 55 years old, 50% can already meet this target. And if we only count active members, it is around 70%. This figure will no doubt get higher and higher for the even younger cohorts. Retirement adequacy, at least for the basic level provided by CPF LIFE, will not be out of reach going forward. We just need government support for the Pioneer and Merdeka generations.

Which is the best CPF LIFE Plan?

Since retirement adequacy at a basic level (i.e. based on CPF LIFE payouts) is unlikely to be an issue for the majority of future retirees in Singapore, thanks to rising CPF balances, the question then becomes with plan is the best to choose upon turning 65? Recall that there are three plans, Standard, Basic and Escalating:

The three types of CPF LIFE Plans

Which CPF LIFE plan is the best? Or to show our bias, is the CPF LIFE Escalating Plan the best plan? When we first looked at this issue back in our post CPF Life: Is it a worthwhile investment?, we show that from an investment perspective, the Basic Plan was the best value-for-money plan. But an annuity like CPF LIFE cannot be evaluated solely as an investment. It is more like insurance for longevity risk (see here for how it works). So a key consideration is really how well it protects us against living too long.

Longevity Risk: We are living longer and longer

Let’s start by considering some key facts. Usually the choice between the Standard Plan (higher payouts, less for beneficiaries upon passing) and the Basic Plan (lower payouts, more for beneficiaries)is couched as a choice between what you’d like to leave for your loved ones. The bequest for the Standard Plan ends at 80, while the Basic Plan runs out at the age of 90. Assuming average life expectancy for a man is 83 and for a woman, 87, this makes sense. But we are living longer and longer. For someone retiring today (as we show here), the life expectancy is actually 85 for a man and 89 for a woman. And for someone retiring in 10 years time in 2030, these become 87 and 91 respectively.

Life expectancy in retirement – 2019, 2030 and 2040

Retirement year when aged 65	Gender	You will expect to live up to this age	10% chance of living up to this age
2019	Male	85	96
2019	Female	89	98
2030	Male	87	98
2030	Female	91	100+
2040	Male	89	99
2040	Female	93	100+

So, for future retirees, there is at least a 40% to 50% chance that they will outlive the Basic Plan bequest. And even if you don’t, the bequest will have dwindled to a small amount by your 80s. Alternatively, if you had chosen the Standard Plan, and forfeited the additional bequest amount, you would have benefited from an additional $140 per month in payouts all this time! So the trend in longevity are quite clear:

As we are all going to live longer and longer, the additional bequest under the CPF LIFE Basic Plan becomes irrelevant. Choose the Standard Plan over the Basic Plan!

But what if leaving a bequest to our loved ones is really, really, important to us? Well, as we discuss here, the more straightforward way to do so is to take out a term-to-99 life insurance policy. For a man aged 45, Comparefirst.sg shows that the premium for $100,000 coverage is around $84 a month. At that age, term life insurance will still be an essential part of personal financial planning. And after the age of 65, hen the CPF LIFE payments start, just use the additional $140 per month from the Standard Plan (over the Basic Plan payouts) to continue to pay for the insurance premiums until death. This way, you will guarantee that your loved ones will get at least $100,000 as a bequest! You’ll still do better than choosing the Basic Plan!

Cost of Living Risk: Things will get more and more expensive, especially healthcare

One of the great myths about retirement is that spending will go down after retirement. It actually does not. Most studies which claim it does are simply comparing between the spending of different age groups of people contemporaneously. If we compare them longitudinally, like we do here, we can see that not only does spending not fall after retirement, it continues to go up, albeit a little slower than inflation.

And even if we refer to studies in the US which show that spending might fall a little over time in retirement, we see that it still goes up, perhaps even faster than inflation when we are in our 80s.

Annual Real Change in Retirement Spending from Blanchett (2013)

Why does spending go up in retirement? Simply out, because of healthcare. As we age, we spend a larger and larger amount on healthcare. Outpatient costs, deductibles, co-payments, and healthcare insurance premiums (see here and chart below). And with MediShield Life premiums going up on average 7% per year in the latest premium revision, we can expect that our Medisave will run out (see here), and we will need to pay for the premiums out of our own cash, which means out of the CPF LIFE monthly payouts.

Increases in household spending post-retirement as a percentage of total expenditure

In light of these future increases in spending, only the CPF LIFE Escalating Plan, which increases the payouts by 2% per year, will do. Both the Basic and the Standard Plans do not cater for future inflation. While the effects of inflation are small when we view them over a 10-year period, over the 25 to 30-year period of retirement, they will loom very, very large indeed.

As we will be living longer and spending more, especially on healthcare, in retirement, the best way to hedge against these risks is to pick the CPF LIFE Escalating Plan

Previously, when we look at the pure investment value or present value of the three CPF LIFE Plans, we concluded that the Basic Plan was the best value, from an investment perspective. But as any investor knows, creating a constant stream of income from a portfolio of investments is really hard, compared to just growing the value of the portfolio. And creating a rising stream of income is even harder! So while the Escalating Plan may not have the highest present value or investment value among the three CPF LIFE Plans, it is actually the hardest for an individual retiree, or even a professional fund manager to create. Hence, for this reason as well, we should choose the Escalating Plan, outsourcing the hardest investment challenge to the CPF Board which is the best placed to do so. And leaving the easier investment puzzles for our own investment portfolio!

What would we like to see in CPF LIFE in the future?

Gazing into our crystal ball again, seeing how we will be living longer in retirement, and spending more on healthcare, what should we expect from CPF LIFE to help with these trends? Here are a few thoughts on how CPF LIFE can be enhanced in the future to make it more relevant:

1. Doing away with the bequests

Technically, CPF LIFE is a single premium deferred guaranteed annuity, meaning that:

1. There is a single premium payable which is the Full Retirement Sum
2. You put aside the premium at age 55 before it starts at age 65 (deferred annuity)
3. If you should pass on earlier, there is a decreasing bequest paid, which is the same as guaranteeing the payout for a certain number of years (guaranteed)

But as we are living longer and longer, the guaranteed nature of the CPF LIFE annuity (or the bequest) becomes less and less relevant. The majority of us are going to outlive the annuity in the future. And as we discuss above, there are better and cheaper ways of using term insurance to create the bequest. Technically, term life insurance insures against living too short, while an annuity insures against living too long. Having both at the same time will insure us against both risks. So life insurance is still relevant even after retirement!

What will happen if we have the option of not having a bequest?

Our calculations show that getting rid of the bequest will increase the monthly payouts by 10% to 14% for the men, and 6% to 10% for the women, depending on the Plan (lower for the Standard Plan, higher for the Escalating Plan). While this seems little, these increases are for life, and life may stretch to 30 years! Doing away with the bequests also makes the Basic Plan redundant, as the only difference between it and the Standard Plan is the amount of the bequest.

2. Increasing the amount of payouts for deferring the start of CPF LIFE

CPF members currently have the option of delaying the start of their CPF LIFE payouts by up to 5 years. For every year deferred, the amount of the monthly payouts increases by 7% (so 14% for 2 years, 21% for 3 years and so on). This is actually quite miserly, which is why we recommended not deferring the start of the payouts (see here). In comparison, Social Security in the US rewards deferral of withdrawals by 8% a year! And given that the returns the CPF Board gets are backed by Special Singapore Government Securities which guarantees a higher-than-market rate of interest, it should not be difficult for the CPF Board to match the 8% or even more!

Doing so would definitely encourage more retirees to opt for the Escalating Plan to protect themselves against future inflation. The unattractiveness of the Escalating Plan at the moment is because it starts out paying some 20% less than the Standard Plan, and does not overtake it until some 13 years down the road. Delaying the payouts of the Escalating plan will shorten this “breakeven” point down to just 3 years or so, if the start of the payouts is delayed by 3 years. But increasing the reward for deferral from 7%, to 8% or 9% will nudge the Escalating Plan into a much more attractive choice.

3. Increasing the Full Retirement Sum

As unpopular as it is, the current rate of increase in the Full Retirement Sum of 3% per year needs to be increased. This is to maintain a minimum standard of life for our retirees. At the moment, the 3% increase every year barely compensates for longer lifespans (1% per year) and inflation (2% a year), meaning that the future standard of living for retirees living on CPF LIFE payouts has essentially been locked to the mid-2010s. But the world is moving on, Singapore is moving on, getting richer and richer. And it is only right that we bring our retirees along with us.

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