Some Thoughts on the Closure of the CPF Special Account
There are decades when nothing happens; and there are weeks when decades happen.
– Vladimir Lenin
Just like Russian politics, after a decade where nothing significant changed in the CPF Retirement Sum and CPF LIFE framework, in February, a seismic shock invalidating many of our assumptions for retirement planning excited chatter in both the virtual, and real worlds. This is obviously in reference to the announcement in the Budget 2024 of the closure of the CPF Special Account. At the same time, the Enhanced Retirement Sum will go up, to allow CPF members to place more of their retirement monies into their Retirement Account, and thereafter into CPF LIFE.
Following on the heels of this announcement, the Government has clarified that this move is not about saving the Government from paying out the 4.08% interest the Special Account enjoys, nor is it about locking up our CPF funds. This is true, as the monies placed into the Retirement Account can still earn 4.08% interest. Also, since the excess funds in the Special Account will go into the Ordinary Account, which is withdrawable, nothing is locked up.
But what has really thrown a spanner into the retirement plans for some is really the fact that we can no longer earn the 4.08% interest in a Special Account where we can withdraw the funds at will. Funds in the Retirement Account earn the same amount of interest, but they can only go toward CPF LIFE. In short, we lose a risk-free high interest bearing account which can be our bond holdings for retirement planning. While we still can withdraw from the Ordinary Account, the interest paid is significantly lower at 2.5%.
Changes Ahead for the CPF Accounts!
A Recap of the New CPF Changes
Before we delve into the matter of the Special Account closure and how it affects our retirement plans, let’s take a quick look at the other changes coming into force. Firstly, how has the requirement for the Full Retirement Sum grown over time? We show this in the table below:
Full Retirement Sum for each Cohort of CPF members turning 55
| Year turning 55 | Full Retirement Sum (FRS) | Increase in FRS |
|---|---|---|
| 2017 | $166,000 | |
| 2018 | $171,000 | 3.01% |
| 2019 | $176,000 | 2.92% |
| 2020 | $181,000 | 2.84% |
| 2021 | $186,000 | 2.76% |
| 2022 | $192,000 | 3.23% |
| 2023 | $198,800 | 3.54% |
| 2024 | $205,800 | 3.52% |
| 2025 | $213,000 | 3.50% |
| 2026 | $220,400 | 3.47% |
| 2027 | $228,200 | 3.54% |
What’s interesting about this table is that there seems to be a dividing line at 2022. Before 2022, the FRS rose by about 3% each year. After 2022, it rises at a rate of 3.5%. According to the CPF Board, the FRS increases over time for three reasons:
- Increase in the cost of living, or inflation
- Increase in life expectancy
- Increase in the standard of living
Now, life expectancy in Singapore increases at a fairly constant rate of around than 2% a year (see here). If the FRS is to preserve the same standard of living over a longer period of time, that means that of the 3.5% increase we see yearly, 2% goes towards the longer lifespan, and 1.5% goes towards inflation. Given the events of the last couple of years, a long term projection of 1.5% for annual inflation does seem a little low. Which implies that the FRS runs a risk of falling behind the cost of living over time, to the detriment of the retiring CPF members! And this is so even as the FRS has already increased to after for higher expected inflation in the future, increasing from 3% a year to 3.5% a year!
What’s the solution for this? For one, it is better to take up the Escalating Plan under CPF LIFE. The payouts for this plan start lower than for the Standard Plan, but they increase by 2% every year. For those who have worked at the problem of making sure retirement payouts match a rising cost of living over time, it is fairly hard to withdraw more and more from our own investments over a long period of time. If CPF LIFE has a plan which does this for you automatically, then it is the plan to go for!
What About Healthcare Cost Inflation?
While the CPF LIFE Escalating Plan, coupled with the increases in the FRS may be fine to deal with day-to-day increases in the cost of living in retirement, it certainly won’t be enough to deal with healthcare cost inflation. For this, the Basic Healthcare Sum (BHS) needs to go up at an even higher rate than the FRS. This is in the table below:
Basic Healthcare Sum for CPF members Turning 65
| Year Turning 65 | Basic Healthcare Sum | Increase in BHS |
|---|---|---|
| 2017 | $52,000 | |
| 2018 | $54,500 | 4.38% |
| 2019 | $57,200 | 4.95% |
| 2020 | $60,000 | 4.90% |
| 2021 | $63,000 | 5.00% |
| 2022 | $66,000 | 4.76% |
| 2023 | $68,500 | 3.79% |
| 2024 | $71,500 | 4.38% |
Apart from the rather anomalous year in 2023, the BHS is rising at a rate faster than the FRS. And not a moment too soon, as MediShield Life premiums, look likely to go up and up!
Will this be enough? It’s hard to say, but more likely than not, it will have to go up at an even faster rate. So be prepared to top up the Medisave Account further in the years to come!
Some Implications of the Closure of the Special Account
Amidst the belly aching following the announcement of the impending closure of the Special Account after the age of 55, various comments have been made about how to manage without it. However, it is important to understand how important a pillar of our retirement funding will be taken away.
To start off with, the loss of the Special Account paying a risk-free and uncertainty-free interest rate of at least 4% a year is an important component of how much we can afford to withdraw from our savings in retirement. Many retirement planners know of, and use the 4% rule in their retirement planning. This rule-of-thumb says that we can start off a 30 year retirement horizon by spending 4% of our assets, and increasing this dollar amount by the rate of inflation every year. By sticking to this rule, we are very unlikely to run out of money in retirement.
However, most of the empirical underpinning for the 4% rule comes from the US, where both stock and bond returns have been higher in the past than now. More recent studies, (like those here) recommend something along the lines of a 3.25%-3.50% rule instead. In our local context (as discussed here), due to the higher volatility and lower level of stock returns, the same asset allocations recommended for retirement spending can probably only support a 2.0%-2.5% rule only. And this is only if we can have our Special Account paying a risk and uncertainty-free 4% interest rate annually!
In a nutshell, the level of a Safe Withdrawal Rate (SWR) like the 4% rule depends crucially on two factors:
- Volatility of the assets invested in
- Return of the assets invested in
So, basically, when returns fall (like going from 4% interest to 2.5% interest), we can only withdraw and spend less form our assets. If volatility goes up (like when we lose a risk-free Special Account and make up the 4% return using stocks, REIOTs and bonds), we also can withdraw and spend less.
We show here that a 4% rule for retirement spending (plus adjustments for inflation) can work in Singapore, if, and only if, we put everything into the CPF Special Account. If we no longer had access to our Special Account, and have to rely on the Ordinary Account for getting a risk and uncertainty-free rate of 2.5% instead, we are back to only being able to withdraw at a lower rate (plus inflation adjustments) only. This represents a significant fall in how much we can spend from our own assets (excluding CPF LIFE) in retirement!
Closure of the CPF Special Account which pays at least 4% risk and uncertainty-free, and putting the funds from it into the Ordinary Account paying 2.5% instead, represents a loss of 37.5% of our unrestricted spending power in retirement!
What can we do?
So, what can we do about this? There are several alternatives, none of which fully makes up for the loss of the Special Account:
- The Government/CPF’s suggestion to place more into CPF LIFE through the higher limits for the Enhanced Retirement Sum (ERS). While in theory, we should put as much as we can into an annuity like CPF LIFE for retirement, in practice nobody does so. Why? Simply because retirees have many more objectives in retirement than simply spending a fixed sum every month, such as leaving a bequest, or having an emergency fund (see here).
- Take more risks and invest in higher earning assets to replace the 4% return from the Special Account. However, this does not mean that retirement spending can actually go up. As discussed above, any shift into riskier assets with greater volatility means that the sustainable withdrawal rate has to come down. Even if the funds in the Ordinary Account can be invested in stocks and the like to earn 5% annually, the safe withdrawal rate will still be in the range of 2.5%-3.0%, due to the risks involved. Net, we are still looking at a 25%-37.5% fall in living standards in retirement!
One thing which is clear is that there will need to be greater thought put into how much of our retirement assets we allocate towards CPF LIFE, and how much we allocate to riskier assets. And that is the topic of our forthcoming post!
The Future of Our Retirement Has Become Murkier
