When Should You Top Up Your CPF to Enhanced Retirement Sum (ERS)? The Financial Planning Considerations.

Topping up your CPF Special Account (SA) to Enhanced Retirement Sum (ERS) is optional.

No one is forcing you to do that.

The government is forcing you to have at least an amount equivalent to the Full Retirement Sum or Basic Retirement Sum so that you have enough passive income during your retirement years.

But I get this thinking that many are lost in the cross-currents of CPF strategy discussion that they failed to see the benefit that you enjoy from topping up to the ERS.

Topping up your CPF SA (before 55) or CPF RS (after 55) does not provide income tax relief.

But it does change the nature of your future passive income.

If Sally contributes more to her CPF above the full retirement sum of say $198,000 today, she is making a capital allocation decision that she prefers the income stream she gets from CPF LIFE over other kinds of income streams, and she does not need the money for other future life goals.

So why would we prefer the CPF LIFE annuity income stream over others?

Here are the strong points:

1. Hedges your longevity risks. You do not know how long you will live and want to ensure you always have that income.
2. A low-income volatility cash flow. The risk in retirement or decumulation is different from accumulation. Your risk is less about portfolio volatility than income volatility. You do not want one month you get $1000 a month, then next month you get $850 a month. CPF LIFE smoothens this out.
3. High income relative to the capital you allocate. Due to the people/risk pooling nature as an insurance product, there is mortality credits, which allows your payout to be high relative to the capital allocated. The starting rate is nearly 5-6% of the capital usually.
4. Getting #1 to #3 in one package. It is damn difficult to find something that can do the whole lot together. If you have a strategy that gives high income relative to capital, you run a risk of running out of money (failing #1), or the income being volatile (failing #2). If you have a strategy that can last long, most likely, you cannot satisfy #3.

That said there are considerations:

1. Generally, income is not inflation-adjusting.
2. Illiquid. If you make the decision, there is no recourse to turn back.

I would tell Sally, who is considering this that at some point, you have to shift your decision-making to focus not just on returns because the crucial criteria is not that but about fulfilling the needs of your life goals.

So here are some case study considerations.

Sally has a More Extensive Liquid Capital Relative to CPF Monies.

I refer to liquid capital as the part of your net wealth you can apply your capital allocation decision to fulfil your life goals. Usually, it does not include your residential property if that is where you wish to retire in.

If Sally has $4 million as liquid capital compared to $300,000 to $400,000 for her combined CPF OA and SA, there is a likelihood she belongs to the category where her income needs in retirement is relatively higher.

A good gauge might be her income needs are $4.4 million x 3% = $132,000 a year.

Now, regular readers would know that you can have people with that many assets but living on half that income needs currently, but let us go along with this.

If we break Sally’s income needs to three types, the inflexible essential expenses, inflexible basic expenses and flexible discretionary expenses, we can then think about where the income needs should come from when we consider our CPF LIFE Income or income from our investment portfolio.

The income needs are different based on the degree of volatility we can accept. There might be more considerations, and I am happy to go into them if you leave some comments.

Sally’s inflexible essential expenses might be pretty high and that may mean CPF LIFE is not enough.

Her considerations would centre upon whether to contribute or not contribute more to reach ERS.

In her case, she would probably have enough from her liquid capital to be flexible for the part of the spending she can be flexible. Not just that, she has enough capital to reallocate if there is a shift in her life and she needs to reallocate the capital accordingly.

But ensuring more of her income stream is more predictable may be more important and increasing her contribution to ERS makes sense.

Sally has less Liquid Capital Relative to CPF Monies.

Sally’s liquid capital might be constrained at the other end of the spectrum.

She might have $300,000 and that means she has to think whether $100,000 be used to top up to ERS or not to.

Given the size of her investment portfolio & cash, the income stream will likely be smaller than CPF LIFE Annuity Income.

The majority of her inflexible expenses may be better optimized to be fulfilled by CPF LIFE Annuity Income because of the three advantages I sell you before this.

But I tend to be cautious and advise Sally to consider not topping up so much if she has not thoroughly think through her future financial life, capital allocation decisions.

If you top up to CPF, it leaves less room for reallocation.

Conclusion

Whether to top up to enhanced retirement sum is not just about how lucrative are the returns. At some point, the risks that you should be concern about should shift.

Just like an accumulator are concern about portfolio volatility, capital impairment, a decumulator are more concern about portfolio longevity, income volatility and capital impairment.

The positive and negative features of CPF Annuity enters the forefront of your considerations.

You would realize to make good decision, you will need to know the nature of the desired retirement lifestyle so that you can plan your capital allocation decision.

A lot of people will say I keep being so granular about expenses, but in this very case, you can see what determines whether to top up or not top up to your CPF ERS center upon the clarity of your desired lifestyle.

If you have indecision over to top up or not top up, perhaps you do not have clarity over your lifestyle and how much it costs. And if you still don’t wish to do the work to reach clarity over your lifestyle, then continue to be confused and deliberate on the issue.

At Providend, we do open our clients to the idea of topping up to the Enhanced Retirement Sum. This is because since we know their financial situation, their lifestyle, what they want to achieve in the future, they tend to resemble the first Sally. It makes sense for them to allocate their resources to have a more stable income stream that hedges their longevity risks.

But there are also clients who end up having less resources or are still accumulating. We leave that decision later.

The advantage of CPF is that you can consider your decision later and then contribute more to CPF LIFE to enhanced the income stream. You have the flexibility to do that.

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