This post might be a bit controversial but I think it has to be done for myself.
Whenever I met up with the team at CPF, they made a suggestion that I should see whether there are any products out there that are comparable to the CPF Life. And I often dismissed that outright because of how much of an edge CPF have.
They have the access to a much higher interest bonds, and thus their annuity product, the CPF Life can have a better return.
Now, when we spend down our wealth, the priorities are a little different, and thus it would be not right to look solely from the return perspective.
However, I realize that, as my post with some products such as the AXA Retire Happy, OCBC PremierLife Generation Plan, you cannot compare well without knowing the rough rate of return profile of the CPF Life.
So this post explores that.
I think these are my findings:
- I calculated the IRR for the total income payout and bequest if the assured passed away at different age
- I also calculated the IRR if its just total income payout
- If you estimate your life expectancy is short, then you should go for Basic Plan
- If you estimate your life expectancy is long, then you should go for Escalating Plan
- If your goal is to hedge longevity, then you should go for Escalating Plan
- If you love your next of kin and loved ones more than yourself, you should choose Basic Plan
- If you have no idea about the life expectancy, and would wish to maximize the return you get from this “investment product”, then you should choose the Basic Plan
- To “break even” on your CPF Life, you should strive to live till 75 to 77 year old
The Role of CPF Life in your Retirement Spending Strategy
A lot of people cannot understand the meta of managing money for retirement and often use the same mindset from managing their wealth accumulation, in retirement spending.
Thus, they look at rate of return and growing their net worth as the important aspects of retirement spending.
While rate of return and growing the net worth is important, the primarily purpose of retirement is ensuring that you have a consistent cash flow that can meet your spending needs, while not running out of money.
If I were to summarize, the complexity of retirement spending can be boiled down to:
- financial markets are volatile, causing your wealth to be volatile, and in turn causing your cash flow to be volatile
- we do not know for certain how long we need the money to last. You could have a short lifespan, and you should spend more, but if you have a long lifespan, you have to control your spending
- we do not know for certain the economic regime that we are facing in the future, whether inflation or deflation will take place, and in which sequence
- as we grow older, we wish to spend less of our time managing our money
- as we grow older, our cognitive abilities deteriorate, making active money management challenging
With this in mind, ensuring the majority of the people have a safe spending income floor that does not run out became a viable strategy for the government.
The main reasons are:
- most people tend to overestimate their abilities to manage #1 to #5 of the above
- it tries to provide a safe spending income floor to take care of citizen’s survival expenses
- by letting citizens see that how much spending income they will have in retirement is determined by their own actions, it preserve the meritocratic nature of the country
CPF Life, which is an annuity sought to address this.
The annuity have an added advantage of pooling the citizens together, so that those who passed away first subsidizes those who lived longer. We call this mortality credits.
The above shows a common retirement strategy of a safe spending income floor with spending down a 100% equity portfolio.
The CPF Life provides a baseline income to address the annual survival expenses.
This may not be enough for the citizen, and the additional income will come from the equity portfolio. The equity portfolio is readily interchangeable with insurance endowment, a unit trust portfolio, active individual stocks, or investment property.
The CPF Life annuity might not keep up with inflation so well, and thus having a equity portfolio that is higher in rate of return is necessary to ensure the purchasing power is preserved, and money lasts longer.
The issue with the equity portfolio is that it is very volatile. When the value is down, and you spend too much from the equity portfolio, you may end up depleting the portfolio so much that your portfolio does not last as long as it should. Thus, a sustainable spending strategy is required to ensure you spend wisely.
This is where having that CPF Life annuity income as a safe spending floor helps. As the CPF Life takes care of the essentials, the retiree can cut their discretionary spending, usually paid for by the equity portfolio more drastically, so as to preserve the value of the equity portfolio.
The CPF Life annuity thus acts as the bond, to reduce the overall volatility in the whole net worth. Researchers have shown evidence that it is beneficial to replace bonds with annuity, and that for the portfolio to ramp up to a higher equity allocation.
The 3 Different CPF Life Plans
With the national service explanation out of the way, let us talked about the 3 annuity plans available by CPF Life.
You can choose from the Standard Plan, Basic Plan and the Escalating Plan.
What differentiates them are:
- The amount of annual income payout
- The size of the bequest, or the sum of money left to the next generation
I tried to find a good image from CPF to illustrate this, but I couldn’t so I created something like this:
So the Standard plan has the larger payout annually, but the amount left to your next generation is the smallest. The basic pays out less annually, but it sought to leave the most when you passed away. The escalating plan sits somewhere in the middle. It pays out less than both basic and standard, but over time its pay out increases.
In terms of cash flow how do these 3 plans look?
In the above chart, we can see how these 3 plans compared in terms of cash flow.
At 55 years old, our money from CPF SA, and CPF OA are transferred to the CPF Retirement Account (RA) to satisfy the CPF Full Retirement Sum (FRS). If you have pledged your property, you would only need to transfer the Basic Retirement Sum (BRS). Of course, if you wish to increase the payout, you can contribute an additional sum equivalent to not more than the BRS, to do that as the Enhanced Retirement Sum (ERS).
You will get roughly a constant size payout. The basic plan will have a lower constant payout. The Escalating plan will start off with a lower payout, but increase over time.
If the assured passes away, based on what is nominated, the assured would leave her loved ones a bequest (not in this picture).
So how do we measure which one gives you the most return? From the picture it looks like the escalating plan!
In this article we try to look at the actual numbers, and see if I can help you see which plan fits your needs the most.
The $180,000 Simulation
The problem with doing this exercise is that, the income payout and bequest that you will eventually get depends on the prevailing interest rate of the bonds available to the government, and other factors.
This would mean that your FRS, BRS is different, the income payout yield is also different.
We work with what we have.
CPF have an intuitive calculator to help you estimate the potential payout you could get, and the corresponding bequest, under the three schemes. You can access the CPF Life Payout Estimator here.
So I use the calculator to simulate that if I am a 55 year old born in 1963. I just transferred the equivalent of $180,000 based on 2020 full retirement sum into my CPF RA.
At age 65 I will, start taking 3 different kind of income payout.
The above is the result.
In 10 years time, at age 65, I could enjoy the following payout. If you are a couple, and both met the FRS, then you can multiply that by 2.
The difference that you can spend between the Standard versus Basic is $120/mth more. The difference between Basic and Escalating is $170/mth more.
You can start thinking, in terms of your expenses, how big of a difference, $120, $170, $290/mth will make.
What are the monthly necessities that this additional cash flow can afford you.
I would contend that feels like an utility bill, or town council charges, or a combination of mobile phone bill + public transport + home broad band.
Overall Investment Returns Depends on When you Passed
The CPF Life payout estimator provides 2 set of income payout. This would depend on the interest projection of 3.75% and 4.25%. This is rather different from what the insurance companies used, which tends to be 3.25% and 4.75%.
This means we have more data points, but essentially, it should matter little if we compare standard vs basic vs escalating because the values should be changing in tandem.
We measure the rate of return by measuring the internal rate of return (IRR) of the 3 plans, over different tenures.
We take it that an assured could live to 70 years old. He would collect 5 years of payment + the bequest to his family. So we measure the “interest yield” on this stream of cash flow.
In the table above, the y-axis shows the age that the assured passes away. For each of basic, standard and escalating, we provided the corresponding IRR. The higher the IRR, the better this investment.
The IRR over time, resembles a smile. The IRR starts of high, than fall down, before rising up again.
At 65 years old, the IRR does not differ much among the three plans.
However, the IRR for Standard and Escalating dropped down from age 70 to 80, with 80 being the lowest.
For those with shorter life expectancy, the Basic plan provides the “best investment”.
In fact, the IRR for Basic plan is remarkably consistent. The highest was 4.5% and the lowest it dropped to was 3.92%.
However, if your life expectancy is long, the greatest IRR is that of the Escalating plan.
The problem is that we do not know our mortality that well, and I would think due to this reason folks might be inclined to choose the Basic plan because it is so balanced.
Choose Basic Plan to provide the most Absolute Total Value
We cannot just look at IRR because while it measures performance by taking out the absolute money value, we have to see how the absolute money value fare, since you are going to spend it, or your loved ones are going to spend it.
The table above shows the total income payout if the assured passed away at that age and the bequest paid out.
I one of my takeaway is that, by looking at the actual numbers of the “total value”, we seldom feel short changed.
If you do not get the payout income, and passes away, your nominated loved ones get it.
People are very afraid that they are short changed by the system.
I know for the fact that out of all the payout after someone passed away, the CPF bequest payout is the fastest (beside those joint account which I could withdraw)
If your longevity is hard to determine, CPF Basic looks the way to go because from 65 to 85 years old, the Basic plan gives the highest payout income + bequest.
However, if medical science have its way, then you would want to put your money in Escalating plan.
If the annuity is to hedge longevity risk, then the logical selection here is to choose the Escalating plan.
Choose Basic Plan if you Love your Loved Ones more than Yourself
I have also tabulate the amount of bequest that you would leave behind to your loved ones:
The aggregation of total payout + bequest shows that either you or the loved ones will get the money.
This table shows how much of your CPF you will leave for your loved ones. No prices for guessing which one wins out, but you got to wonder if it make sense to bequest so much since we cannot bring it to the grave.
To not feel short changed, you must try to live till 77 years old
In this table, we look at solely the payout you will get. The table shows the IRR if the assured passes away at different age, and the payout they had utilize.
If you cross over to 75 or 77 years old, you more or less “break even” with your CPF contribution.
The IRR will look very beautiful if you could live passed 85 years old.
In terms of actual payout, they increase over time.
I know this is not the usual way to look at the CPF Life. Or that is how they don’t wish you to look at it.
However, if I understand most people, they don’t want to feel short changed, so these numbers should allow you to make that assessment.
I think once I have this set of figures, it will be better to measure some of the retirement products against the CPF Life, over different duration.
The Basic plan’s payout look deceptively closed to that of the Standard plan, and it is why a lot of people would rather choose the Basic plan.
And since people underestimate their longevity, they would choose the Basic plan. However, our children might grow up in an environment that they could know their mortality or longevity, and in that case, they could possibly choose a plan that is different from us.
Do let me know if you have some interesting take away from reading this.
Here are My Topical Resources on:
- Building Your Wealth Foundation – You know this baseline, your long term wealth should be pretty well managed
- Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
- Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
- Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
- Free Stock Portfolio Tracking Google Sheets that many love
- Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free