Clearing the air on CPF Life: the best annuity in the market

JUST days ago, a healthcare professional from whom I sought treatment chided me for not “shielding” my Central Provident Fund (CPF) Special Account (SA) some years earlier. What a waste, he exclaimed.

I was aware of the practice of SA shielding, in which members invest their SA savings just prior to turning 55. This is the age when funds in the SA and Ordinary Account (OA) are channelled into the Retirement Account (RA).

There is a particular order to this transfer. The SA funds are taken first. If that’s insufficient to make up the required retirement sum for your age cohort, then the OA savings will also flow into the RA.

By temporarily investing SA savings, a member can maximise the interest rates under the CPF. Shortly after turning 55, once the OA savings are transferred into the RA, the “shielded” funds – maybe invested in a short Treasury bill that matured – can be transferred back into the SA.

Shielding is rational. The RA earns up to 6 per cent; the SA earns 4 per cent and the OA 2.5 per cent. The OA savings will begin to earn more interest after they flow into the RA, instead of just 2.5 per cent. And, you will still have your SA savings.

Plain inertia was why I didn’t act on it. But, one thing was clear when I turned 55. If I chose to withdraw my CPF savings, the amount in the higher-interest SA would be paid out first, despite a huge balance that may be sitting in the OA.

Retirement adequacy

Budget 2024 delivered several pieces of good news in support of retirement adequacy. These include higher CPF contribution rates for those between 55 and 65, as well as an annual bonus for “working seniors” depending on their monthly income. But, Finance Minister Lawrence Wong also announced steps to “rationalise” the CPF, which elicited an outcry.

From 2025, the SA is to be closed for those who turn 55; the balance will be transferred into the RA up to the Full Retirement Sum; and any balance of SA monies will be transferred to the OA.

To me, by far, the most significant retirement-related move in the Budget is the increase in the Enhanced Retirement Sum (ERS), which will enable members to receive more income from CPF Life, the CPF’s annuity scheme.

From 2025, the ERS – the maximum that can be put in the RA – will be raised to four times the Basic Retirement Sum (BRS). The new ERS will be S$426,000.

This is no small matter. With the higher ERS, a member can receive S$3,330 a month from age 65 for life. The current ERS of S$319,500 gives a monthly income of S$2,530. These numbers are based on the CPF Life’s Standard Plan; there are two other plans, Basic and Escalating.

I often urge friends who are pre-retirees to put as much as they can into CPF Life. I don’t believe there is an equivalent in the market. If there is, please feel free to e-mail me.

CPF Life is unique because it pays an income for life with no fees and no distribution costs. As for premiums, a retirement income insurance product in the market today will likely require a significantly higher premium for a comparable income – but mostly for a finite payout period of up to 20 years.

Of course, CPF Life is not designed to be your only income in retirement. Your desired income may be based on your lifestyle, expenses and last-drawn pay. Hopefully you have other assets to generate a passive income. But, CPF Life serves its purpose in providing a basic and assured income stream.

The outcry reflects a couple of things, in my mind. First is the distinct preference for a guaranteed savings option. The SA is pegged to the average yield of 10-year Singapore Government Securities (SGS), plus 1 per cent, with a floor set at 4 per cent.

Historically, for more than a decade, the 10-year SGS yield has been well below 3 per cent, even falling below 1 per cent at one point in mid-2020. Hence, members had very attractive risk-free savings in the SA. The 4 per cent interest rate also posed a high hurdle for investment funds.

Misunderstandings

Second, most people appear to misunderstand an annuity, which hedges longevity risk. Detractors of CPF Life compare the supposed rates of return to the OA and SA rates. They argue that the effective interest rate of CPF Life may be significantly less than 2.5 per cent, let alone 4 per cent, particularly if you don’t live long enough. One blog even posits that the worst age to die is 80.

Such calculations are based on a combination of the indicative monthly payout and bequest. The bequest is the sum that remains in CPF Life at time of death.

But, it’s important to understand how an annuity product differs from an interest-bearing account such as the SA. As CPF explains, CPF Life is a longevity insurance annuity scheme. “Its main feature is lifelong payouts and not the bequest amount that nominees can receive upon member’s demise.”

The level of income is based on an independent actuarial calculation. Five variables are taken into account: the RA savings used to join CPF Life; gender; age; CPF interest rates; and mortality rates. The payouts are not guaranteed, but are “designed to be stable”.

“Any adjustments to CPF Life payouts are expected to be small and gradual. CPF Life is a self-sustaining insurance scheme where payouts are matched to premiums. Guaranteeing a minimum payout would require higher premiums,” the CPF says in its website.

Like other insurance plans, CPF Life pools risks; your individual share of the risk pool isn’t transparent. By default, income distribution starts at 65. This can be delayed until 70, which would help to enhance the payout.

MoneyOwl chief executive Chuin Ting Weber says that the purpose and risks of annuities differ from those of interest accounts and accumulation investments. “In retirement, the objective is not to maximise a rate or an IRR (internal rate of return) based on when you might die. It is to get as reliable an income for as long as possible, with a focus on what is sufficient as a safe/base tier of income so you can have a dignified retirement. This base tier is provided by CPF Life.”

Christopher Tan of financial advisory firm Providend says that CPF Life might have a lower effective interest rate than the SA’s 4 per cent floor precisely because it is an annuity. “I buy an annuity because I’m afraid of living too long – not because I’m afraid of dying too soon. That’s why I’m willing to pay a premium for it. The cost of insurance to mitigate longevity risk is the interest gained on the annuity premium. It goes into the risk pool.

“Because of this cost, if I die younger, I would be worse off than if I die later because I received less payout. But, I can’t have my cake and eat it too,” he notes.

“I don’t think the effective interest rate should be the deciding factor on whether to put more or less into an annuity product. Instead of focusing on maximising returns, CPF Life should be seen as supporting members’ retirement through monthly lifelong payouts and to hedge against longevity risk.”

He adds: “As life expectancy increases with medical advancement, no one can accurately predict how long he or she will live. Those who live longer will receive more than their CPF Life premiums.”

Lorna Tan, DBS head of financial planning literacy, says there are two major benefits from the interest earned in the CPF Life. First, it is factored into the monthly payouts. Second, “the interest accumulated on our CPF Life premium, along with the premiums of other CPF Life members, ensures that we can continue receiving payouts no matter how long we live, even if our CPF Life premium balance is depleted”.

Might you live to a hundred? The number of centenarians here has more than doubled from 700 in 2010 to 1,500 in 2020. With CPF Life, you can hedge the risk of outliving your savings.