The Central Provident Fund (CPF) is the nationally-run, compulsory savings scheme for Singaporean citizens and permanent residents to which both employers and employees have to contribute a certain amount of the employee’s salary every month, subject to changes as the employee crosses various age bands.

The CPF is a laudable scheme aimed at achieving self-funded retirement adequacy. On 23 October 2017, the 2017 Melbourne Mercer Global Pension Index, which looked at 30 countries covering 60 per cent of the world’s population, ranked Singapore tops in Asia and seventh in the world for our pension system due to good scores for adequacy and sustainability.

In recent years, a national annuity scheme, the CPF Lifelong Income for the Elderly (or CPF LIFE), was set up to better address retirement adequacy objectives in light of longer life expectancies in a more affluent society. The CPF LIFE protects the member from longevity risks, providing an income stream for as long as he/she lives.

There are currently three plans for CPF LIFE, namely:

  • The Basic Plan: The member opts for a lower monthly payout for a higher bequest amount;
  • The Standard Plan: The member has higher payouts (essentially the normal or usual payouts) than the Basic plan but the bequest amount is minimal; and
  • The Escalating Plan (available from 1 Jan 2018): The member enjoys payouts which increases by 2% annually but starts from a payout amount that is 20% lower than that in the Standard plan.

The CPF LIFE Escalating Plan was one of two key recommendations put forward by the CPF Advisory Panel which was set up in 2014 after PM Lee Hsien Loong spoke about the need to relook the CPF scheme during the National Day Rally 2014. (The other recommendation was for the creation of a low-cost, passively-managed fund that can potentially accrue higher rates of return for CPF members.)

As reiterated a number of times by key members of the Advisory Panel, as well as the mainstream media and the Manpower Minister Lim Swee Say, the crux of the Escalating Plan is to safeguard the real value of the annuity payouts against the erosive effects of inflation on real purchasing power for those who are concerned with inflation. In layman’s terms, this means that the annuity payouts rise in tandem with Singapore’s cost of living – in essence, preserving the real purchasing power of one’s monies or savings with the passage of time.

Warding off the ill-effects of inflation

The following analysis will focus on retirement adequacy and inflation. Thus, any bequests will be disregarded as the bequest is only unlocked when the member passes on.

I take issue with the point that only those who are concerned with inflation ought to plump for the CPF LIFE Escalating Plan. In fact, everyone ought to be concerned with inflation and its insidious effect of making a dollar today worth less tomorrow in real terms.

On an equitable basis, and importantly, more than protecting the real value of savings of Singaporeans who know well enough to guard against inflation, the government and CPF need to protect the real value of the savings belonging to Singaporeans and PRs who are not as financially savvy and hence are unable to hedge against inflation which could ultimately diminish the real value of their life savings.

Inflation is indeed insidious – it mostly hidden in the background and manifests itself in small hikes in the prices of daily necessities. However, over a prolonged period of time, these seemingly small increases add up and are compounded to become sizeable adjustments to the cost of living. Inflation, while needed at healthy levels to keep the economy chugging along well, is a scourge that savers need to take precautions to ward off.

I remember reviewing my father’s insurance policies some time ago and I stumbled upon a life insurance policy which he bought when he was 30 years old or so (some 25 years ago). The policy insured him for SGD30,000 – a pittance when viewed through present-day lenses but a fortune (and a heavy but necessary burden) for him back then when he had only just started his career and made barely a thousand dollars a month. Yet, not three decades later, here I am, wondering why he made such a “short-sighted” decision to only insure himself for SGD30,000 which is really nothing much today if one suffers the misfortune of health hiccups.

But on deeper thought, SGD30,000 to him back then was probably “enough” in nominal terms then, given that it was probably 2-3 times his annual salary. However, inflation over the years has put paid to his perceived sufficiency with regards to his insured amount, making what seemed like a small fortune then – SGD30,000 – into an insignificant amount today.

Therefore, the CPF LIFE Escalating Plan which offers nominal payouts that increases by 2% annually is a good feature that should be automatically extended to all CPF annuity schemes and not only to those who know well enough to guard against inflation. After all, there are investment instruments in the market – a common one is TIPS, or Treasury Inflation-Protected Securities – that are inflation-indexed and effectively preserves the real value of one’s investment.

In short, everyone ought to be concerned with inflation eating into their purchasing power, not just those who are well-versed in finance or economics. Those who do not understand the insidious effects of inflation require even more care in ensuring that they are protected against inflation in the long run.

Comparison of CPF LIFE plans.

A simple model calculating the real values of the Standard ($1200 flat rate) and Escalating ($960 plus 2% increase annually) Plans for a person aged 65, using a discount rate of 2% and a 20% lower payout in the beginning for the Escalating Plan reveals that in real value terms, the breakeven point between the abovementioned two plans is reached at approximately 23 years later.

An inflation protection scheme should maximise the cumulative real value of cashflows. This means that for the first 23 years from the commencement of either plan at age 65, the Standard Plan actually does a better job of preserving the total real value of the annuity cashflows compared to the Escalating Plan. Only after age 88 is the Escalating Plan the preferred plan to preserve the total real value.

While this Escalating Plan is a step in the right direction in bringing into salience the need to consider inflationary pressures when planning for retirement many years down the road, this plan falls short upon closer scrutiny. If this new CPF Life Escalating Plan deducts the initial payouts and loads the deducted quantum across the time periods, and does not change the total nominal value of the payouts, then the real value is still diminished by inflation and does not achieve the stated objective of protecting against inflation.

Essentially, up to the breakeven point (when the CPF member is about 88 years old), what the Escalating Plan has done is to rearrange cashflows and compel the member to consume less in the near term and more in the longer-term. Only when the member lives beyond 88 years old does the Escalating Plan make sense.

To me, it feels more like delayed gratification rather than inflation protection!

Recommendations

  • Peg all plans to headline CPI: What the government ought to have done (and should quickly correct) is to peg CPF LIFE payouts from ALL plans to either the annual price increases or the long-term trend for inflation in Singapore (which is around 2% – the normal for developed countries with advanced economies). These inflation-indexed payouts will ensure that all Singaporeans who are on state-sanctioned annuity plans will at least preserve their purchasing power (somewhat) over the long run. This should also be done without accompanying reductions in the initial amount of payouts that is currently proposed.
  • Fix the annuity payout regardless of investment returns: Currently, the CPF LIFE annuity payouts are subject to no drastic changes to the projected investment returns. That means that payouts could potentially be adjusted downwards (or upwards) if investment returns are poor (better) than expected. This introduces an element of uncertainty to CPF members, the majority of whom have conservative risk appetites, and could derail the best-laid retirement plans. If payouts are increased, then the windfall is obviously not an issue; conversely, if payouts fall, the shortfall may not be easily made up for by ageing retirees with diminished earning power. Thus, if the member is willing to forego the upside, then his downside ought to be protected, ensuring greater certainty in retirement planning outcomes.

Bottomline

Inflation is an insidious enemy which nibbles away at the real value of our savings if these monies are not employed to productive ends and everyone – not just those who understands this concept of real versus nominal – needs to be safeguarded against the real value of their retirement savings being eroded by inflation and becoming insufficient for their golden years.

The government understands that inflation whittles away real monetary value which is why the payments for the Minimum Sum for the CPF LIFE annuities are increasing according to a ten-year schedule.

However, and weirdly enough, even as pay-ins rise, pay-outs remain stagnant. Only with the introduction of the Escalating Plan does there exist an option with rising payouts to combat inflation.

Even then, the Escalating Plan does not perform better than the Standard Plan if the member does not live pass 88 years. Up to this point, the Escalating Plan, which commenced with a 20% reduction to the initial payouts, has only served to rearrange cashflows and not protecting against inflation.