Life Hack #7: CPF (Part 1)

Writing about CPF has been on my to-do list for a long time, because I feel some people either don’t really understand CPF for what it’s worth, or (worst) – don’t consider as part of their money that they need to manage with a degree of diligence.

The latter thinking is (imo) a little dangerous, because 20% of your monthly salary (up to $6k) is deducted from your pay-slip, and essentially you bid that amount (capped at $1.2k) goodbye in a blink. It’s still your money nonetheless, albeit you can only use for specific use cases (but more on that in future post on Part 2).

The main reason why I’m holding back (I usually eat the frog) on writing about CPF is because there are quite a few parts to the system, and for you to appreciate the beauty of how it is designed for our benefit, we need to consider the mechanics (the foundations) of CPF which is the key focus of this post, and earmark the usage (the withdrawal) in part 2.

Disclaimer: This is going to be quite a lengthy post that requires your attention (or rather, only if you care).

“Compound interest is the 8th wonder of the world.” Albert Einstein

I’ll say it right at the start that I am a proponent of the CPF system (if you haven’t sense it already), and my post today is to convince you that instead of sleeping on it, recognize that there is a greater power (read: compound interest) acting on behalf for you, and in addition, you get tax savings as icing on the cake.

Well in case you are not a local resident or permanent resident, I cannot assume you know CPF and so, this is the official definition from CPF.

CPF is a social security system put together by the Singapore Government that enables its citizens and permanent residents to put aside money for retirement.

Wait for a second. Hold my cup before I go any further.

I know some critics will argue why we need the government to teach us about retirement and keep our money for our sake, but for the sake of the argument, let’s consider the utilitarian principle where the approach is enforced for the greater good.

To that end, not everyone has financial literacy to begin with, and may not consider saving up for retirement. If we fast forward the stimulation, the social burden of taking care of the aged society will (likely) in turn depend on the working class (and inadvertently leading to higher taxes paid by everyone else). It is not Armageddon by any stretch of the imagination and whilst I’m not an economist to comment further, I certainly think there is some truth behind prudence, and taking precautionary steps.

Enough of the lecture, and let’s get straight down to the numbers (I just love math). This is how CPF works.

Assuming you earn $6k a month. 20% of your salary will be deducted for CPF mandatory purposes. What is cool about CPF is that your employer will top up an additional 17% to support your retirement funds (no question asked).

In other words, while you contribute $1200 (20% of $6k) to CPF, your employer will top up another $1020 (17% of $6k) for you.

Basically you contribute $1200 to get $2220 worth of value.

The CPF consists of 3 different accounts – OA (ordinary account), SA (special account), and MA (medisave account).

So going back to the actual figures that will be added to these 3 accounts, the actual proportion will be 23% ($1380) into OA, 6% ($360) into SA, and 8% ($480) in MA.

If you sum up $1380 + $360 + 480, you get $2220.

Some people might get confused with the calculation so my advice is to apply the proportion percentage against the $6k to figure out how much money is added to each of your CPF accounts every month.

Now the beauty of CPF doesn’t just end with you getting more money for less.

Each account also grows at a different guaranteed* interest rate.

For example, OA grows at 2.5% annually, and both SA and MA grows at 4% annually. In addition, for your first $60k (combined across the 3 accounts), it grows with an additional 1% interest. To illustrate this example, say you have $20k in OA, and $40k in SA. The annual interest rate will be 3.5% on $20k in OA, and 5% on $40k in SA.

It’s a lot of numbers here but my point is your money grows at a better interest rate than what most banks can offer today, and you can’t go too wrong with using CPF as a baseline retirement fund (by being ‘forced’ to put aside money for your own good).

In case you are worried with not being about to see this pool of money, you can always assess that in your CPF account.

In my opinion, there is little to no risk in putting money in CPF as it is backed by the Singapore Government. I put a caveat on the word guaranteed because the interest rates may of course change (but that is highly subjected if there is a change in the ruling party with different opinion on the CPF system altogether).

It is also worth noting that there is a current 1M65 or 4M65 movement going on with a small group of CPF supporters which I recommend giving it a read. The TL;DR is that a common man can be a millionaire if you take advantage of the CPF system (of the compound interest) and do voluntary top-ups (and do absolutely nothing else).

Probably sounds too good to be true, but math don’t lie.

Which leads me to the next benefit of CPF that allows you to get some savings (rebates) off your personal taxes.

For SA, you get taxes rebate up to the first $7k of voluntary top-up. So assuming you fall under the income bracket that demands you to pay up to 15% of your taxable income, 15% of $7k ($1050) is what you saved (check out my previous post on taxes if you need a refresh).

And the pool of money grows bigger by the year at 4% (or 5% for the first combined $60k in CPF) annually.

Now I need you to follow me very closely on what I’m about to say – because this is where it gets me really excited about the full potential of CPF – the spillover effect.

There is a cap to SA (Full retirement sum (FRS): $188k), and MA (Basic Healthcare sum (BHS): $60k). Which means to say – you cannot add any more money into any of these two accounts when the cap has been fulfilled.

Let’s say you have $60k in the MA account in May – and you are about to receive the Jun CPF payouts.

Your MA account will receive no additional mandatory top-ups. Instead, the monthly 8% contribution ($480 allocated to MA) + the additional annual interest of $60k (4%) in MA gets spilled over to SA.

Now (roughly) on the 15/16th of every month, your CPF account will get updated with the mandatory contributions, and your statement would look like this:

OA ($1380 added), SA ($360 + 480 (MA) + $200 (MA interest – 4% annual interest of $60k)

The spillover effect is awesome because it expedites your rate to get to the SA cap which is $188k (take note that both FRS and BHS increases every year).

The holy grail is achieved when you hit the FRS and BHS cap for both your SA and MA account respectively.

This is when maximum spillover is activated, and all mandatory contributions (previously allocated to SA and MA) + interest for SA + MA gets spilled over to your OA (thus creating the supercharge effect).

That is essentially the key ingredient behind the 1M65 /or 4M65 where the supercharge effect combined with guaranteed compound interest will grow your retirement pod at an incredible speed when you let time to play itself out.

Now let’s recircle back to the voluntary top-ups.

Previously we talked about topping up your SA account. There is a cap to how much you can contribute. This is referred to the CPF annual limit of $37740 or deductible annual salary of $102000 – salary + bonuses combined).

If it confuses you, $37740 is basically 37% of $102000. In other words, your bonuses will also be subjected to CPF deductions up to $30k ($102k – $72k). Remember we said that mandatory CPF contributions will be capped at $6k monthly. If we multiply that by 12, you get $72k. So from a voluntary top up perspective, you only have another $30k that you can choose to top up ($102k – $72k).

What that also means is if you are a high flyer who earns $300k annually, you can only contribute up to $102k of your salary for CPF (too bad).

Voluntary top-ups can be performed in 3 ways – (1) top up to all three accounts, or (2) top up to SA only, or (3) top up to MA only.

For (1) and (3), they oblige by the annual CPF limit, but there is no limit to (2). In other words, you can voluntarily top up SA to the FRS cap tomorrow, and enjoy the compounded interest together with the spillover effect to OA (if only if you have the means to do so of course).

In the next post, we need to switch our attention to the usage of CPF in which we will discuss the retirement account (RA) and CPF Life (which sets guidance on when you can withdraw the sums in your CPF accounts).

To give you a glimpse of what is coming, RA is an account that will be created when you turn 55 of age, and is the combined account of OA + SA.

For now – enjoy the mechanics of CPF, and may the (compound) odds be ever in your favor.

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