CPF: The ultimate trust fund for kids?

CPF: The ultimate trust fund for kids?

In the current low-yield environment, those in the know often highlight the Central Provident Fund's (CPF) wonderful, risk-free interest rate of 4 per cent a year. And they bemoan how they cannot put more in the scheme.

Yet, two little-known facts can make your eyes light up - especially if you have children.

The first is that Special Account (SA) monies in excess of the Full Retirement Sum (FRS) amount - currently at S$161,000 - continues accumulating in the SA and compounding all the way till a member is 55 years of age.

The second is that you can set up a CPF account for your child the moment he or she is born.

In fact, you can immediately contribute up to the FRS - S$161,000 - straight into his Special Account, under the retirement sum topping-up scheme.

Assuming the floor interest rate of the CPF SA stays at 4 per cent, your initial contributions can compound to some S$1.5 million over the next 55 years.

When he starts working, the interest gained from subsequent SA contributions will pale in comparison to the interest snowballing from the lump sum you have invested for him so early on in life.

Some may say, so what? He can't withdraw any part of the money till he's 55. And the withdrawal age might go up.

That's precisely the point. You wouldn't want your child to think there is a tidy sum of money waiting for him even before he starts working. He won't be incentivised to work.

By settling his FRS for him, you can ease his eventual worries about not being able to retire. He can pursue a career he enjoys, unfettered by monetary worries.

You might think S$1.5 million won't be much to live on in 50 years' time. But assuming inflation continues at its historical rate of 2 per cent, S$1.5 million 55 years from now is still worth half a million today.

That won't fund a luxurious retirement, but it's still more than enough for most people.

Moreover, your child will have made contributions of his own, assuming he even works at all.

Back-of-the-envelope calculations show that even if the child starts working at the monthly wage of S$5,000 25 years from now (the current average wage of S$3,000 adjusted for inflation), with a two-month bonus, he will have some S$1.8 million in the SA by age 55. This is assuming his wage does not change for the rest of his life.

Of course, such compounding only works because the CPF scheme pays a decent return at zero risk, and you have a runway of more than 50 years. Most people who start investing for retirement don't have the luxury of so much time.

If this low-yield environment persists, the government will eventually not be able to sustain paying out such a high rate on the SA.

For now, the SA's current guaranteed floor rates make it a decent place to park that extra inheritance or hongbao money. In inflationary times, if bond yields soar far higher, the SA rate rises too under current rules.

Meanwhile, if you don't want to lock up your child's money for so long, you can always top up using the Voluntary Contribution Scheme, which has a current cap of S$37,740 a year. Contributions will be split between the Ordinary, Special and Medisave accounts.

Ultimately, the CPF SA provides an interesting mechanism to set up a very-long-term trust fund for your children without incurring any administrative costs.

Even if you are in your teens or in your 20s or 30s, it is not too late to take advantage of the current snowballing feature of the SA.

It pays to have excess money left in the SA upon reaching 55. This is after the requisite FRS is moved out from it (and the Ordinary Account) to eventually fund the CPF Life annuity.

If you are in that situation of having excess monies, the SA morphs into a "bank account" of sorts. You can choose to leave your money in there to enjoy the current 4 per cent interest rate, or apply to withdraw money anytime. It will take 5-10 working days to get back whatever money you choose to withdraw.

You can even just withdraw the interest and live on that. And while you can't top up the SA after age 55, contributions will still trickle in if you continue to work.

It is not clear how many people have cottoned on to this very-long-term savings strategy for kids. CPF does not provide any such statistics. People also still have a healthy suspicion of whether they will even get their CPF money back at all.

There is also regulatory risk in the future, if the government decides that this savings tactic benefits only a small minority.

After all, couples with children already get many tax breaks. Allowing richer parents to transfer wealth across generations this way might be perceived as unfair. Limits might be set on how much interest one can enjoy.

But for now, if you ever wanted to make some really long-term planning for your children or teach them the power of compound interest, making CPF contributions for them isn't a bad idea at all.


This article was first published on Aug 18, 2016.
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