Seven pillars of a good retirement savings system

Seven pillars of a good retirement savings system

THERE is a famous American South saying that goes, "If it ain't broke, don't fix it". In the more enlightened North, branding gurus and academics would prescribe a rebranding exercise for ailing entities.

Let me explain why the Central Provident Fund (CPF) system ain't ailing nor broke (no pun intended), and why we should actually be celebrating the fact that some folks from the pioneer generation almost 60 years ago had the foresight and extraordinary prescience to come up with a mandatory, fully-funded, defined contribution social security savings system that is able to provide for our basic retirement expense needs with assurance.

Ain't broke...

A DEFINED contribution (DC) plan - like the CPF, the 401(k) programme in the United States and Australia's Superannuation scheme - is one in which the employee, along with the employer in many cases, make contributions to an employee's individual retirement account on a monthly and tax-advantaged basis.

In a defined benefit (DB) plan, the sponsor promises to provide the retiree with a pension income, which is usually a function of her salary, tenure of service and so on.

The CPF savings scheme, along with CPF Life, an annuity plan with a clear schedule of benefits, is almost a hybrid of the two plans. But that is where the similarities end.

In America, many DB plans are going broke or are grossly underfunded, which means they are making promises to future retirees that they cannot keep.

As a consequence, the trend around the world is for systems to move towards a CPF-like, hybrid DC/DB retirement savings system - that is, with fully-funded individual accounts that cumulate over one's working years, with some (but not a large) amount of investment and withdrawal flexibility, and that converts to a life annuity upon retirement.

The beauty of the CPF system is that it has been practising this for many years, with savings rates of up to 5 per cent per annum. There is also the recent CPF Life annuity scheme, both fully-guaranteed by the Government. There is an employer-matching and tax-advantaged supplementary retirement scheme to boot.

The CPF offers 3.5 per cent interest for the first $20,000 of Ordinary Account savings, and 2.5 per cent for sums above that in the OA. It gives 5 per cent on the first $40,000 of balances in the Special, Medisave and Retirement Accounts (SMRA) and 4 per cent for sums above that in the SMRA.

What's significant is that these are guaranteed rates devoid of risk. This is in effect the Government's "borrowing rate" from CPF's members.

One may rightly ask why any sound government would borrow at 4 to 5 per cent when it could go to the public debt markets and borrow at around 2.9 per cent over 30 years.

In effect, the Government is providing a healthy "subsidy" on our Retirement Accounts. Hence, the call to increase the riskless savings rate any further is not prudent.

One common criticism of the CPF is that the Government stands to enjoy higher returns from the CPF monies, which are pooled and handed over to investment agency GIC to be invested.

GIC returns are sometimes higher than what CPF pays.

But we have to realise that it is preferable that a retirement system is not subject to the kind of risk borne by the GIC. The Government, on the other hand, guarantees the CPF savings rates, irrespective of market cycles or global financial crises.

What the Government does with the money it raises by issuing Special Singapore Government Securities is part of its business of running government, as long as it is managing its assets and liabilities prudently. To subject CPF members' savings, which is less than the Minimum Sum, to the (risky) returns of the GIC may not be prudent.

Neither is the call to increase the risk-taking appetite on our CPF savings - at least for savings not in excess of the Minimum Sum, as the volatile recent stock market experience, circa 2008- 2009, informs us.

Lastly, simple financial mathematics tell us that at our current expected mortality and discount rates, the estimated $1,200 payout for CPF Life from the cumulated Minimum Sum of $155,000 is an extremely reasonable payout.

Whether this $1,200 is enough for now, or more importantly in our twilight years where the threat of rising prices is real, is another matter.

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