Why it makes financial sense to top-up your child's Child Development Account

Raising a child in Singapore is by no means cheap.

To support parents financially when it comes to raising their child, eligible Singapore Citizen children born on or after March 24, 2016 will receive an initial balance of $3,000 (CDA First Step) in their Child Development Account (CDA). You can open a Child Development Account (CDA) with one of the three local banks - POSB, OCBC, UOB.

The Child Development Account (CDA) works as a special account. A NETS card for the account will be issued to you (the parent), and this will allow you to pay via NETS/GIRO for educational and healthcare expenses at Approved Institutions (AI). You can find a list of these Approved Institutions here.

In addition to the initial CDA First Step of $3,000, the government also provides a dollar-for-dollar matching when parents top-up their Child's CDA, up to $3,000 for the 1st and 2nd child, $9,000 for the 3rd and 4th child and $15,000 for the 5th and subsequent child.

Do note that for Singapore Citizen children who are born between Aug 17, 2008 to March 23, 2016, the dollar-for-dollar matching from the government is higher by $3,000. That's because children born March 23, 2016 and earlier do not enjoy the initial $3,000 CDA First Step.

Table above is for children born between Aug 17, 2008 to March 23, 2016 only.

Receiving the dollar-for-dollar matching from the government is easy. Simply transfer or deposit funds to your Child's CDA, and the government will also do so. Funds can be transferred to your child's CDA till Dec 31 of the year your child turns 12.

YOU EARN INTEREST OF 2 PER CENT P.A. ON SAVINGS IN THE CDA 

One useful feature of the Child Development Account (CDA) is that savings in the account earn an interest rate of 2 per cent p.a.

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This includes the initial $3,000 that the government credits into the account when you first open it. If you leave the account untouched with its initial $3,000 balance, you will earn $60 in interest each year.

One common strategy that many parents adopt is to top-up the CDA whenever they need to pay for a CDA-approved expense.

For example, if their child is going for a checkup that cost $1,000 and there is insufficient balance in the account, they will top-up the CDA for $500, receive the additional dollar-for-dollar matching of $500, and use the CDA to pay for the expense.

But what if you don't need to use the funds immediately? Does it still make financial sense to top-up the account early?

The simple answer is: Yes.

DOLLAR-FOR-DOLLAR MATCHING MEANS YOUR EFFECTIVE INTEREST IS 4 PER CENT

Even in a scenario where you don't intend to use the funds in the CDA in the near future, you should still top up your child's CDA early as long as you can afford to.

By topping-up your child's CDA, you get the dollar-for-dollar matching from the government straight away. This allows you to earn interest based off the government's top-up.

For example, by topping-up $3,000, you will receive a total of $6,000 in the CDA. With $6,000 in the account, you will earn an interest of $120 a year (2 per cent of $6,000).

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However, your effective interest rate is actually 4 per cent, since the initial top-up that you made was only $3,000.

If there is already a sum that you intend to set aside for your child's education and healthcare expenses, you should top-up up your child's CDA as early as possible to take advantage of the fact that you can earn additional interest as a result of the government's top-up.

One of the reasons for not topping up the CDA early is opportunity cost. However, many parents incorrectly assume the opportunity cost of not keeping savings in the CDA to be 2 per cent.

In reality however, the opportunity cost of holding cash, as opposed to topping up your child's CDA, is 4 per cent - because of the dollar-for-dollar matching from the government.

So, if you want to earn the highest possible risk-free interest, topping up your child's CDA for child-related expenses that he/she will eventually incur is actually a savvy move.

Of course, if you barely have any savings today, emptying your bank account to top-up $9,000 (3rd and 4th child) to enjoy the dollar-for-dollar matching from the government may not be prudent if this causes you more stress because of tight cashflow problems.

WHAT HAPPENS TO UNUSED FUNDS AFTER THE AGE OF 12? 

If you are not able to use all the funds in your child's CDA by the time he/she turns 13, fret not. The remaining balance would automatically be transferred to their Post-Secondary Education Account (PSEA).

If funds in their PSEA isn't used by age 30, it will be transferred to their CPF OA which will allow them to use it for housing, education and investments.

This article was first published in Dollars and Sense.