Thursday, 12 June 2014

No reason to doubt CPF's intentions

To understand the CPF, we must understand that its primary purpose is to help us meet our basic retirement needs
By Christopher Tan, Published The Business Times, 11 Jun 2014

I KNOW for a fact that many of us do not really understand our CPF (Central Provident Fund) well. To many, it is just one of the many ways our government "hoards" our assets. Over the past two weeks, online postings and discussions have brought this mistrust to a higher level.

To understand the CPF, we must understand that its primary purpose is to help us meet our basic retirement needs. It is on this premise that the scheme was built upon and it is from this perspective that we must look from. All other uses of CPF monies are meant to support this purpose. Therefore, rules are set such that if you use your CPF monies for housing, children's education, insurance, paying medical expenses and investments, they must either help you in your retirement or not affect your retirement.

An example would be if you use your Ordinary Account (OA) monies to fund your children's education at one of the local universities or polytechnics. One year after they leave the course, your children have the obligation to pay back the money plus interest not earned by their parents in their OA. Another example will be, if you want to top up say, your parents' CPF account using your own CPF monies, you can't do it unless you have met your own minimum sum as CPF is meant for your own retirement, not your kids' education, nor someone else's retirement.

In the same vein, if you sell your property that was funded by CPF for the purchase, you need to put back the amount you have used plus the accrued interest not earned (if you had kept it in the OA), back into your OA. It is not that you are paying interest for your own money, but rather, this is to be sure that your retirement money is there when you need it.

For this purpose, the CPF Board was started on July 1, 1955. Life was hard then and the government at that time feared that our forefathers might not have the knowledge and ability to save for their retirement. CPF became a form of forced savings for them. When Singapore was forced to leave Malaysia and became independent in 1965, we were struggling to survive and many needs arose. The government implemented schemes to meet those needs, such as Public Housing (1968), Medisave (1984), the Minimum Sum (1987), Medishield (1990), CPF Investment (1997) and CPF Life (2008), while keeping the primary purpose of the CPF in mind.

Minimum Sum Scheme (MSS, 1987)

Each year, at the end of the Chinese New Year season, my children always excitedly count how much money they have collected in their angpows (red packets) and plan for the things they want to buy. This is when my wife steps in, takes a portion of the money and "force saves" it on the children's behalf, in their bank accounts. The

children are left with some money to spend, usually on unnecessary things. Are they happy? Never. But we know that they will grow up seeing a pretty decent sum in their account, and knowing that their parents always have their welfare in mind.

The MSS works on this same principle. At age 55, before one can take all their CPF monies (and we have heard stories of how people use it up very quickly on unnecessary things), the CPF board will take a portion of it (known as the Minimum Sum or MS) and deposit it into their Retirement Account (RA). At age 62 (previous draw down age or DDA), the retirees get a monthly annuity till about age 82. However, with Singaporeans now living longer beyond 85 years old, the old MSS became dated. CPF Life was therefore launched to bridge this gap.

The objective of CPF Life is simple. To give a retiree a lifelong income stream till his death, the CPF Board made two changes to the old MSS:
- Take a portion of monies in the RA and pool it with other members to form an "insurance annuity" fund
- Extend the DDA to age 65.
As a result, based on the new MS of $155,000 in July 2014, a couple contributing this amount to their own RA will have about $2,400 per month till their demise. If they die early, the unused portion of their monies will be given back to their beneficiaries.

The hottest debate now

Allow me to share with you a parable. Two men, Peter and John, struck an agreement with each other. Peter will lend to John $100,000 on the understanding that John will pay Peter a guaranteed 4 per cent per annum with no risk of losing the capital. The deal was done and John took the $100,000 he borrowed from Peter and invested it.

At the end of the year, John made 7 per cent from his own investments and as agreed, paid Peter 4 per cent. Peter became angry with John and insisted that John pay him more, since he had made more with his money. Although this was not the original agreement, John was prepared to change the agreement, but told Peter that in the same way, if he loses money in his investments, in the future, Peter must be prepared to get lesser than 4 per cent or even suffer a capital loss. Peter was very angry. He scolded John for not being trustworthy as getting a guaranteed 4 per cent per annum with no capital loss was what they had agreed on.

By now, you will understand that I am referring to the interest rates we are getting from our CPF accounts. Our CPF is invested into special issues of Singapore Government Securities (SGS) - otherwise known as Singapore Government Bonds - as they are rated AAA and deemed very safe. These bonds are issued specifically to the Board to meet its interest and other obligations.

They do not have quoted market values and the Board cannot trade them in the market. The CPF Board currently guarantees that we will get a minimum return of 2.5 per cent per annum for the OA and 4 per cent per annum for the Special Account (SA), Medisave Account (MA) and RA. OA interest is lower because the OA is, in essence, no different from a special-purpose demand deposit - savings are withdrawable on demand primarily for housing.

By investing it in Special SGS, we are effectively lending our monies to the Singapore government for a guaranteed 2.5 per cent per annum to 4 per cent per annum with very low risk. If the monies are subsequently invested by our government and reaped higher returns, I do not think it is fair for us to demand a higher return for our CPF monies because we cannot ask for a higher return without taking on higher risk.

But what if one wants to take higher risk and get higher than CPF returns? There is the CPF Investment Scheme (CPFIS), which allows one to invest his CPF on his own. Why doesn't the CPF Board invest it on our behalf? Because the primary purpose of the CPF is to help us meet our basic retirement needs and therefore the investment objective should be one of capital preservation rather than growth.

Over the past two weeks, plenty of numbers and statistics have been brought up to discredit the CPF and its custodian. But let's not lose sight of its purpose. It is not that numbers are not important. They are, but they exist to serve a purpose, and must be discussed in that context. We can continue to debate on how the current CPF should be improved, but we should never cast doubts on its intentions.

The writer is the CEO of Providend Ltd, a fee-only independent financial advisory firm.

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