Set maximum sum for CPF members

By Chia Ngee Choon, Published The Straits Times, 20 Dec 2014

IT IS well known that while a provident fund system is fiscally sustainable, it does not address certain risks faced by members.

They face the risk of not having enough income to live independently with self-respect and dignity. They also face longevity risk, the risk of outliving their resources, and inflation risk as higher costs of living erode their fixed retirement income, if any. In Singapore, Central Provident Fund (CPF) members face these risks.

To raise retirement adequacy, in 1987, an innovative scheme - the Minimum Sum (MS) scheme - was introduced. The MS is the amount that must be set aside at age 55 to safeguard CPF members' retirement nest egg. The decreed sum has increased progressively to yield higher payouts. The amount that can be cashed out if one pledges property is now up to 50 per cent of the MS.

In 2009, CPF Life was introduced. This is a life annuity using the MS. As a payout for life, it addresses longevity risks. But inflation risk remains since the payouts are fixed, with no cost of living adjustment.

The two measures - the MS and CPF Life - help improve retirement adequacy and remove longevity risk. But they are not comprehensive enough.

After 27 years, it is time to fine-tune the Minimum Sum scheme. Manpower Minister Tan Chuan-Jin recently mooted the idea of having different Minimum Sums to cater to different needs.

I agree that the MS framework needs refining.

First, the framework is helpful in postponing lump sum cash withdrawals beyond age 55. It does not, however, address retirement adequacy adequately.

This is because half of CPF members are unable to meet the MS at age 55. There is a clear need to help a large segment of our population set aside more funds for retirement.

For those of working age, this can be done within the labour force by raising wages or via wage supplements such as Workfare.

For those already elderly who were unable to contribute to CPF during their productive years - such as the disabled, or women who stayed home to raise children - I would propose a basic pension for their old age, means-tested and preferably inflation-indexed.

Second, the structure of the MS scheme needs to be changed.

Right now, CPF Life annuity payouts depend on the cash component in the MS, and excludes the property pledge. Raising the cash component of the MS, while unpopular, will help make sure members have a higher payout in their old age.

Third, the CPF scheme can be tweaked to give more choices to members who want to set aside more for their retirement.

CPF members generally know that the decreed MS amount will yield payouts to cover "basic" needs. But "basic" can mean different things to different people.

Some retirees plan to live simply in retirement, while others aspire to affluent or luxurious lifestyles. That will affect their decision to either cash out more at age 55 or to save more. CPF Life is currently capped at MS and cannot be annuitised beyond the MS.

To meet the retirement aspirations of different members, a single cohort-specific decreed sum will not be optimum.

One solution is a tiered Minimum Sum. However, it will be administratively challenging to calibrate MS for different incomes or retirement needs and aspirations. The CPF Board would have to estimate the present value of future retirement consumption for different expenditure or income quintiles or different retirement needs/aspirations.

Having different MS levels for different groups may also not necessarily make people happy. This is especially for those on the margins - they may end up having to save more or less than they want.

A tiered system would mean mandating how much people ought to save. But one thing we know from behavioural economics is that people want to have control over their own monies.

A better alternative is to allow people to save more in their retirement account, up to a maximum sum. This is administratively easier. It does not require sorting members into defined categories, which is not easy to do. CPF members can exercise their option to save more if they so wish - up to the maximum sum.

This maximum sum can be set at 40 per cent higher than the Minimum Sum - 30 per cent to beat inflation and another 10 per cent for flexibility.

But all CPF members must still set aside savings to meet the MS for a basic retirement.

Those with more savings in their accounts can opt to set aside more to support a more comfortable retirement.

Why the need to cap the amount that can be set aside? This is necessary as the primary role of a national provident fund is to address the retirement needs of the majority.

Those with monies in excess of the maximum sum can make use of the private annuity market.

With tweaks to raise retirement savings at the bottom, provide a basic pension for the vulnerable, and let people put more aside up to a maximum sum, the CPF will be better able to provide for a variety of members' needs.

The writer is Associate Professor in Economics at the National University of Singapore and Co-Director of the Next Age Institute, Faculty of Arts and Social Sciences, NUS.