Adequate Savings for Retirement

Many people rely on their contributions to the Central Provident Fund to accumulate sufficient savings for their retirement. For a few years prior to 1985, the contribution to the fund was among the highest in the world. A total of 50 percent of the monthly earnings went into the fund. This was contributed equally by the employer and the employee.

Since then, the contribution has been reduced in three ways. The rate of contribution was reduced and is now at a combined total of 36 percent for younger workers. This rate is further reduced for older workers above 50 years. The maximum monthly earnings for which contribution was allowed had been reduced over the years.

The CPF member is allowed to use their savings to pay for the purchase of a property for their own occupation. Many workers used nearly all of their savings towards the purchase of a property.

They believed mistakenly, that property represents the best investment for the future. This turned out to be not the case for most people. They can realise the investment gain only by selling the property and at the right time, that is, when property prices are high. This is not a viable option for most people, as they need a place to live in.

The outcome is that many people do not have adequate cash savings to live on, when they retire from full time employment. Many people have to continue to work to an older age, even at a low pay, due to inadequate savings.

The interest rate paid on the savings in the ordinary account of the CPF had been pegged at 2.5 percent for many years. A higher interest rate of 4 percent is paid on the special account.

The interest rate of 2.5 percent is low, considered to what can be earned from other types of investments.

In the mid 1990s, the Central Provident Fund introduced a scheme to allow the CPF member take out their savings to invest in certain CPF-approved investments. This included unit trusts, insurance policies and government bonds. Several tens of billions of dollars were invested over the past years.

The return earned by the CPF members on the new investments had generally been unsatisfactory.

The CPF members were bewildered by the wide range of approved products. Many of them are complicated for the ordinary people. They have high charges for the fees paid to the intermediaries who market the products and to the financial institutions that designed and manage the products.

Many of these products allow the intermediaries and managers to boost their earnings. They do not give good value to the investors.

Prime Minister Lee Hsien Loong announced two years ago that the Central Provident Fund will introduce a “private pension plan” for its members to earn a better return on their savings. The aim was to reduce the cost of investing for the members. The challenge was not in the design of the scheme, but to educate people about their choices and to face the consequences of their decisions.

I understand that there were some problems in implementing this new scheme. Nothing much has been heard about it for the past two years. Perhaps, the private sector was not enthusiastic about a new scheme that can eat into their lucrative business.

Solution

I like this idea mooted by the Prime Minister. It is good for the CPF members. I wish to suggest the following approach to carry this idea forward.

1) Facility. The Central Provident Fund should set up a large, well diversified, low cost investment fund. The fund comprises the total savings of members who opt for this type of investment. It aims to earn a market rate of return, less expenses which is kept at less than half a percent a year. The total fund can be divided into several portions to be managed by several carefully selected fund managers.

2) Educate. The members who invest in this fund have to be educated about the principles of long term investments. They should not be concerned about the daily fluctuation in the value of their investments in the fund. It is the long term return, over a period of 30 or 40 years, that matter to them. Historical records have shown that the market return of equities and bonds over a long period of time, have been much higher than short term interest rate. It should be able to earn an average rate of return of more than 6 percent per annum.

3) Choice. The members can be given a choice on the proportion of their total savings to be invested in the investment fund. The remainder can be kept in the ordinary and special accounts to earn the current rates of interest. Those who are risk adverse can keep most or all of their savings to earn a guaranteed rate of interest. Those who are willing to take risk can channel their money into the investment fund to earn a higher rate of return.

I have suggested only one CPF-managed investment fund to be offered to members. The decision on how much to invest in this fund is already quite challenging for most ordinary people. There is no need to add to this complication by having to choose from many different funds with different features and options.

This approach has the benefit of simplicity, low expenses and choice for the member. It also allows the private sector to participate in managing the investments of the fund.

I suggest that the CPF member be allowed to make voluntary contributions, above the above contributions mandated by law. The voluntary contributions should be used only for retirement purpose, for example to buy a life annuity. The voluntary contribution can be given some tax relief, which may not be as generous as that now allowed for the compulsory contribution. This contribution can be invested in the CPF-managed investment fund.

It is useful to create an additional channel for voluntary, supplementary contributions to the Central Provident Fund, in addition to the options available for the better educated people to make their own separate arrangement through the private sector. This new channel gives a more focused approach to ensure adequate savings for retirement.

I hope that my suggestions can be a step forward in giving a better return to members on their savings in the Central Provident Fund and, more importantly, to help members to accumulate sufficient savings for their retirement needs.

Tan Kin Lian

The writer qualified as an actuary in 1975. He served as chief executive of NTUC Income for 30 years, prior to his retirement on 31 March 2007.