By Eric Tan
When the People’s Action Party inherited the Central Provident Fund system from the British, they did not change a basic flaw in the system, which was to allow members to withdraw all the funds when they reached the then retirement age of 55.
Later in the 1980s when they tried to move the withdrawal age to 60 in tandem with the retirement age, there was strong resistance from the ground, and there is reason to believe that this was a contributing factor to the loss of the second parliamentary seat to opposition in 1984.
The introduction of the minimum sum and special account structure seems to have been a step to address this issue – allowing a withdrawal of funds at age 55, while retaining the bulk of fund in the CPF system for later use. The government designed the minimum amount to increase over time such that when the baby boomers retire, it would balloon to a substantial amount.
Today, for more than 50 percent of CPF members who reached 55, almost all their funds in the ordinary account are transferred to the special account to meet the minimum sum requirement. And once again, we see the government oblivious to the public outcry arising from this move.
If CPF is “ideal”, then what gives?
The CPF as a retirement scheme has two problems. First, the withdrawal age of 55 is outdated as people live longer and need to work longer before they can withdraw their CPF. Furthermore, withdrawal at 55 is uncoordinated with the current retirement age of 62 today.
Second, the lump sum withdrawal is not in line with the principles of pension, which is an annuity. The CPF members should convert the lump sum into an annuity. It looks like the government understands all these concepts. They put in place the minimum sum and CPF Life annuity. Why then are they facing another confidence crisis?
For one, they did not effectively persuade people that these reforms are good for them. People felt they had been manipulated and had no choice in the matter. Ironically, in the age of the Internet it is difficult to dispel conspiracy theories.
For another, the CPF Life annuity, which is now compulsory for those who turn 65, is not attractive. For the full minimum sum of $155,000, the retiree receives an annuity of about S$1,200 every month for life. However, the people perceived that they have to be over 80 years old before they get back all their money. Most people do not believe they can live that long and they do not believe in the evidence reflected in the statistics. I am not an expert on annuity or actuarial science, but shouldn’t the public know the amount of profits the outsourced insurance company make from this scheme?
And finally, the most important reason of all: Most Singaporeans do not have sufficient funds in their CPF to retire. CPF is used to pay for housing, Medisave, Medishield insurance premiums and for paying parent’s medical expenses and children’s education. Furthermore, the government use CPF as a tool in recession to reduce wages. These measures depleted the peoples’ CPF. Why did the PAP government allow this to happen? Were they kicking the can down the road?
A pension scheme chasing rising costs?
In the 1990s, we witnessed a significant increase in prices for housing and medical expenses, and we cannot possibly delink the use of CPF for these expenses to the increase. Then as a member of the Workers’ Party, I felt that we must debate these issues in Parliament for public scrutiny.
On one occasion in the 1990s, I remember a Minister saying that we have progressed so well that clerks are now opting for class A hospital wards and soon there may not be a need for class C wards. In effect, people were depleting their Medisave accounts for first class medical treatments. For a while, the HDB stopped building two room flats under the illusion that we have prospered and hence have no demand for two room flats.
Unfortunately, it took another generation for the public to see the follies of these policies. From the 1990s to 2011, the people only voted in two opposition MPs, signaling to the PAP that all is well. It is only now that the people experienced the negative impact of these policies. Today, costly healthcare services, unaffordable HDB flats and the CPF system are hot button issues.
By not allowing the people to withdraw all their CPF when they reached 55 years old, it appears that the government has broken its promise, resulting in a loss of the people’s trust.
The PAP also has to contend with cultural factors. Pensions are generally a Western concept, whereas Asians expect their children to look after them. In the best case, we give our children a good education and happy childhood and hope that they will look after us. In the most cynical case, we promise them an inheritance to induce them to look after us when we are old. Pension schemes like the CPF can complement this system, but when they are far from sufficient to live on, you have a social time bomb.
CPF rate of returns
For a pension scheme to work, the government urgently needs to persuade the people of the need to convert their CPF into an annuity to be drawn down after they retire at 62. One way is to make the CPF Life annuity very compelling and offer better rate of returns for CPF funds.
In the past, CPF rate of returns have always been low but Singaporeans accepted them as we see it as supporting our nation building. In the early 1980s, Ong Teng Cheong had to defend the low 4% per annum CPF rate when rates offered by bank deposits were close to 10%. But there were no Hong Lim Park protests back then as people can see their lives improving, and they believed that the CPF funded state expenditure in roads, airports and other infrastructure. Ministers and top civil servants were not paid million-dollar salaries then.
Today, despite what the officials say, we have reason to believe that CPF is funding GIC and Temasek Holdings. Both sovereign wealth funds are run like private equity funds with multi-million dollar salaries and bonuses paid to the fund managers working for them. The public response is understandable: Why should they provide their hard-earned CPF funds for these people to earn high salaries? The government is in a quandary: The more they boast that these funds are doing very well, the more the people demand a share of it. They will demand more transparency and accountability for these funds.
Now comes the difficult question: How much risk should a pensioner take to get better returns?
CPF members have an option to invest part of their CPF balance in their ordinary account in CPF-approved equities and unit trusts. However, the success rate for these investments is low, as the average CPF member is not a well-informed investor. Also, in the case of unit trusts, the trust fund managers are not accountable to the individual CPF investor for poor performance. As a result, the take up rate for this option is low.
Proposed solutions and action plan
I foresee that the solution would be to restructure the CPF funds into a pension fund with fund managers who are accountable directly to the CPF members or the public. These fund managers would enjoy economies of scale to reduce their costs. The large fund size would give them the advantage to gain access to the best deals in equity funds.
The Ministry of Finance, through the CPF board, can set guidelines on the range of risk appetite for different categories of investors. For example, those who have amounts in excess of S$100,000 in their CPF can invest in equities, otherwise they should be restricted to investment-grade bond funds. These guidelines should be debated in Parliament. CPF can then offer various mutual funds, including those from GIC and Temasek Holdings, to accommodate the CPF investor risk profile.
But growing the pot is not enough. We also need to look at reducing its depletion. The government must restore the original pension objectives of the CPF by gradually reducing the amounts that people can use for housing and healthcare.
The financial impact of a housing loan on your CPF balances when you retire is punitive, as the total interest paid for a 25-year loan could be equal to or greater than the amount borrowed. For example if you borrow S$200,000 and repay it after 25 years, the total amount deducted from the CPF could be more than S$400,000. Reducing the amount that can be used for housing will have a negative impact on property prices, and this is something that the government has to manage separately.
The government must convince the people that deferring the CPF withdrawal and converting lump sums into annuities are good for them. They can do so by making annuities more attractive and improving returns.
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