By Chris Kuan
Sparring partner and friend Cynical Investor wondered why the more you leave in CPF for your retirement, the less you get proportionately from CPF LIFE payouts from age 65. https://atans1.wordpress.com/2016/0…. Here is what CPF shows us
As seen, the FRS is double the BRS but the pay-out is less than double. The ERS is triple the BRS but the payout is less than triple the BRS payout. As a Facebook comment said “I asked the same question. No one knows the answer”. The answer is in the complicated way of allocating interests.
At age 55, the monies are all moved to Retirement Account earning an interest rate of 4%. The first $60,000 of your account earns an extra 1%. From this year onwards, there is another extra 1% on the first $30,000. The average interest rates earned on the sums over 10 years are as roughly follows
BRS 4.9%, FRS 4.5%, ERS 4.3%
Hence the bigger the sum the lower the interest rate earned. The determinant of CPF LIFE payout is the balance at age 65, not at 55. One may start with 2x or 3x BRS but the balance after 10 years is not 2x nor 3x respectively because of those extra 1% interest add-ons. In addition, at age 55, the government credits the Retirement Account with the LIFE Bonus, a flat sum which does not increase if one has more than the BRS. Hence CPF LIFE payouts do not rise proportionately. Why so?
The answer: like the tax-funded state pension and social entitlement systems of the West but to a much lesser extent, the government is using CPF to do a bit of redistribution, i.e. allocating more to the lower income from the higher income and to the old from the young.
The amount of interest CPF receives from the Government is roughly 4.1% (calculated from CPF’s Annual Report). Therefore, someone must lose out when those aged above 55 are earning 4.9% (BRS), 4.5% (FRS) or 4.3% (ERS) and furthermore those aged below 55 with combined balances below $60,000 are also earning aggregate interest rates higher than 4.1%.
This works because those who are below 55 earning lower returns are subsidizing those who are above 55 earning higher returns. Those who have higher combined balances, presumably richer are subsidizing those who have lower combined balances, presumably poorer with the former earning lower returns than the latter. Moreover, LIFE Bonus is paid out of the government budget expenditures which are funded by tax revenues. The high income pays higher taxes but receives the same or slightly lower LIFE Bonus.
The government is therefore taking from the richer and the younger and giving to the poorer and the older. That is like playing Robin Hood with our CPF monies and taxes just like the European welfare system, albeit just a tiny bit. But is it?
Redistribution should be based on income not CPF balances. A member with higher CPF balance is not necessarily richer than one with a lower balance because the former may prefer a less costly home and a safer retirement. The latter may max out his CPF to overreach for a bigger home or indulge in property investments. Think of it as a system that is primed for the public and private real estate market and therefore primed to generate financial reserves for the government who ironically is still rather tight-fisted in redistributing the returns from the reserves back to citizens.
Taken as a whole, CPF is not at all redistributive. It is highly regressive because CPF contribution caps deliver disproportionately higher investable income to the rich. In an era of escalating property prices and low wages, having higher investable income to plow into property and businesses means outsized returns earned compared with those who have to make do mostly with lower returns from CPF. Dividends from financial investments are also mostly untaxed so think of the outcome delivered by CPF as welfare for the rich.