Using CPF LIFE as investment income

by Chris Kuan

Good question from a friend who asks what do I think of CPF LIFE as a person who has to use his wits to invest for his retirement income.

First my thoughts about what a retirement portfolio should have.

In my humble opinion, in a retirement investment portfolio, there needs to be a risk-free component to give one a semblance of peace of mind in case something goes horribly wrong investing for retirement income.

The closest risk-free asset is government bonds – there is nothing safer and if they are unsafe for some reason, other investments are even more so, including bank deposits. This is where CPF LIFE comes in– it is an investment in government bonds to provide risk-free or low-risk retirement income.

The annuity feature is critical in giving the benefit of a risk pool that raises payout and protects against longevity that investing by oneself is unable to achieve. Hence an annuity pay-out is always higher than the rate of return – roughly over 6% versus 4% in CPF LIFE. One may not like the annuity feature of losing out when dying earlier than expected, but it has a higher income stream and you do need to protect against a long life.

Therefore, contrary to my initial assessment, I now use CPF LIFE as my back-stop risk-free retirement income stream and plan on topping up my missus’ account when the time comes. I have also put her on a separate government bond annuity product. Of course, one may say this is a luxury that middle-income Singaporeans do not have.

On the contrary, the less money one has, the more those monies needs to be secured. All I am saying is that some part should be risk-free, how much to each his own. I understand the anger about withholding the Retirement Sum but even if you can withdraw every cent, the sensible thing to do is to put them into an annuity to secure your retirement income stream.

In most countries, holders of similar pension schemes (defined contribution pensions) are required to do this anyway. That increasing number of Singaporeans are out of work well before they can draw their CPF LIFE is more an issue of the lack of social protection. This can also be mitigated by savings and buying annuity products that start paying at say 60. Just my 2 cents…

The Retirement Sum scheme is not because there is no money left in CPF! It is mostly sensible, the only surprise the government made such a mess explaining it. Of course, the government can make the payouts more generous by improving the rate of return or be less conservative in the estimation of life expectancy but this is the People’s Action Party after all.

CPF LIFE is necessary to ensure that part of one’s retirement income is safe and has the protection of an annuity risk-pool to mitigate the financial risk of a long life. But how does it fit into a retirement investment portfolio?

As a retiree, the portfolio ought to be less risky than when one is still at work plainly because savings from salaries can cover investment losses. The asset allocation varies according to each preference, mine is a 40% equities 60% bonds which is flipping over the standard 60% equities 40% bond allocation mix run by most asset managers in the asset build-up phase. The drawdown phase, i.e. the retirement income phase, is more determined by bonds because a retirement income stream is a bond-like cashflow.

Presently I am slightly below benchmark on bonds and well below benchmark in equities (which means I am defensive). Bonds are generally safer than equities but within the 60% bond allocation, the sub-allocation between various categories of bonds matters a lot. A tilt towards government bonds and high-grade bonds makes the bond allocation less risky than one that is tilted towards lower-grade bonds and high yield bonds. This where CPF LIFE comes in. It is properly part of the bond allocation and makes the allocation less risky in aggregate.

Any allocation towards alternative asset classes like commodities and energy are small as these are the riskiest. I put them under the equities allocation although I tend to invest if at all in these asset classes via stocks and bonds issued by companies in these sectors. That leaves real estate – I considered REITs as an equity asset class but what about condos and houses? I do not regard one’s primary residence as part of the retirement portfolio even if there is a value that can be tapped.

To extract equity or monetize one’s primary residence should be a choice, not part of deliberate retirement planning as the Singapore government seems to want us to do so particularly with their HDB flats. Hence I do not buy into Mr. Tharman’s rhetoric that Singaporean’s retirement proposition is on par with our peers in Europe if we unlock the value of homes. That is a bad comparison in my view.

This article is first published on Chris Kuan’s Facebook page as two separate posts. (1) (2)