*For the past decade, the restriction on the withdrawal of CPF funds and its reliability as a retirement solution has remained a perennial concern among Singaporeans, particularly for the senior generation. In addition, the national pension system has often drawn flaks for its annual increment in the minimum retirement sum.*

*Regardless of the sentiment, the CPF will continue to be a hot button issue among Singaporeans. Similarly for me, it has remained at the forefront of the conversations that I have with my friends, especially when we have reached the ideal age range and of stable financial capabilities for BTO.*

*As 20% of our monthly salary is being stashed away in CPF, I feel that it is perhaps time to go back to the basics and understand this pension system better. For that reason, I would like to initiate a series of articles on CPF and to pen down my thoughts on how it can fit in as part of our retirement planning.*

## Additional 1% paid on the first $60,000 in combined CPF accounts

As part of the changes to CPF system in 2008, the first $60,000 in the combined CPF balances, with up to $20,000 from the Ordinary Account (OA), will earn an extra 1% interest.To illustrate this simply, I have come up with a few common scenarios to elucidate the conditions imposed on the balances across the 3 accounts in order to earn the additional interest.

**Scenario 1:**Even though the individual has a total of $65,000 of combined balance in his CPF accounts, only $45,000 of it is eligible to earn the additional 1% interest. This is because there is a cap of $20,000 balance contributed from the OA.

**Scenario 2:**The combined balance that will rake in the extra 1% interest is capped at the first $60,000 even though the CPF member has a total of $100,000 across all 3 accounts.

**Scenarios 3 & 4:**These two are extreme examples that serve to exemplify the working of the CPF interest rate system, chiefly for those who might have insufficient fund in their OA. Basically, you will be able to bag the extra 1% interest as long as you have $60,000 in the combined (or either) accounts of SA and MA.

In a nutshell, the table above outlines the basic idea of the interest rates across OA, SA and MA after taking into consideration the bonus interest earned.

To add on, CPF members aged 55 and above, will earn an additional 1% on the first $30,000 of their combined balance, on top of what is presented above.

## Where does the additional interest go to?

Initially, I had the misconception that the additional interest earned will be returned to the respective accounts. Naturally, it would be a logical deduction that one can make. But I was wrong.

Instead, the extra interest received will go into either the individual's SA (below age 55) or Retirement Account (RA) (age 55 and above).

Instead, the extra interest received will go into either the individual's SA (below age 55) or Retirement Account (RA) (age 55 and above).

## CPF Allocation Rates

With the current CPF allocation rate as tabled above, it is reasonable to extrapolate and assume that the OA will have the highest balance, followed by MA and then SA. At least, that is the trend that I have observed for my CPF accounts.

Hence, I reckon that most working adults under the age of 35, might find themselves in situations closely resembled that of Scenario 1 in which the amount of extra interest received is not maximised.

Hence, I reckon that most working adults under the age of 35, might find themselves in situations closely resembled that of Scenario 1 in which the amount of extra interest received is not maximised.

## Power of Compounding

For CPF members below the age of 55, the maximum amount of extra interest that he can earn each year is $600. It might not seem much with just an additional $50 per month. But when time is on our side, it might evolve into a formidable ally eventually.

Give me a minute, I'm good.

If I've got an hour, I'm great.

You give me six months, I'm unbeatable.

- Col. John 'Hannibal' Smith (The A-Team)

Suppose that we carry out a projection of the $600 additional interest yearly and lay out the following simple assumptions:

The accumulation of the extra interest alone would snowball to $26,587 over the span of 25 years. This would also bring us closer to meeting the Full Retirement Sum ("FRS") when it is time for us to enjoy the fruits of our labour.

As much as I am at variance with the illiquidity aspect of CPF funds, I have to acknowledge the power of compounding effect over time. In this case, it has accounted for 41.32% of the ending balance after 25 years.

Hence, I am convinced that we should optimise the additional interest, especially for working adults at the nascent stage of their careers and with time as their advantage.

- Timeline of 25 years to reach the CPF withdrawal age of 55
- Extra interest is credited to SA at the end of the year
- Balance in SA earns 4% interest (compounded annually) for the next 25 years

The accumulation of the extra interest alone would snowball to $26,587 over the span of 25 years. This would also bring us closer to meeting the Full Retirement Sum ("FRS") when it is time for us to enjoy the fruits of our labour.

As much as I am at variance with the illiquidity aspect of CPF funds, I have to acknowledge the power of compounding effect over time. In this case, it has accounted for 41.32% of the ending balance after 25 years.

Hence, I am convinced that we should optimise the additional interest, especially for working adults at the nascent stage of their careers and with time as their advantage.

## Ways to Optimise the Additional Interest

__1. Transferring from Ordinary Account to Special Account__**Given the CPF allocation rate as tabled above, it is highly likely that the OA balance will exceed the $20,000 cap after 2 to 3 years of working.**

Thereafter, the most straightforward way to optimise the additional interest is to carry out a transfer from OA to SA so as to circumvent the upper limit imposed on the OA balance. Furthermore, the transferred funds would earn a higher interest at 4% in SA, instead of 2.5% in OA.

Nevertheless, one should be cautioned on the irreversibility (one-way) of such process. The underlying concern stemmed from the comparatively versatile nature of the funds in OA than that in SA. For example, the OA balance can be utilised for the servicing of mortgage and as payment for tuition fee, but not with the funds in SA.

Thus, the tradeoff of shifting from OA to SA is unquestionably the confinement of choices that one may have with regard to the usage of OA funds.

__2. Make a Voluntary Cash Contribution__For those who have already come up with a game plan for the usage of OA balance, the next strategy on the playbook is to make a voluntary cash contribution to either SA or MA. This comes with the added benefit of income tax relief of up to $7,000 per year.

As always, there are 2 sides to a coin and the tradeoff is between the liquidity of cash and the locking up of retirement funds until the age of 55 (subjected to the fulfillment of FRS).

## Closing Thoughts

With the various restrictions imposed on the withdrawal of CPF funds, it is of little wonder that many have labelled the pension system as "money that you can see but cannot touch".

In spite of that, I feel that the combination of the compounding effect as well as the ample time available until retirement, would certainly arm young working adults or even students with the advantage of meeting the FRS early. Thus, it would probably make sense to optimise the additional interest and reach the $60,000 balance as early as possible.

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**Disclaimer:**Kindly note that this is not a sponsored post. The author is in no way affiliated with any of the parties mentioned and does not receive any form of remuneration for this post.**The Boy who Procrastinates**has compiled the information for his own reference, with the hope that it will benefit others as well.
## 4 comments

so the only way to max out the +1% extra on the first 60k.

ReplyDeletewill be scenario 3 & 4 to fully optimize the extra 4+1%. ?

any balance in the OA will mean, the extra IR is effective 2.5+1% only.

Hello Foolish Chameleon!

DeleteScenarios 2, 3 and 4 would have met the maximum combined balance of $60,000 that will earn the extra 1% interest. Scenarios 3 and 4 are just extreme examples to show that the combined balance can come from both/either SA or MA if there is insufficient fund in OA.

If we were to take Scenario 3 as an example, It is only the first $60,000 that will earn 5% interest while the remaining balance in SA (assuming there is) will earn 4% interest. Hence, the additional interest is $600 ($60,000 * (5-4)%)

Likewise for Scenario 2, one can also derive the additional interest to be $600 by taking the difference between the 2 sets of interest rate for the 3 accounts: 3.5%/5%/5% and 2.5%/4%/4%.

Therefore, the maximum amount of extra interest earned in Scenarios 2, 3 and 4 is the same and fixed at $600 per year.

Nice blog. Glad to be here. I like the quote in the beginning. Very true!!

ReplyDeleteHey MMF Solutions!

DeleteThanks to the great mind of the renowned theoretical physicist!