Mention CPF to any Singaporean and they will have some form of opinion towards it. Singaporeans (who are employed) automatically contribute 20% of their income to their CPF accounts. So, how does this impact our finances?
Naturally, if we were to deduct 20% of our salary, we should be worse off. But what if there was another way of looking at it?
Singapore’s home ownership rates have been hovering around 90% for the past 20+ years. This means that most Singaporeans would have to service at least one mortgage in their lifetime. CPF allows its members to use their CPF Ordinary Account (OA) to pay for the monthly installments for their home. Let’s take a look at how the CPF OA is funded.
The percentages in the table is based on your total income. Take a look at the column under Ordinary Account, with ages up to 50 years old. Do you see what I see? Roughly 20% of your wage is allocated to your OA, which can then be used to pay for your monthly installments. This is the same percentage as what you contribute to CPF! We can think of our CPF contributions as our mortgage payments.
But what about after 50 years old? The percentages drop quite a bit. We have to keep in mind two mitigating factors that come into play here.
1) You may have already paid off your home loan, or your outstanding balance on your home loan may not be very large. The mortgage term in Singapore is usually 20 to 30 years. If you bought a home at 30 years old and took a 20 year mortgage, it would have been paid up by the time you hit 50. A nice present for your 50th birthday. If you took the 30 year mortgage, the monthly installments should be lower, and 12-15% of your income should be able to support it. If that amount is not enough, you may have over-consumed on housing and could look into down-sizing. Of course, each individual’s situation varies and you have to consider your own present and future needs.
2) Your income will increase as you grow older. After being in the workforce for over 20 years, your income should have grown by a large amount.
Let’s assume John starts off at 25 with a monthly income of $1,000.
23% of $1,000 is $230.
Between 35-45, to keep his OA contribution constant, his income needs to be $230/0.21 = $1,095. That’s a 10% increase over 10 years, or 1% every year.
Between 45-50, his income needs to be $230/0.19 = $1,210. That’s also a 10% increase over 10 years, or 1% every year.
Between 50-55, his income needs to be $230/0.15 = $1,533. Here’s where it gets crazy. This is a 25% increase over 5 years, or 5% a year.
Between 55-60, his income needs to be $230/0.12 = $1,916. This is also 25% over 5 years, or 5% a year.
If we look at the overall growth of John’s income from 25 to 60, his income grows from $1,000 to $1,916 over the course of 35 years. Using the rule of 72, to (almost) double his income, John needs to get an average of a 2% increase per year, which is very doable.
All these being said, whether you should use cash or CPF to pay for your house is another issue altogether.
From my previous post, my simple model shows that the average person needs to save 33% of his income over his working life. So, what percentage of income is contributed to CPF?
For employees aged 55 and below, 37% of their income is contributed to CPF (20% by the employee and 17% by the employer). This is more than 33%. Coincidence?
Now, let’s look at the categories between 55-60 and 60-65 using the example of John again.
37% of his income is $370
Between 55-60, his income needs to be $370/0.26 = $1,423. This is a 42% increase over 30 years.
Between 60-65, his income needs to be $370/0.165 = $2,242. This is a (crazy) 58% increase over 5 years.
Let’s look at the overall growth again. John’s income needs to grow from $1,000 to $2,242 in 40 years. Using an investment calculator, this is equivalent to a 2% increase in income every year. Sound familiar?
Annual wage statistics show that the average wage increase has been more than 2% per year, so 2% is very achievable.
From my simple analysis, it seems like CPF does not impact our finances much. Maybe the psychological effect of seeing a deduction from your paycheck and/or having CPF locked up for a long period of time creates a bad impression. Looking at things from a different perspective would help us have a better understanding and make better decisions.