In my previous post, I wrote about how we distinguish between Financial Independence Funds and Retirement Funds. Although their purposes are not mutually exclusive, it’s the timeline of drawdowns that differentiates the two. Before age 65 – 70, we intend to rely on our Financial Independence Funds heavily to enjoy “financial freedom”. After age 65 – 70, we expect to rely more on our Retirement Funds to enjoy “retirement”. As such, the management of our Retirement Funds is something we do in the background now for future use.
Weekend trip to Penang
By the way, I went to Penang for the long weekend with my wife and enjoyed the great food, street art, sights and sounds etc. I decided to go with one of the most famous street art piece in Penang as the picture in this post just for me to remember how much fun we had!
Monthly CPF contributions
Anyway, back to how we manage our Retirement Funds. Every month that we are employed, our employers contribute 17% and we contribute 20% of our salary (both compulsory) to our Central Provident Fund (CPF). As an introduction, CPF is a comprehensive social security system that enables Singaporeans to set aside funds for retirement and addresses healthcare, home ownership, family protection and asset enhancement. The contributions are allocated across the Ordinary Account (for housing, insurance, investment and education), Special Account (for old age and investment in retirement-related financial products) and Medisave Account (for hospitalisation expenses and approved medical insurance) in the percentages of 23%, 6% and 8% respectively. These percentage allocations of the contributions change over time.
As you can see, the Ordinary Account (OA) and Special Account (SA) receives about 29% of our monthly salary and that is a significant amount. This means that our Retirement Funds grow consistently as long as we remain employed, which continues to be a working assumption for now. If unemployment ever happens to us, the duration will determine the extent of the impact to our Retirement Funds and we will continue to monitor this.
Drawdown of OA
We use some of our OA for our housing loan i.e. we pay the monthly mortgage amount in cash and OA. The percentage split changes once in a while depending on the asset allocation. Our target asset allocation for Retirement Funds is 20%. When the asset allocation starts to differ significantly from 20%, the main mechanism we use to bring it back to 20% is to increase or decrease the withdrawal from the OA for the housing loan. That being said, we only make the adjustment when the differential percentage is big and this does not happen often.
Cash top-up to SA
We contribute cash to our SA as a top-up and this qualifies for tax relief. There are many valid arguments for and against contributing cash to our SA. Increasing our Retirement Funds and decreasing our tax liability are the main benefits of making the cash top-up. Losing liquidity especially in bad economic conditions like now can be damaging since there is a higher risk of retrenchment and we might need the cash if it happens. As such, the way we do it is to make a monthly contribution of S$100 each to our SA at the end of each month of work.
This still increases our Retirement Funds (albeit at a slower pace) and the tax relief is applicable since we are only doing the cash top-up for every month of work. Most importantly, we don’t lose as much liquidity since the monthly contribution is small compared to our monthly salaries and it will stop if retrenchment is to happen. This is another mechanism we use to keep the asset allocation for Retirement Funds to 20% since we can increase or decrease the monthly cash contribution to our SA. However, this is usually our last resort since any changes to the cash top-ups to the SA is permanent and we try not to adjust the monthly cash contribution.
Transfer from OA to SA
Our target asset allocation for Retirement Funds is 20%. Once it starts to exceed 20% significantly, we transfer a certain amount of funds in our OA to SA to lock them in as Retirement Funds. The interest rate on the SA is higher than the OA, which means the effect of compounding on the SA is greater than the OA. However, we can’t access the SA for any other purpose and we only do the transfer when we can confirm that the excess OA can be locked in as Retirement Funds in the SA.
This transfer from our OA to SA is irreversible. It doesn’t change our asset allocation for Retirement Funds and is not one of the mechanisms we use to keep the asset allocation to 20%. It doesn’t happen often and the transfers are not big amounts given that we are still young and depend on our OA for the housing loan. However, I anticipate these transfers to increase in frequency and size as we get closer to age 65 – 70.