[ST Premium] How to use the CPF Ordinary Account for retirement

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ST Article "How to use the CPF Ordinary Account for retirement"

When it comes to retirement planning, many of us overlook the importance of our CPF Ordinary Account (OA) just because it earns 1.5 percentage points less than the 4 per cent reaped by our Special Account (SA).

Many people want to top up their SA to the prevailing maximum - this year's full retirement sum (FRS) of $186,000 - but fewer will choose to put more money back into their OA, such as by refunding their mortgage.

The MediSave account also earns 4 per cent interest but the funds are for healthcare-related use only. While the OA earns the least among the three accounts, it is actually the most versatile because it gives you more control on how you want to use the funds, especially after you hit 55.

A 2.5 per cent yield is not something to scoff at - half of those who use these funds to invest ended up worse off because their investments either made losses or couldn't beat the account's interest rate return.

The choice between OA and SA is even more stark at age 55 as some people use "shielding" as a tactic to retain more money in their SA.

What is shielding?

When a member hits 55, the prevailing FRS ($186,000) will be transferred from his SA to the Retirement Account for the CPF Life national annuity scheme.

If he does not have enough money in the SA, the balance to make up the $186,000 will be deducted from his OA.

What if a member has $250,000 in his SA? He can "shield" it by withdrawing $210,000 to invest in a fund before his 55th birthday, leaving only $40,000, the required minimum sum for SA.

So when he turns 55 this year, the CPF Board will transfer the remaining $40,000 from his SA and another $146,000 from his OA to make up the $186,000 retirement sum. After this happens, the CPF member can sell his investment and the shielded sum will go back to his SA.

Things to consider

While shielding allows you to keep more money in your SA, you should do your sums too.

You gain not 4 but only 1.5 per cent of the $146,000 that is shielded because the $146,000 that was taken out of the OA would earn 2.5 per cent too. So this extra interest is only $2,190 annually.

But shielding is not free and you have to factor in the investment charges, the risk of investment losses and the loss of 4 per cent interest on the amount that you took during the shielding period. Such costs will reduce your gain in the first year.

Even if you still think this is a worthwhile effort, you should know that after 55, whenever you transfer or withdraw money from CPF, the funds will be deducted from the SA first.

So even if the $210,000 earns $8,400 interest annually, any withdrawal that exceeds this interest will gradually reduce your principal sum in the SA.

More importantly, if you focus on the SA only, you will miss out on the main benefit that an OA can give you in old age - more cash any time you need it.

A lifetime of high interest

If you have withdrawn money from your OA for your housing loan, you can refund this sum plus interest and enjoy the 2.5 per cent interest rate.

If you have been contributing to CPF diligently, once you refund the full amount of the housing loan, you could have over $700,000 in your OA when you are in your early 50s.

Let's look at one such scenario for a member who has $700,000 in his OA, $250,000 in his SA and $63,000 in MediSave now. (Only standard interest rates are used here).

At his 55th birthday this year, $186,000 will be deducted from his SA, leaving him with $64,000. Despite this, he will still earn $17,500 interest from his OA, $2,560 from his SA and $2,520 from MediSave, giving him a total of $22,580.

If he shields his SA, he will have these balances and interest: OA $554,000 ($13,850 interest), SA $210,000 ($8,400) and MediSave $63,000 ($2,520), giving him a total of $24,770.

While shielding gives you $2,190 more initially, this is not sustainable, unless you don't withdraw any money from CPF for your own use, which is a ridiculous notion. So if your plan is to always spend the interest, over $20,000 a year, your balances in the SA will drop and cannot last beyond 10 to 15 years.

From then on, your options are left with either $700,000 or $554,000 in your OA (assuming MediSave balance and interest stay the same for this exercise).

If you have $700,000 in your OA, you can withdraw about $20,000 in interest annually for life without affecting your capital sum and about $16,000 for the lower sum. This means that if you do not shield your SA and instead choose to preserve your funds in the OA, you stand to gain in the long run, with more interest earned.

Of course, if you take the $700,000 to invest elsewhere, you may make more than the 2.5 per cent. But you could also be the other chap who won't make any gain, or worse, loses money - something retirees should not have to endure.

So, if you just want to enjoy life and not worry about the volatility of markets, you can look to the OA to fund part of your retirement needs by allowing you to draw out up to $20,000 in interest annually. Together with CPF Life, you can stand to get another $27,600 annually from 65, or up to $100,000 a year for couples who plan together.

The best part? This income - comprising only interest and CPF Life payout - is for a lifetime and does not include the principal sum in CPF or your other savings and investments.

So it makes sense to treat your OA as a risk-free cash reserve that earns over five times more than most fixed deposits now.