What are the different returns that CPF SA can give us? Are there even different returns in the first place?

Let us explore these questions with a simple but tricky Multiple Choice Question (MCQ) on CPF SA:

Now let’s be good students, not jump to conclusions and use the process of elimination (“yes ‘cher I remember!”) to get the right answer.

Process of Elimination

We can safely eliminate option a) as 4.0% interest is the current rate for CPF SA. Fun fact - the government has extended the 4.0% floor rate for interest earned on all SA monies for another year until 31 December 2020.

So Option a) is eliminated. You need to go to CPF remedial classes if you actually think that Option a) is the answer.

Option b) is eliminated too, since the government offers an additional 1.0% interest on the first $60,000 of a CPF member’s combined balances (with up to $20,000 from the OA).

Option c) seems like another choice to be eliminated. After all, CPF members are entitled to an “Additional Extra Interest” (someone needs English classes) of the first $30,000 of combined balances from the month they turn 55 years old.

There is a priority on how the additional interest will be given though, as illustrated by CPF.

1st: Retirement Account (RA), including balances used to pay for the annuity premium under CPF LIFE

2nd: Ordinary Account (OA), up to $20,000

3rd: Special Account (SA)

4th: MediSave Account (MA)

Based on the current Basic Retirement Sum of $90,500, the CPF RA account will get the additional extra 1% interest instead. SA still earns only 4.0% interest for those above 55. RA is the one that can earn up to 6.0% returns.

Surprise surprise, Option c) should not be eliminated and is actually the right MCQ answer!

Spoiler alert! - The forgotten tax relief factor

So how is it possible that a person gets 22.4% return, or in fact, anything above 5.0% on your CPF SA?! The answer is simple, through tax relief!

The Retirement Sum Topping up Scheme (RSTU) allows CPF Members to reduce their taxable income by contributing up to $7,000 into their CPF SA, provided that they have not reached the current Full Retirement Sum (FRS) in their CPF SA. In the above example, the CPF Member tops up $7,000 at the age of 54, and manages to get a whopping 22.4% return on his CPF investment, pretty much risk free.

So 22.4% is a possible return. Option d) is eliminated as well.

Understanding how RSTU works for your age group and your income tax bracket

But hold on, most regular employees would have hit their FRS by the age of 54. Most people topping up their SA would most likely be in their mid-30s to mid-40s. What would their SA RSTU returns be?

Let us use a sensitivity table, considering tax bracket as well as age to CPF SA withdrawal age as the variables for the table.

Let's take a deeper look at the information provided in the table - if you are 54 years old (1 year before 55), and at the 15% tax bracket, your CPF SA CAGR is 22.4%. If you are 30 years old, and are at the 20% tax bracket, your CPF SA CAGR is only at 4.9%. What exactly is going on here?

The underlying concept is actually very intuitive. The older you are, the earlier you can realise the tax savings you have, the higher the CAGR of your top-up. Correspondingly, the younger you are, the later you can realise the tax savings you made, the lower the CAGR.

Implications and takeaways

So what is the implication of these figures? For younger working adults, it might be better to consider topping up their SRS accounts instead, earning equities returns for their monies locked up. Since the investment horizon is longer, it allows them to have greater certainty of achieving long term equity returns while not risk losing any tax savings caused by market volatility.

At a later stage of their career, it may be more prudent to top up their CPF SA  due to the lower risk involved.

Looking at the above sensitivity table, I question if it makes sense for high-earning 30-year-olds to top up their CPF SA through RSTU. Perhaps the greatest benefit of the scheme is the forced saving feature of CPF - if you cannot see it and do anything about it, you are forced to let it grow and compound at a more measured rate, if it stays at 4.0%.

With this advice in mind, consider your options carefully when you receive your bonus in the next month or so!