As Singaporeans, we are required to save for our retirement by making contributions to our CPF account. Being considered as one of the best retirement schemes in the World, the CPF Ordinary Account gives us a guaranteed, risk-free return of 2.5% that is compounded every year. Unless you are a seasoned investor, for most of us, a 2.5% return each year is considered quite a sweet deal.
However, for the majority of Singaporeans, the funds are commonly used for the purchase of our home. Are you aware of the consequences of doing so and how it might affect you in the long run?
In this article, we explore the common mistakes that most property owners are unknowingly making that is eating away their hard-earned savings.
How Our CPF Ordinary Account Could Have Grown Over The Years?
The table below shows just how much savings we can expect to have for our retirement in our CPF Ordinary Account. To keep things simple, the following assumptions are made.
- Fixed monthly salary of $4,000 per month (no increment nor reduction)
- We will use $4,000 per month as it's the current median income of Singaporeans
- Started working and making CPF Contributions at 25 Years Old
- Worked for 40 years and retire at 65 years old
- Additional bonus interest not taken into consideration
- Additional 1% on the first $60,000 of combined balances & another additional 1% on the first $30,000 of combined balances when we are above 55 years old (up to $20,000 from OA) not inclusive.
Retiring at 65 years old, we should have:
- Contributed a total of $341,040 to our Ordinary Account
- Earned a total interest of $309,927 on our Ordinary Account based on the interest rate of 2.5% per annum
- CPF Ordinary Account Balance of $650,967
Just by leaving our funds untouched in our CPF Ordinary Account, our funds would have almost doubled and we would have accumulated more than $650,967 for our retirement.
However, Most Often Than Not, Reality Proves To Be Otherwise.
Let's take a look at John and Mary...
John and Mary are both 30 years old and have just gotten their BTO flat from the Housing & Development Board. They have chosen a BTO flat at a non-matured estate which will cost them $300,000 before grants. Both of them are drawing a fixed monthly salary of $4,000 each. In this case, they are eligible for the CPF Special Housing Grant of $10,000 since the combined household income is less than $8,001. The CPF Special Housing Grant will be credited directly to both their CPF Accounts - $5,000 to John, and $5,000 to Mary before it is being deducted from the property price.
Having started working at 25 years old, both of them have accumulated a total of $144,567 in their CPF Ordinary Account.
Since they are taking on an HDB Loan, both of their CPF Ordinary Account will be wiped out before the loan is disbursed so as to reduce the mortgage loan amount.
(As of 28 August 2018, flat buyers now have the option to leave up to $20,000 in the CPF Ordinary Account when taking an HDB Loan. Do note that the maximum amount that can be retained is still $20,000 each for both parties and not $40,000 in one particular account)
Mortgage Amount = Flat Price - CPF Special Housing Grant - CPF OA Balance
= $300,000 - $10,000 - $144,567
Like most of us, John and Mary are looking to pay off their mortgage using just their CPF without having to touch on their cash at all in the shortest period of time so that they wouldn't be paying extra interest on the loan amount. They decided to go for an 8 years loan tenure since the monthly mortgage is at $1,680, the closest to their combined monthly CPF Ordinary Account contribution.
By taking an HDB Loan of $145,433, John and Mary would have paid a total interest of $15,803 over 8 years. While most property owners will assume that their breakeven price will be at $300,000 (purchased price) + $15,803 (interest paid), apart from the 2.6% interest rate on the HDB Loan, there is also an additional 2.5% that is compounded annually even after the property has been fully paid.
When You Use Your CPF Funds, You Are Required To Grow The Funds By 2.5% Each Year
As seen on the CPF website above, John and Mary will have to refund the principal CPF amount they have used for the HDB flat, as well as the accrued interest which they would have earned if the funds had not been withdrawn from their CPF account. Instead of the CPF Board guaranteeing a 2.5% return each year, the responsibility has now shifted to John and Mary to grow the funds that were used in their property.
As the Special Housing Grant of $10,000 was credited into their account before it was offset from the purchased price of the property, It generates accrued interest as well. As such, the accrued interest of 2.5% is compounded annually based on $144,567 + $10,000, as well as the amount that had been used to service their monthly mortgage each year.
Over a period of 8 years, John and Mary would have accumulated a total of $52,992 in accrued interest. Not taking the renovation cost into consideration, John and Mary would have to sell off their property at $368,767 in order to break even, without having any cash proceeds yet.
No More Outstanding Loan? Accrued Interest Is Compounding On An Even Bigger Figure Than Before
Even after having fully paid off the mortgage loan, the CPF Accrued Interest is still continuously being compounded at 2.5% each year as the funds are still "withdrawn" from the CPF Ordinary Account. In case you missed it, the 2.5% is not just compounded on the funds you have used, it is also being compounded on the interest that you could have earned.
With most of our CPF funds being locked in our HDB flat, many Singaporeans will choose to downsize to a smaller apartment so as to generate their retirement funds. If John and Mary were to hold on to their property until their retirement and then downsize it to cash out on their retirement, they will have to sell it off at $718,285. It is also important to note that the property will only have a remaining lease of 64 years. The property will be much less attractive to potential buyers as restrictions will start to kick in when the property reaches the 40 years mark. Buyers will also be worried about having problems to sell it off in the future as seen in the News Article below.
In the case of John and Mary, after staying at their home for the past 15 years, they eventually sold it off at $500,000.
Selling Price: $500,000
Outstanding Loan: $0
CPF Used: $315,775
Accrued Interest: $122,574
Cash Proceeds = Selling Price - Outstanding Loan - CPF Used - Accrued Interest = $61,651
Combined CPF Balance = CPF Used + Accrued Interest + Current CPF Balance = $629,695
With the proceeds from the sale of their HDB flat, John and Mary decided to purchase a 10 years old 5-Room HDB flat on the resale market at $550,000and fully pay it off using their CPF funds. The cash proceeds of $61,651 received were then used on the renovation of their new home.
What Happens When John and Mary Turn 65 Years Old And Decided To Downsize And Cash Out On Their Retirement? What Would Be Their Breakeven Price?
By fully paying off their 5-Room HDB flat with the $550,000 from their CPF Account, the Accrued Interest is now being compounded at 2.5% on the base amount of $550,000. After 20 years, John and Mary would have accumulated $351,239 in Accrued Interest and would have to sell off the 5-Room HDB flat with 70 years remaining on its lease at $901,239 in order to break-even.
Is it really possible to sell off a 30 years old HDB flat above $901,239? When BTO flats with brand new 99-year leases will be going at much lower prices since the mission of the Housing and Development Board is to provide affordable homes?
What If Your Breakeven Price Is Much Higher Than The Market Value?
What if they are not able to sell it off at $901,239? What if the market value of the property is at $700,000 instead of $901,239? Apart from the fact that there will not be any cash proceeds since it's a negative sale, John and Mary will technically be losing $201,239 of their own funds. If they had instead chosen to leave the funds in their CPF account without doing anything at all, this $901,239 would have been guaranteed. Now, to be clear, the CPF Accrued Interest is refunded back into your own CPF Account and is still your money. However, should the market value of your property not appreciate to your required break-even price, you are basically losing your very own retirement funds.
Basically, John and Mary are losing:
- The opportunity cost of $351,239
- Had the funds been left in their CPF account, they would have been guaranteed this amount
- The accrued interest of $150,000 that has to be refunded into their CPF account
- After deducting the principal used ($550,000) they will only be able to return $150,000 out of $351,239 in accrued interest.
- The $201,239 that they weren't able to cover
- Assuming that they were fortunate enough for CPF to waive off the $201,239 instead of topping it up with cash. If the waiver is not approved, they will need to fork an additional $201,239 cash from their savings to refund into your CPF account. Do note that the appeal is on a case-by-case basis and is subjected to approval.
Our Ancestors May Have Seen Their Property Value Appreciate From $30,000 to $300,000. But Is That Still Possible Today?
While many will argue that the HDB flats our parents or grandparents purchased cost only $30,000 in the past and can be sold at $300,000 today, our minister, Mr Khaw Boon Wan perfectly illustrates why our current generation will not get to enjoy these huge increase.
He said: "That's why you heard of, say your grandparents buying a flat, maybe in Woodlands for S$30,000, S$35,000, (that's) very cheap right? But right now, they can sell for at least S$250,000."
However, the current generation of Singaporeans would not be able to enjoy such a "huge increase" as economic growth rates are now trending between 2 and 3 percent, said Mr. Khaw, a Sembawang GRC MP and grassroots adviser.
"That is the critical difference between (your parents' and grandparents' generation) of living, growing up in a third world, transforming to the first world, and yours, born into already a first world, almost first world economy," he added.
Don't Stop Using Your CPF To Pay For Your Property. Learn How To Use It Correctly So That You Can Make The Best Of The System.
Of course, there is nothing wrong with paying for your property using your CPF funds. If so, the government would have implemented policies to restrict us from doing that. In fact, if we were not allowed to purchase our home using our CPF funds, many Singaporeans would not be able to afford it and be forced to live on the streets. The key is to understanding and using our funds correctly so that we can make the best out of this system.
To summarize, here are the 3 common mistakes most property owners are making that is eating away their hard-earned savings.
- Putting their funds in a property that is not appreciating by at least 2.5% each year
- Holding on to their property for far too long
- Not knowing the RIGHT way to utilize their CPF and make their funds work for them
Think about it, you have already made the sacrifice of taking a portion of your salary and contributing it to your CPF account each month. The reward for that is supposedly the 2.5% interest that you should have earned. It makes sense to ensure that you are not at risk of losing your funds, doesn't it?
Your Property Is Much More Than Just A Home.
Your property is not just a roof over your head. It is also:
- A Savings Account
- As we pay for our monthly mortgage, we are actually saving to our "property account".
- An Investment Vehicle
- Properties are an investment as they generally appreciate and grows in value over time.
- A Retirement Fund
- Majority of Singaporeans depend on our CPF funds for retirement, with 70% to 90% of it being LOCKED in our property.
As such, it is essential that we take a look at our property portfolio to ensure that the value of our property is growing faster than the accumulation of our accrued interest. If accrued interest has already started to accumulate much faster than the rate of appreciation, then the least you can do would be to cut your losses and put your funds in an appreciating asset so as to protect your family's future.
Of course, if you have already secured your retirement funds and are absolutely certain that you will never ever sell off your HDB flat, then you wouldn't have to worry about refunding the accrued interest back into your CPF account. However, in this case, it would be as good as forfeiting the guaranteed 2.5% that you should have earned over the decades. To put it simply, you would be effectively turning your asset into a liability since it cannot be liquidated.
Now, just to be clear, simply upgrading to a Private Condominium is not the answer to these issues. Upgrading to a Private Condominium should not be the endgame. You need to have a plan for your entire property journey.
For example, apart from understanding the property market and identifying the right properties, planning your finances for unforeseen circumstances, knowing how to channel your funds into your property, and having a brief idea of when to exit and what to do thereafter is also equally vital.
Failing to plan is planning to fail. Without understanding what your available options are and having a clear and concise plan for your property, you may be setting yourself up for a disastrous situation in the future.
While it may be easier to do nothing and "see how it goes", the truth is, your action or inaction today will affect your future. You will have to face the consequences sometime in the future. The only difference is whether you are facing it when you are still having a stable and sustainable income from your career, or when you are already retired.