The recent Central Providend Fund (CPF) changes will affect the majority of Singaporeans. What is the extent of these changes and what do they mean to the individual?

Below are the most significant changes at a glance:

• Lowering of the CPF contribution rate from 36% to 33%. (Employer's portion down by 3%)
• CPF salary ceiling to fall from $6,000 to $4,500 by 2006.
• Minimum sum increased to $120,000 by 2013 (half of this can be property).

We looked at how the changes would affect almost all salaried Singaporeans across a large income range. We find the impact to the individual increases over the long term. The changes mean that Singaporeans need to save more than before, and invest those savings in investments that can offer a good return.

The table below shows the changes to the annual CPF contribution.

Table 1 (Changes to annual CPF contribution and annual total income)

Assumptions and notes:

Annual income is derived by multiplying gross income by 12 and including employer's contributions.

Total annual income (I) = (C) + (E) + (G)

Change in annual income (J) = (B) - (I)

As table 1 above shows, everyone contributing to the CPF would be affected. However some are affected more than others. Those earning more than $4,500 actually see their take home pay increase, but their annual income decrease, because of the reduction in both the employer's contribution and the CPF salary ceiling. For example, those earning gross $6,000 per month will see their total income decrease by 5.4%, whereas individuals earning below $4,500 will only see their total annual income decrease by 2.59% as a result of the changes. The impact of the CPF changes peak for those earning $6,000 per month, and is proportionately lower for those earning more than that.

On the surface, the impact of these CPF changes may not seem large. However, when the long term effect of compounding is taken into account (allowing the CPF monies to compound based on the current CPF return rate), it makes a big difference to an individual's CPF savings. This point is illustrated in the table below.

For this table, it would have been too confusing to look at all the age groups, and assess the how much they'd have in their CPF accounts when they finally hit 55. Instead, we calculated how much they would have in their various accounts after 10, 20 and 30 years, assuming contributions and income do not change. The actual figure may be higher or lower as salaries may change and the CPF contribution rates get lowered even further as individuals get older.

Table 2 (The accumulated effects of the CPF changes over a long period of time)

Assumptions and notes:

1. Annual income is derived by multiplying gross income by 12 and including employer's contributions.
2. CPF OA contribution include both employers' and employees' contributions.
3. Income stays constant over the years.
4. Lower CPF contributions due to age not taken into account.
5. The new CPF ordinary account (OA) contribution rates remain constant (no further changes).
6. The interest on CPF OA stays at the current 2.5% per year.

As table 2 shows, when the compounding effect of the CPF rate of 2.5% is taken into account the impact on an individual due to the changes is increasingly significant as the time period is extended.

When we take into account the minimum sum remaining has to be increased to $120,000, the new CPF changes mean that financing a dream home as well as one's retirement, would require increased savings. It would be difficult for an individual can do both just based on his CPF savings alone, as CPF OA only offers a 2.5% return a year. This is why Singaporeans should think about how to increase the returns they get from their CPF contributions.

We have established there is a difference that the CPF changes would make to an individual's retirement savings. We now try and establish how much extra an individual would have to save and invest in order to make up for that difference. Since cash can be invested into all sorts of financial instruments including fixed deposits, unit trusts, and stocks, we assume different rates of returns on the invested cash and show the extra amount that needs to be invested each year.

Table 3 (The extra amount of cash that needs to be invested each year to make up the difference)

Assumptions and notes:

1. All assumptions to obtain the figures shown in column B are the same ones used in table 2.
2. Annual take home pay does not include 13 month bonuses or any additional bonuses.
3. The fixed deposits return on average 0.5% per year, as shown under column (D).

We note that many people would fall under column (D) because they place their money into mainly savings and fixed deposits. In such a situation, the extra monies they would need to set aside from their take home pay would be quite hefty. A person who earns a monthly gross salary of $6,000 would have to set aside an extra 9.3% of his take home pay each year just to make up the difference if he only puts it into fixed deposits (this is taking into account even his increased take home pay as a result of the changes). This 9.3% works out to around $500 per month.

However, an individual who invests the money properly would be able to reduce the impact on the CPF changes with a lot less effort. For example, the same person earning $6,000 gross who invests $1,800 per year into investments returning on average 10% per year over the long term would be able to make up the shortfall caused to his ordinary account. This works out to just $150 per month.

Please note that the additional amounts shown above only represent what may have to be set aside in addition from cash just to make up the difference caused by the CPF changes. Table 3 above does not show whether a person would be able to retire comfortably or achieve his dream home. Nevertheless, we hope this article does highlight the impact that CPF changes will have on a person, and that planning ahead and investing your hard earned savings is now more important than ever. The alternative is that you would now have to save much more than before.