About Annuities Part 2

Annuities comes in different forms. Today we will talk about the types of annuities available in the market.

Firstly we understand that annuities serve as an income distribution vehicle in our retirement years, or for some it may be used as a form of passive income during the life stage of financial independence.

1. FIXED ANNUITIES

Fixed annuities serve to provide a fixed income for a certain period of time the insurer guarantees. Each payout each year is fixed. Taking for example the latest CPF Life Annuity proposed by CPF Board, it is considered a fixed annuity because it promises a payout of example $610 a month for the rest of your life after age 65. The same amount of $610 in the CPF Life is fixed and it does not change, it does not take into account inflation or the time value of money. Since its payment if for life, say over 20 years, the value of money can change and its lowered value due to inflation will have some impact on the standard of living for someone who only relies on this CPF Life annuity.

2. VARIABLE ANNUITIES

These serve to provide a variable income based on the underlying performance of the invested funds in single subscription. It can also provide an income for a guaranteed period or for life. The payout is fixed at a percent of the current account value of the subscription. Or it can be looked as an increasing percentage of the single initial capital outlay. For example, Manulife’s Secure Retirement Plus provides an increasing percentage of payout each year because of loyalty bonus and the locking in of investment profits. If the underlying investment grows by 25% over 5 years, and the payout is 5% of the capital injection, say 5% of $100,000 = $5000 pa. the capital will have increased to $125,000 and thus the new payout has increased from 5% to 6.25% of the initial subscription. This continues to grow and despite market downturns and if the account value drops, the payout is still based on the previous higher account value.

Now through a variable annuity, the payout is now hedged against inflation and in ideal times, it out performs the rate of inflation, in conservative times, it at least gives a respectable match to inflation, in the worst times, it gives the basic fixed income.

With the above explanation of the 2 types of annuities, variable annuities have began to catch up in more highly matured financial markets as people begin to realize the importance of the impact of inflation.

Asset Rich and Cash Poor

I was once talking to my property agent and discussing property buying trends in Singapore and our topic of discussion slowly started to revolved around the issue of using CPF to finance homes in Singapore. Singapore has a unique situation whereby our CPF can be using in the Public Housing Scheme and Residential Properties Scheme. I would dare say without these schemes, there will be a lower property ownership compared to what we have now. However the current situation also gives us insight on how dependent we are on CPF to have a home. CPF has released a statistical newsletter stating the changing trends of home ownership. How it was growing and then how it was affected by national event such as SARS and economic downs.

What is certain is this; More and more people will use more of their CPF to finance a home. Public housing scheme has been utilized by more than 1.2 million Singaporeans. while private residences is tagged at at least 220,000.

From 2005 to 2006 alone, a net increase in 2 billion CPF withdrawn was used for housing purposes. This reflects strongly the the increased usage in CPF for housing. CPF board strongly advices Singaporeans to set aside sufficient CPF for our retirement nest.

A home loan issue is becoming increasing prevalent with already at least 25,000 Singaporeans at 55 financing their home loan not with CPF but with Cash. This figure is expected to increase and slowly and the retirement nest of Singaporeans are being eroded away by increasing home loans.

From now to 55. Statistics have shown that most Singaporeans do not have an issue paying their home loan using their CPF as long as they are working.

From 55 to 60, most Singaporeans may still be able to pay for their home loan using their CPF as long as they are working and contributing to their CPF.

From 60 to 65 is where a question arises. Most people are in retirement mode and even if they are working, CPF contribution rates would have significantly been reduced. Thus they have to use cash to pay for their home loan instead of CPF. The cash would have come from their hard earned retirement savings meant for their retirement. Or they would have to continue working and continue to pay for the home loan, otherwise seek further refinancing. So this is a serious problem when we use CPF to pay for our home loan.

Now, if given a choice when you are 60 facing such a home loan issue, which would you rather, Cash or CPF?

The good news is that a solution can be implemented today to avoid that situation in the future.  Every person’s situation is unique in some ways therefore to really know how to implement a solution correctly, it takes some effort to correctly establish the needs and address it appropriately.

Contact me at 9644 6924 to discuss how a solution implemented today can help you.

Take back control over your CPF

CPF, the supporting pillar for our retirement in Singaporean, a forced savings plan and the key to secure a roof over our heads. Throughout the years, CPF policies has changed in response to changing needs for each and every Singaporean.

The good-O-times…
1. CPF used not to have any income cap, meaning, even if a person was getting a gross salary of $10,000 per month, and if the contribution rate was 20%, the person was contributing $1667 and the employer was contributing $1208 each month.

This comes up to $2875 each month thus CPF accumulation rate would have been significantly higher, which could account for the previous generation’s higher CPF balances. (This does not take into account CPF investments that have generated profits).

2. HDB units were much cheaper then, a 5 room executive massionette costed $150,000 (my dad bought it more than 20 years ago)

Now..
1. CPF contribution rates are capped at $4,500 income for private sector employees. Thus the current generation would have lesser CPF balance. In 2007, only 1/3 of those who have turned 55 could meet the minimum sum scheme. They were only able to draw out 50% of their CPF. It is expected that the NOW generation of working adults may not be able to meet the minimum sum by 55 years old. Furthermore, by 2013, remaining CPF balance cannot be withdrawn compared to 50% in 2007.

2. HDB unit; 3 room in bukit batok would cost at least $250,000. A 5 room in Toa Payoh central would cost $400,000. Such rising costs will quickly erode the CPF balance and sets the accumulation cycle back to square one.

Situation and Opportunity
Looking at the both examples of rising housing costs versus lowered CPF accumulation rates, the NOW generation would have to find other means to enhance their CPF in order to serve a primary housing loan issue as well as a supporting pillar for retirement.

The primary objective is to meet increasing housing loans which is a certain event.

The secondary objective is to meet the minimum sum scheme and withdraw the remaining CPF as cash upon reaching the statutory age specified by CPF.

Solution
The GOAL is to accumulate enough  CPF to reach the minimum sum at a certain age to withdraw the remaining CPF as cash when reaching a certain age.

CPF can be set aside into an investment within the 1st to 2nd working years, either into fixed income instruments or variable returns instruments. This is to grow the money at higher returns for the payment of the initial HDB or housing deposit. Spouses can work together to accumulate the savings thru the use of CPF approved CPFIS.

Upon meeting the initial deposit, purchasing a home will consume less of their existing CPF balance, in fact purchasing a home may be advised at the age of nearing 30 and not after 30 years old. A home loan repayment problem may be created if a home is purchased after the age of 30.

The remaining CPF balance can then be fully concentrated on reaching the minimum sum scheme thru investment top ups.

At the certain statutory age, the CPF is consolidated into a single account and to cut the story short, if the person meets the minimum sum scheme, CPF in investment accounts or policies will be converted into cash policies. Thus upon maturing, these can be surrendered as cash.

Recent CPF Changes – Opportunities for all

The recent CPF Changes have certainly raised many eyebrows and talk in the heartland of Singapore. The 1% increase in interest rates offered by CPF looks enticing, many welcome the changes as part of the government’s move to ensure a more stable retirement platform for the aging population of Singapore.

In a recent CPF Newsletter “In Touch with CPF”, the additional 1% interest is explained to give Singaporeans higher returns on their CPF OA, SA as well as their Medisave. However the additional 1% is not as straight forward as it seems.

1. 1st $60,000 of the combined CPF balance will enjoy additional 1% interest.
2. Only 1st $20,000 of the CPF OA will enjoy a guaranteed additiomal 1% interest
3. The 1st $20,000 of the CPF OA cannot be used for CPFIS approved schemes, starting from Jan 2008
4. The Special Acc and Medisave will enjoy additional 1% interest guaranteed for 1st 2 years only. thereafter it will be invested into a 10 year SGS bond in which can expect some fluctuations overtime averaging at higher than 4% (as mentioned in the CPF write up)

IN A NUTSHELL…

It simply means that that additional 1% of $60,000 which is up to $600 per year will be paid out to CPF members by the government. or rather up to $200 for the OA only per year, since the SA will be put into the SMRA scheme after 2 years.

POSSIBLE SCENARIOS
Current CPF scenario
$20,000 at the 2.5% in 20 years will give $16,386 based on future value calculation.

New CPF scenario
$20,000 at the 2.5% + 1% in 20 years will give $39,795 based on future value calculation.

ENDOWNMENT PLAN scenario
By taking $20,000 and putting it into a savings vehicle with 4.4% that has low risk for 20 years will give $47,319 based on future value calculation.

CAPITAL PROTECTED GROWTH PLAN scenario
$10,000 in a low risk fund at 4.4%  = $23,659
$10,000 in a higher performing fund at an average of 7% = $38,696
The above will come to a projected return of $62,356, which is far higher than the previous 2 scenarios.

The above example is simply talking about OA, not even the SA, given the same situation for SA based on the new scheme of using the 10 year SGS, a capital protected growth plan can still give potentially higher returns and yet protected the based principle from market fluctuations when compared to the new scheme.