Never too late to compound your SA and save on taxes

I started Retirement Sum Topping-Up Scheme (RSTU) or topping up my child’s SA in Sep 2019. Working out the sums, I have seen how small contributions over a long period of time could substantially snowball into a big sum. What if I look further beyond the OA to SA transfer and also do a cash top-up on a frequent basis? There is still a good 20-30 years before I reach 55 or 65. I am not too late in the game to let the money roll.

Moreover, cash top-ups in the preceding year under the CPF RSTU to your Special Account (below age 55); or Retirement Account (55 and above) enjoys up to $7,000 tax relief from your assessable income.

Starting from Sep 2019, I will be contributing $100 monthly to my SA as well. It is a small and manageable amount. Also, this will translate to an annual $1,200 in tax reliefs for my self. With this, I will be maximising my CPF returns even more and will reach Full Retirement Sum (FRS) even sooner.

Power of compounding your child’s SA from young

All Singapore Citizen newborns born on or after 1 January 2015 qualify for the enhanced $4,000 MediSave Grant for Newborns. This means that each Newborn kick-start their lives on this world with $0 in their Ordinary Account (OA) and Special Account (SA), and $4,000 in their MediSave Account (MA). Wow! This is a great start in an account that earns 4% interest annually. In addition, the first $60,000 of combined balances (with up to $20,000 from the OA) earns an extra 1% interest.

Previously, I have mentioned about leaving a legacy for my child. Part of my plans is to use CPF as a tool to fulfill this goal. Some might ask me. Why not top up my own CPF accounts instead for my retirement or leave the CPF monies as a bequest when I am gone one day? Well, there are many ways to leave a legacy for your loved ones. I have also considered an allocation of cash and assets (stocks, gold, insurance etc) for my bequest. However, leaving it as a bequest via CPF would also mean that the next generation would not be able to easily misuse this money early in life without understanding hard work.

Logically, the most efficient way of making the monies work the hardest is to throw in $60,000 to your child’s SA from the start to earn 5% (including the extra 1%) interest from the start. As a middle-income salaried worker, I admittedly do not have the capability. However, what if I start small?

If I top up just a one-time $100 at age zero, at 4% annual compounding interest, this will snowball to $865 at age 55. At 5% annual compounding interest, it becomes $1,464.

I began on a small monthly mission of topping up $100. Notice the date of 01 Sep? I missed topping up on the last day of August due to some miscalculation. So moral of the story is not to wait till the last day to top up! Thus far, the true start to this mission is from Sep 2019 and I shall keep track of this growth as much as possible.

Topping up $100 monthly translate to $1,200 annually. If this keeps out, a capital outlay of $30,000 over 25 years will become $60,136 whereby the first $60,000 will earn the maximum 5% interest. Let us see where this will take us in the future.

Maximising my CPF returns while I am young

The Central Provident Fund (CPF) is a comprehensive social security savings plan for retirement years. It is a tool whereby one can carry out home financing, healthcare financing and lifelong income with the end goal of a secure retirement. Those who hates it laments about it, while those knows how to work it as a weapon towards their advantage embraces it.

I was one of those who was skeptical about it, as I was not willing to go out of my comfort zone to sit down and digest the complexities of its workings. What actually intrigued me was the power of compounded interest and the taming of interest rates to your favor.

Compounded interest is easy enough to understand. It cycles “interest on interest” and if you look at it over a long term, the earlier you start the larger the snowball effect. Let us make a case in point.

Assume 2 persons A and B are aged 20 years old and retire at the same age of 55. They invest in a product which gives 5% interest per annum. A starts investing $1,000 yearly at aged 20 but stops investing at age 30. He does not take out the money till age 55. B starts investing $1,000 yearly at age 31 just at the time where A stops but all the way till age 55. What would you expect to see?

ABC
Number of years
of annual investment		112536
Capital outlay$11,000$25,000$36,000
End result at age 55$50,515$50,113$100,628

Even though A has a lower capital outlay as compared to B, he was still able to achieve a similar return as B at age 55 because he started early. This is the power of compounding interest. What if A had been consistent with his annual investment? He would have cashed out with $100,628 with a modest $36,000 capital outlay.

Taming interest rates to your favor involves a little more appreciation about interest rates in investing and borrowing. Generally, one would prioritise investing in instruments which gives a higher return (or higher interest). For loans, prioritise the return of loans with a higher cost of borrowing (or higher interest rate). Therefore, it is also logical that when you have cash on hand but also a loan and a potential investment opportunity – to consider investing if the returns is higher than the cost of borrowing, and to settle the loan first if the cost of borrowing is higher than the returns from the potential investment.

Currently, CPF interest rate is 2.5% for the Ordinary Account (OA) , 4% for the Special Account (SA) and Medisave Account (MA). OA is more flexible in terms of usage (e.g. Home financing, education financing, investment in a wider range of instruments). The SA is geared more towards retirement needs and less flexible in usage, thus compensating with the higher interest rates. Interest is computed at the end of each month based on the lowest balance of that month and added altogether at the end of the year. Interest could be said to be compounded annually unlike your regular bank account.

I had a long consideration before I embarked on this move. Monthly housing installments is not an issue for us. Education needs would come in only at least 10 years later.

Based on what I have discovered earlier, compounded interest works wonders the earlier you start. Also, it makes more sense to invest or move to an instrument that gives a higher returns. With this in mind, I initiated the move from my OA to SA for the higher interest rate and intend to do this on a monthly basis till I reach Full Retirement Sum (FRS) for my SA at age 55.

A quick calculation shows that I will reach the prevailing FRS at that time in 5 years or less. That is assuming FRS is raised by $5,000 each year from 2019 FRS $176,000. By then, mandatory contributions will overflow to OA and we will tackle that part on how to beat the 2.5% interest rate.

Infancy

Ironically, I have never been interested in managing my finance, increasing my wealth or working towards retirement until the birth of my first child. All of the above had seemed so far off. Short-term goals were more of a priority – planning for the next holiday, buying a car, getting the latest IT gadget.

A new addition to the family relates higher household expenses. Formula milk, diapers, childcare, medical care etc adds up to quite a sum. However, what comes along inspires new long term dreams and goals – enrichment classes in the areas she desires, an overseas education, wedding and last but not least a legacy.

Personally, I have a new goal in life, that is to retire at 45 while I am still at the prime of enjoying life. How I go about doing it will be captured through my though processes along the way.