Because of inflation, you can’t just stuff your dollars in a Milo tin until you retire. Here’s where you should keep your retirement savings instead, and why.
The biggest threat to retirement is inflation: your money will not be worth as much 25 or 30 years down the road. So as much as we’d like to tell you to “just save”, it’s not quite that simple. Gone are the days when we could stuff dollars in a Milo tin and find out we had enough to one day stop working.
Here are some retirement planning methods that work, and why.
Understanding Inflation Rate Risk
Inflation rate risk refers to the way your wealth declines as a result of the rising cost of goods. In a stable economy, inflation is unavoidable--this is why you could have bought a flat for less than S$20,000 in the 1970s, but would pay at least 11 times that amount for a three-room today.
In the same way, your S$20,000 today will not buy you as much in 2046.
There are many ways to measure the rate of inflation, but the most commonly used method is the Consumer Price Index (CPI). This tracks the rising cost of a given basket of goods. There is also core inflation, which excludes the rising prices of private housing and transport (on the basis that Singaporeans do not have to buy these things).
In either case, the inflation rate in Singapore is comparable to that of most developed countries: it is about 3% per year. If you think you can escape this by retiring to a “cheaper country”, think again.
In developing countries, the inflation rate is typically higher than developed countries. It is 3.7% in Thailand, for example, and almost 10% in Brazil. These countries are finding their footing and becoming prominent--in 30 years, they may even be more expensive to live in than Singapore.
So rethink the idea that you can “retire in a cheaper country.” You savings may not last quite as long as you imagine.
How to Outpace Inflation
As a rule of thumb, a retirement fund should beat the inflation rate by 2%. Later, after you have retired and are nearing the end of your life, you can scale back returns.
So in Singapore, a decent retirement fund should generate around 5% returns per annum, and can be toned down to around 3% returns (the lower the returns the lower the risk) per annum after you have retired. This is why most insurers project 3.75% to 5.25% returns when they show you the benefits illustration.
Here are some ways you can consider to get the desired returns. However, this does not amount to financial advice and everyone’s needs are different, so do consult a financial advisor or wealth manager before taking action:
1. Exchange Traded Funds (ETFs)
To keep things simple, we are referring to the Straits Times Index Fund (ST Index Fund). You can start buying these for as little as S$100 a month (although you should try to set aside more!) from banks like POSB or OCBC.
The ST Index fund mirrors the returns from the Straits Times Index, and has generated annualised returns of between 5% to 8% over a 10 year period. One advantage to the ST Index fund is that it has low fees, as there is no need to pay an expert to “pick” stocks. It is a simple matter of replicating the movements in the stock market. This is part of what contributes to the high returns.
With insurance and mutual funds in Singapore, you have to pay management fees, agent commissions, etc. that can eat into your returns.
2. Insurance Policies
If you loathe the idea of managing your own portfolio, your best resort is to turn to an insurer. These days, a variety of insurance policies--from Universal Life policies for the affluent to whole life insurance--are designed to provide for retirement.
However, don’t make the mistake of going with the first insurer you find. You may face high-pressure tactics, and it can be tiring to hear out the complexities of an insurance plan. But remember your retirement depends on your willingness to endure it. So always compare the plans before buying.
Pay especial attention to the Effect of Deduction (the name may be different, in which case you can ask for the distribution cost), which is shown in the benefits illustration. This reflects what you are paying for your insurance plan. Compare these amounts between insurance plans, and be sure you are willing to part with the sum (if you manage your own portfolio, that is money that could be in your pocket instead.)
3. Work with a Wealth Manager to Build a Well-Diversified Portfolio
A well-diversified portfolio includes a mix of lowly-correlated stocks (companies that have little to do with each other, so they won’t all go down at the same time), bonds, and simple cash investments.
It is impossible to tell you what a “well-diversified” portfolio is here, as it is different for each individual. The portfolio needs to take into account how much you want to have each month after retirement, how many children you have to provide for, where you want to live, your medical costs, etc.
The portfolio will also be subject to formula and calendar based rebalancing: it will have to be tweaked in response to current events (such as the current oil plunge), as well as on a semi-annual basis.
You will need a qualified wealth manager to help you do this. It is inadvisable to do it yourself - even wealth managers often have their own wealth managers (emotions always get in the way of managing your own money).
The cost of wealth management is often around 2% to 3% of the amount being managed. This means returns should range from 7% to 8% at least, as your portfolio must both pay for your wealth manager, while providing for your retirement.
4. Put it in your SRS
The Supplementary Retirement Scheme (SRS) is another layer above the CPF. Contributing money to your SRS provides tax relief--so if you make S$30,000 a year, and you contribute S$10,000 to SRS, you will be taxed as if you made S$20,000 (which means zero tax, as you are not taxed for amounts of S$20,000 or below.)
In addition, when you start withdrawing from your SRS after retirement, you are only taxed on 50% of the amount withdrawn. For example, say you withdraw S$40,000 every year. You would normally incur a tax of around S$550 for this.
But if the S$40,000 is withdrawn from SRS, you are only taxed on half the amount (S$20,000, which again means zero tax.) If you have done well yourself, and can withdraw large amounts, this means significant savings.
If you saved enough to withdraw S$80,000 a year after retirement, for example, you would normally be taxed S$3,350. Through SRS, the tax would be reduced to S$550. This makes your retirement savings last considerably longer.
However, note that there is a steep penalty on withdrawing from SRS before the retirement age of 62. Besides getting the normal tax on the amount withdrawn, you will also have to pay an additional 5% for the withdrawal. As such, there is less flexibility with your money.
Alternately, you can also place your savings in your Special Account, like this one Singaporean did.
Before you start dreaming about your retirement, make sure you are debt free. Ongoing debts will almost always outpace your retirement fund. For this reason, you should try to pay down debts fast (barring your mortgage). You can do this by switching to lower interest debts.
For example, you could repay a credit card loan through an interest-free balance transfer, rather than at the usual 24% per annum interest rate. You could also trade high-interest debts for a low interest, 6% per annum personal loan.