Saturday, December 18, 2004

Planning for retirement 

The Straits Times has a special report on retirement planning today. The report highlights the growing trend of Singaporeans working past the official retirement age of 62.

Excerpt from the report:

The bottomline message...to Singaporeans is stark: Save more, spend less or retire poor. But besides starting to save earlier, financial planners say that Singaporeans desperately need to know how to invest their money... Most have no clue... Indeed, a survey of 1,000 Singaporeans who earn more than $2,000 a month done five years ago by the NUS and commissioned by Citibank found that most Singaporeans do not plan for their future simply because they don’t know how...

[M]ost Singaporeans badly need to revise their typically unreal expectations of retirement living. Ms Anne Tay, vice-president of wealth management at OCBC Bank, notes that most professional “refuse to believe” they will need at least $1 million to keep up their current life-styles... But the sobering reality is that $1 million in the bank only works out to $4,000 a month, or $2,000 each if shared by a couple, over 20 years of retirement, without even factoring in inflation. That is by no means extravagant, especially with rising medical costs today.
But is it really not extravagant? And why assume 20 years of retirement? The problem with retirement planning is that you have to deal with many uncertainties.

The first uncertainty is how long you will have to save for. With a life expectancy of about 80 years, the average Singaporean will live about 20 years after retirement at 62. But most people will not live to the life expectancy. Many die before 62. Many live to their 90s. The margin of error alone exceeds 20 years. In the face of such uncertainty, people need to plan for the near-worst case. That means planning to live another 30 years or so after retirement. That makes the task of accumulating adequate savings about 50 percent more daunting.

The second uncertainty is the cost of living in old age. Probably the single biggest uncertainty here is medical cost. How healthy will you be in old age? Most age-related diseases cannot be cured; they need to be treated. In other words, they impose a financial burden on the aged for the rest of their lives. How sick you are in old age can make a tremendous difference in the amount of money you will need. Can you predict how sick you will be? And what about inflation? If you can’t predict these, again you may need to plan for the near-worst case, which means another huge addition to your savings need.

If you plan to save and invest to meet the financial needs of your retirement, you face the third uncertainty: How well will you investments perform? Financial planners generally assume that stocks provide the best returns. However, stocks are very risky. There is a high chance that they may fall in value at the very moment the retiree needs the money from them. The least risky are savings deposits, which return next to nothing after inflation, which essentially means that you are actually relying on savings and not investment.

What do all these lead up to? It is that relying on savings alone is difficult in practice for many people. The uncertainty involved means that each individual who does his own retirement planning will have to plan for the near-worst case, which adds to the burden of saving.

One solution, which is the underlying theme of The Straits Times report, is to continue to work after 62. However, this option leads to a fourth uncertainty: What are the kinds of jobs that will be available for those above 62? The labour market report put out by the Manpower Ministry recently is not optimistic about job prospects for those above 40, much less those above 62.

Which means that individuals will still have to do some sort of planning to accumulate assets for their retirement. However, assets don’t need to be in the form of cash holdings. In fact, a way of handling situations of uncertainty is already available: insurance.

No, I’m not an insurance agent. I’m not recommending that everyone rush out and buy insurance. In fact, I think that many people are actually over-insured, or they may be insured for the wrong things. If you already have enough cash savings or investments to meet your needs, insurance is unnecessary; they actually involve costs and may lower the overall value of your portfolio — insurance companies cream off part of the investment returns. If you want to increase your returns but don’t want to take on too much risk, simply invest a small portion of your funds in riskier assets like stocks or unit trusts.

However, if you are still in the process of building up your savings through your income flow, insurance is a good way of protecting that flow by fixing a minimum future value or income stream. The cost of insurance can then be treated as the cost of buying peace of mind.

Therein lies the shortcoming of relying on the current Central Provident Fund (CPF) scheme for the retirement funding of Singaporeans. The CPF largely relies on members to save for their retirement. Of course, some of it can be used to buy insurance at the member’s discretion. However, the amount involved is usually small. The main mechanism for building up your retirement funds through the CPF is essentially savings, and as the foregoing discussion and the article in The Straits Times show, this is actually rather difficult in practice. Mandate too much in each individual’s CPF account and you essentially deprive members of their hard-earned money and the economy of disposable wealth. Mandate too little and members may not have enough for their retirement.

So Singaporeans will have to do their own financial planning to ensure a comfortable retirement.

And I agree with a comment in the article in The Straits Times: Children are not your ATMs.

Those counting on their offspring to maintain them financially in their retirement are headed for disappointment. Singapore has one of the fastest ageing populations in Asia. Increased life expectancy is expected to impose undue financial strain on even the most filial and capable of children.
Unfortunately for many Singaporeans, especially the middle-aged and above, this realisation may have come too late for them. Traditionally, people have relied on their children to provide for them in their old age. So they saved less than they should have. The change in economics and demographics is likely to hit many of these people hard.

Change, like retirement itself, is often painful to the unprepared.


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