Strange way of how CPF Interest is calculated & retirement planning

Last Updated on 29, July 2022

CPF has a rather strange way of calculating interest. In this article, I will explain how CPF interest is calculated and how you can make use of this knowledge to reduce the disadvantage of such a system.

First, CPF interest is calculated on a monthly basis but it is only credited at the end of the year. The interest that is credited at the end of the year forms the new balance for the following year. This method of crediting is not the standard practice in the banking sector. If you check your bank statements such as POSB or OCBC saving statements, you will notice that interests are credited at the end of every month. For fixed deposits, interests are credited at the end of the term period.

Hence, the actual rate of return for CPF is lower compared to a system in which the interest is credited every month all else equal. This is because the former’s interests do not get to compound every month.

Second, how CPF interest is calculated every month is unfair. Interest is based on the lowest balance for that month. Thus, it is possible you could end up with a significant loss of interest if you are careless in how transactions are done.

Let’s take for example: your CPF-OA balance on 1st March was $100,000. On 28th March, you make a CPF-OA withdrawal of $80,000 (say for investments or to make partial mortgage repayment). This resulted in the balance falling to $20,000. Hence, the lowest balance for March is $20,000. Thus, the interest at the end of March is calculated as 20000 * 2.5%/12 = $41.67. Notice that the interest for $80,000 was completely lost despite it in the CPF account for 27 days for that month. This works out to be a loss of a whopping 80000 * 2.5%/12 *27/31 = $145.16 of interest!

Knowing this, you can avoid the lost by making the withdrawal on 1 April instead. In this way, March’s interest would be 100000 *2.5%/12 = $208.33.

Another related question is when is the best time to contribute your CPF using say CPF Voluntary Contribution Scheme or CPF Retirement Sum Topping-Up Scheme?

Assuming you want to top-up $37,740 under the CPF Voluntary Contribution Scheme, the best time to top-up is at the end of the month since topping up at the beginning of the month will not earn any extra interest as interest is calculated based on the lowest balance for that month.  Of course, in practice, you do not want to top-up on exactly on the last day of the month because you need to take into consideration of the turnaround time required for the computers and the cloud to sync and to run their batch processes at night - you could end up topping up on the 1st of the following month which is the worst-case scenario.

Extra CPF Interest

The government gives an additional 1% CPF interest for the first $60,000. Another 1% extra of the first $30,000 is also given to those 55 and above.

This interest extra is meant to target those with very low CPF balances. If your balance of your CPF accounts (OA+SA+MA+RA) is $60,000, the CPF interest is $600 a year if you are below 55 and $900 a year if you are above 55.

If you are an older person say above 55 and your CPF balances is or below $60,000, the extra interest increases your CPF effective interest significantly. Let’s say your CPF balance is exactly $60,000, the extra interest increases your effective interest rate in the CPF by 900/60000 = 1.5%. For those with large CPF balance say $500,000, the extra interests are insignificant. 900/500000 = 0.18%.

However, I am always confused by how this extra CPF interest is calculated because it is really complicated. I finally figured it out on 1 November last year when I attended a training session for financial advisers conducted by CPF Board itself.

The amount of money that make up that $60,000 and $30,000 is from the following accounts in order of priority:

1st: CPF Retirement Account balance inclusive of the premium for CPF Life

2nd: CPF Ordinary Account balance (but capped at $20,000)

3rd: CPF Special Account balance

4th: CPF Medisave Account balance

So let’s take for an example you are below 55 and SA=10000, OA=100000, MA=10000, the amount used is 0 (from RA), 20000 (from OA but capped at 20K); 10000 (from SA); 10000 (MA) making a total of $40,000. Unfortunately for this scenario it is below $60,000 and hence this person can only enjoy 40000 * 1% = $400 extra interest a year instead of the full $600. This is despite have a total combine balance of $120,000.

Frankly speaking, I do not know why the government come up with such complicated system as life is already so hard – why making life even harder for financial advisers like me?  Why can’t they just use simple combine balance of all accounts?

By the way, these extra interests are credited to the Special Account (if below 55) and Retirement Account (if 55 and above).

How extra interest impacts retirement planning?

These extra interests are useful for those who are young because their CPF balances are low. Hence, the extra interest increases their CPF effective rate of return significantly.

For those with large CPF balances, the extra interests do not have any material implications.

For those who are older say above 55 and their CPF balance is low, these extra CPF interest do not help at all – practically. Although the CPF rate of return is significantly higher than without the extra 2%, this group of individuals have more serious things to worried about.

By the fact that their CPF balances are low could mean that their actual networth is also very low. This is because of the correlation between CPF balances and salary. The cumulative balances of the CPF is a function of CPF contribution due to salary, interests and withdrawals. Even if a person has used up all his CPF-OA for housing, there should still be a significant amount of money in the CPF-SA and RA when he is 55. I ran a simulation of a person who starts work at 30 years with a monthly gross of $3500 and no bonus and no salary adjustments. His salary remains the same until end of 54. At 55 years old, his CPF-SA/RA is $261,973. His CPF-MA is $133,292 assuming no Medisave deductions for insurances. My simulation is very comprehensive as it takes care of the extra interests, varying CPF contribution rates with age, Basic Healthcare Sum, Full Retirement Sum limits, CPF contribution limits (OW+AW) and the convoluted way of how balances overflow to SA/OA. Of course, my simulation is based on current CPF rules but with some provision for inflation adjustments of the various limits (too long to explain here). But considering CPF Contribution Rates used to be much higher in the past, current CPF Members in their mid-fifties should be seeing a CPF-SA/RA balance of around $200,000 if they had a proper job for the past few decades.

(As a side note, I will not be making an online calculator for this CPF Contribution Simulation but recent clients who engaged my service would have seen the huge spreadsheet that I had to run this simulation to predict their CPF-SA/RA balances which in turn predicts the projected CPF Life payout.)

Thus, I would say that if you are currently in your mid-fifties and your CPF-SA/RA is significantly below $200,000, it is likely you cannot retire as your salary for the past decades were far below what is required. On the other hand, if your CPF-SA/RA is far above $200,000 – congratulations! Assuming you did not squander the CPF-OA into useless properties or investments and you did save/invest prudently outside of the CPF system, then retirement is likely a reality!

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