Recently, I was asked how much does a Singaporean need to retire? We can break the problem into two stages to get a ballpark number:
- Stage 1: Savings required to last until we start receiving CPF Life payouts
- Stage 2: Savings required to supplement CPF Life payouts (if required)
If CPF Life alone is sufficient to fund our retirement, we only need to figure out the answer for Stage 1 (i.e., zero savings required for Stage 2). Note that the Stage 2 analysis is complicated by longevity risk. Hence, we should try to meet the desired expense by maxing out our CPF Life payout (i.e., enhanced retirement sum and defer payouts to age 70).
If you are unfamiliar with CPF Life, you can find out more at its official website.
Stage 1 analysis
The answer to the Stage 1 problem is essentially the present value of your expenses before receiving CPF Life payouts based on real return rates (i.e., inflation adjusted). The following information are required for the calculations:
n: Number of years before CPF Life payouts start
e: Annual expense
f: Annual inflation rate (CPF LIFE assumes f = 2%)
i: Annual investment return rate (i = 2.5% under CPF Ordinary Account)
If you are unfamiliar with present value calculations or real return rate, you can see my online learning material for IE5003 – Cost Analysis and Engineering Economy.
Stage 2 analysis
First, we consider the savings required for perpetuity (i.e., payouts that continues forever). The formula for computing the savings required is:
(Annual expense – CPF Life payouts) ÷ Real return rates
For example, if investment rate is 2.5% and inflation rate is 2%, the real return rate is approximately 0.5%. If annual expense is $60,000 and annual CPF Life payouts is $42,000, then an additional $18,000 is required annually. The savings required to fund an infinite stream of $18,000 is approximately:
$18,000 ÷ 0.5% = $3,600,000
Since we will not live infinitely, the above is a conservative estimate (i.e., upper bound). In practice, a lower amount of savings is likely to be sufficient.
For example, suppose that we assume that we will live for another 50 years after collecting our first CPF Life payout, then the analysis will be similar to that of Stage 1. Using the following n = 50 years, e = $18,000, f = 2% and i = 2.5%, the savings required to fund 50 annual payments of $18,000 to supplement CPF Life is approximately $780,000.