You will be able to explain why essential spending should be matched to guaranteed income.
Picture two retirees in 2009, both watching their portfolios fall by a third in a few months. One lies awake wondering whether to sell before it falls further, because next month's groceries and conservancy charges come out of that portfolio. The other is uneasy but sleeps, because her basics are paid by income that arrives on the same day every month whatever the market does. Her holiday is in doubt. Her meals are not.
The difference between them isn't the size of their savings. It is how their income is arranged. This lesson is about arranging yours the second way.
Lesson 1.2, Estimate retirement spending from today's budget, split your spending into essential and flexible. The split pays off here, because each kind of spending suits a different kind of income.
Essential spending can't wait for markets to recover. Food, utilities, conservancy charges, insurance premiums and an allowance to a parent fall due every month. If they are paid by selling investments, a bad year forces you to sell at low prices, and lesson 5.1, Why a crash early in retirement does more damage, shows how much that costs.
Flexible spending can wait. A trip can move a year. Eating out can drop from three times a week to once. So flexible spending can be paid from investments that are allowed to rise and fall, because in a bad year you can simply spend less of it.
The planning rule follows: cover essential spending with guaranteed income as far as you can, and pay for flexible spending from the portfolio. Planners sometimes call this a floor-and-upside approach. The income floor is the guaranteed income under your essentials. The upside is everything above it.
Guaranteed here means two things: the payment doesn't depend on markets, and it doesn't stop while you are alive.
CPF LIFE meets both tests. It pays a monthly sum for life, so it removes the risk of outliving that part of your money. That is something no savings account or portfolio can promise, because a pot of money has a bottom and a lifetime doesn't have a known end. CPF Mastery: every account and the choices you control, lesson 7.1, How CPF LIFE pools longevity risk, explains how the pooling works.
A private life annuity bought from an insurer also meets both tests, as long as the insurer can pay. Lesson 2.3, Ways to raise the floor, compares it with CPF LIFE.
Plenty of income feels guaranteed and isn't. Dividends from blue-chip shares and REITs can be cut, and were cut in 2020. Rent depends on a tenant, a working air-conditioner and a lease that renews. Interest on deposits and T-bills is safe for its term, but the rate resets. Part-time work depends on your health and the job market. All of these are useful. None of them belongs in the floor at full value, and lesson 2.3 deals with how much of them to count.
Jasmine, from module 1, ran the CPF LIFE estimator on cpf.gov.sg. For this course we use a made-up figure in its place: S$1,600 a month from age 65 on a level plan, or S$19,200 a year. That number is invented to show the method, and it says nothing about what CPF actually pays. Your own estimator figure is the only one to use.
Her essential spending at 65, from her sheet in lesson 1.4, is about S$35,000 a year in future dollars. CPF LIFE covers about S$19,200 of it, a little over half. The gap for essentials is about S$15,800 a year.
Then she looked further out. Her CPF LIFE payout on a level plan stays at S$19,200 a year, while her essentials keep growing. At 75 they are about S$47,700, and the gap has widened to about S$28,500. At 85 they are about S$65,700, CPF LIFE covers under 30% of them, and the gap is about S$46,500.
This is the most useful thing the floor sheet shows. A level payout is a floor in dollars, and its value against your spending falls every year. If CPF LIFE covers your essentials exactly at 65, it won't at 80. Lesson 2.2, Choose your CPF LIFE plan and start age for the whole plan, weighs the plan with rising payouts against that problem.
Most people find a gap for essentials, as Jasmine did. That doesn't break the approach. It tells you how to treat the money that fills the gap.
The part of your savings that pays for essentials above the floor should be the safest part: cash, deposits, T-bills, Singapore Savings Bonds or high-quality bonds, often arranged so something matures each year. The part that pays for flexible spending can hold shares, because a fall there means a smaller holiday rather than a missed bill.
There are only a few ways to close an essentials gap: raise the floor, lower essential spending, or set aside enough safe money to cover the gap for the years it lasts. Module 2 looks at the first, and module 4 at the third.
Payouts depend on your Retirement Account balance when payouts start, the plan you choose and the age you start. Averages in news stories mix people with very different balances. The CPF LIFE estimator uses your own balance and lets you change the start age and the plan.
Log in to cpf.gov.sg with Singpass, open the CPF LIFE estimator, and note the monthly payout it shows at your payout eligibility age on the plan you are on. Have your essential spending at retirement from lesson 1.4 beside it.
Write your essential spending at retirement and your CPF LIFE estimate from the CPF Board estimator, and the gap between them.
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