Saturday, 25 March 2017

When is the best time for making OA to SA transfer | Earlier is not always better

Few months back Max wrote a post to discuss the things to consider before transferring our CPF money from OA to SA savings. Essentially, the post discussed that if the transfer is made earlier, the power of compounding at the higher interest rate will reap significant benefits, but because the transfer is irreversible, the 'in case I need it' mentality is still the key barrier for some to optimize their CPF savings.

Majority of us (if not all) understand the principle that we should make the transfer early for CPF optimization. This statement is absolutely correct. But do you know, if we add our cash savings into consideration, there will be unique cases which we should delay the OA-SA transfer.

Yes you heard me right, D-E-L-A-Y. Something new huh, let's proceed.

Delay your OA-SA transfer to optimize your savings? 

This guy does't know what he is talking about... Or does he?

This realization came about when Max was evaluating the amount to transfer from his OA to SA savings for year 2017. While working out the figures, there are situations where the combined value of total CPF savings and cash savings decreased after an OA-SA transfer is made.

This is briefly illustrated by the graph below (with hypothetically exaggerated numbers) - while the CPF savings increased with an OA-SA transfer, there is a corresponding (larger) decrease in the cash savings.

Combined CPF and cash savings decreased with OA-SA transfer - simple illustration

It was after a long process of examining the figures (and hours of hair-pulling) before the reason for this counter-intuitive behaviour was identified - the voluntary cash top-up to SA savings.

*For the remaining of this post, transferring OA money to SA savings will be referred as Transfervoluntary cash top-up to SA savings will be referred as Top-up.

Is there a correlation between OA-SA transfer and cash-SA top up?

The correlation between the two is not obvious. It is subtle and was not discussed at length. It is written somewhere out there, but we did not pay enough attention to it.

OA-SA transfer: Maximize CPF savings by transferring spare OA money to SA savings to earn higher interest rate
Cash-SA top up: Maximize overall net value by topping up SA savings with cash to earn higher interest rate and to enjoy tax relief (for eligible top up)

Both schemes involve the accumulation of SA savings through fund injection, either from OA savings or cash savings, to achieve higher interest rate for our savings.

Ideally, if the two schemes doesn't affect each other, we can treat them as independent schemes and make our decisions separately i.e. we should make the OA-SA transfer as early as we can.

But one criteria in cash-SA top up scheme complicates things: the amount of cash top up that qualifies for tax relief is limited by the Full Retirement Sum (FRS). This means that if our SA savings exceed the FRS, future cash-SA top up will no longer enjoy any tax rebate.

Tax relief limit for cash-SA top up - adapted from CPF website
Many of us are aware (or have at least heard) of this FRS limitation for cash top-up eligible for tax relief. As we 'fast-track' our SA savings, we are also closing out one of the the available channel for us to enjoy tax relief. In another words:

In the process of making OA-SA transfer, we are in fact reducing the amount of tax relief for the future

Cost benefit analysis

To decide between the two, we have to determine which option will give us more returns for our CPF and cash savings combined at the reference year. The reference year is the year when our SA savings exceed the FRS and the tax relief for cash-SA top up is removed from the equation.

If we make the OA-SA transfer now, we will gain the higher interest return at the SA interest rate for the amount transferred. However, the opportunity cost of doing so is the amount of tax rebate we could have been eligible for if the OA-SA transfer is made after the reference year.

Let's consider a simple example to better understand:
Sandy has $160k in her SA savings now. On a yearly basis, she make a $7k voluntary cash top-up to her SA savings, enjoying 7% tax rebate (based on her income tax rate). Her annual contribution to the SA account is $3k. 

The FRS will be increased to $176k by next year (year 2018). For simplicity, the interest on CPF savings is excluded from this example.

Sandy is considering to transfer $10k of OA money to SA savings this year. After all, everyone is encouraging her to make the OA-SA transfer as early as possible, there should be no benefit to delay the transfer. Is that really true though?

As illustrated by the table below, if Sandy delays her OA-SA transfer by two years, she will be able to enjoy two more years of tax rebate (highlighted in orange) which adds up to $980. But as mentioned, this is a very simplistic example, the full cost-benefit analysis will need to include other considerations.

Sandy's example: more tax rebate if OA-SA transfer is delayed

Factors that will affect your decision to delay OA-SA transfer

The decision whether to delay the OA-SA transfer is as good as determining if the additional tax rebate gained is more than the CPF savings (or interest) lost. If it does, we should delay the transfer until the SA savings exceed the FRS, otherwise, we should make the transfer now.

Additional years before SA savings exceed FRS

This is the number of years we should delay the OA-SA transfer, and is also equivalent to the number of additional years of tax rebate we can expect for future cash-SA top up.

This will directly affect the future value of the tax rebate and the opportunity cost of the lost CPF savings due to delayed OA-SA transfer. There are a few factors that will directly affect this.

SA savings at the proposed year of OA-SA transfer
If the SA savings is low, then it will take many years before SA savings exceed FRS.

Future FRS
The FRS is expected to increase over the years. Based on 3% interest rate, the FRS is expected to increase to over $300k in 20 years' time. A higher FRS will require more years before we reach the reference year.

Annual SA contribution
Depending on our annual income and age, the annual SA contribution to the SA savings will vary. A higher annual SA contribution will require less years before SA savings exceed the FRS.

Future value of tax rebate

Amount of OA-SA transfer
If we were to transfer a big amount from our OA to SA savings, then the number of remaining years of eligible tax rebate on our cash-SA top up will be lesser. This means that more potential tax rebate from the OA-SA transfer will be lost.

To better illustrate this point, let's say if  Sandy is considering to transfer $5k (instead of $10k) from OA to SA savings, then the amount of tax rebate lost is reduced to $490, as compared to the previous $980.

Sandy's example: impact of OA-SA transfer amount on tax rebate

Cash saving interest rate
The interest rate on our cash savings will also affect the future value of the tax rebate we receive from the cash-SA top up. Depending on what we do with the tax rebate, this rate will vary across different person. Unless we treat this money as unexpected fortune and spend it away, the tax rebate will grow it's value over the years.

In Sandy's example, the $490 tax rebate saved in year 2018 will grow to $505 in year 2019 based on a hypothetical 3% interest rate. In considering the decision whether to delay OA-SA transfer, the comparison should be made against the future value of the tax rebate and not just the total tax rebate received.

Income tax rate
Another factor that will affect the amount of tax rebate is the income tax rate. The income tax rate is dependent on the chargeable income of the preceding year. Most of us should fall between an income tax rate of 3.5% and 11.5%. The higher the income tax rate, the higher the amount of additional tax rebate we can expect by delaying the OA-SA transfer.

Opportunity cost of lost CPF savings

Amount of OA-SA transfer
When we delay the OA-SA transfer, we are giving up the higher SA interest rate for the amount of OA-SA transfer. A larger amount of OA-SA transfer will mean that the opportunity cost of lost CPF savings is correspondingly higher.

In Sandy's example, if we had taken the CPF interest rate into consideration, the $10k would have accumulated to $10,816  by year 2019 based on a 4% SA interest. Correspondingly, by delaying the transfer, the amount kept in OA savings will only increase to $10,506 at 2.5% OA interest. In this case, the opportunity cost of delaying the OA-SA transfer is $10,816 - $10,506 = $310.

So, should I transfer now or wait?

As there are too many factors affecting the decision, it is not immediately obvious whether we will be better off making the transfer now or to delay the transfer.

To help with the decision, Max has created a calculator to perform the cost-benefit analysis. A few guidelines became obvious while punching in different sets of data into the calculator.

It is better to make the OA-SA transfer now if:

  • The SA savings is far less than the FRS, requiring at least 3 years before SA savings is expected to exceed FRS
  • The amount of OA-SA transfer is large, more than $30k in value

The amount of additional combined savings for delaying the OA-SA transfer will not be significant, it will be in the range of few hundred extra bucks. But who would say no to more savings?

As you can see, the guiding principles are very general. If you would like to perform your own detailed cost-benefit analysis, the subscribers to this blog will be able to access the calculator in the link here - do expect slight lead time before I grant the access.

Ending Note

It is an indisputable fact that we will be able to make the most out of our CPF savings by making OA-SA transfer as early as possible. But if we bring the cash savings into the equation, there will be situations where we will be better off delaying the transfer.

For people looking to optimize every dollar in our savings, this is definitely one area to consider. But the additional savings may not be significant enough for some of us to consider looking into. Which type of CPF user do you belong to?


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