Most of the time, we scratch our heads when it comes to putting away money for our future retirement and healthcare needs. Is it better to save as much as we can? Or should we just live in the present, spend and enjoy life? Intuitively, we know that neither option is desirable or sustainable in the long run.
Saving as much as we can implies making long term sacrifices and depriving ourselves of many material comforts in life. It probably means foregoing the weekend meal at the restaurant, or depriving ourselves of the occasional new electronic device. Even though this approach may allow us to save for our retirement and healthcare needs, more likely than not, it would negatively affect our emotional well-being.
The other extreme is to spend freely and to live in the present. While leading an extravagant lifestyle would probably boost our short term happiness, this approach would compromise our long term well-being, especially in the event where we experience a health crisis or enjoy a long life expectancy.
The key is in finding a balance in life. This is especially so in the domain of saving and planning for your future and retirement needs. Finding this balance has become even more complicated with the emergence of new trends and factors for each person to take into account.
The first is Inflation, or the yearly increase in the cost of living. This is what makes fruit and vegetable cost more every year, it is also the same factor which pushes the price of cars and apartments upwards. The second factor is increased longevity, where each individual is expected to live longer as better nutrition and better medical care prolong the general lifespan of each individual. The third factor is the increasing cost of healthcare, also known as medical inflation. It is estimated that medical costs are increasing at a rate of slightly above 5% in Singapore. Apart from all these factors, many of us also aim to retire comfortably and to lead enjoy a high standard of living during our golden years.
The big question: What percentage of my income should I be saving? An entire industry has emerged to provide answers to this question. Many self-styled experts have come up with complicated models and rules to guide people in their retirement planning. Many of these models, while well-intentioned, are often too complicated for the individual to follow. Furthermore, many of these models rely on assumptions which are not well-founded.
We understand the struggles faced by the individual and recognise that life’s realities are not governed by models and theories. As the pioneers of Financial Planning with more than 30 years of experience in helping people save for the future, we know that it is sometimes better to keep things simple. We do not profess to have the ideal answer to this question but we have found that for many people, what works is to adopt the 50% savings rule.
The 50% rule. A Great Way to Save. By Any Measure.
The 50% rule is not something that is plucked out of thin air. It is founded on empirical evidence and a tested model of common sense reasoning. To examine how this rule makes sense, let us first study the concept of taxation and how taxes fund retirement and healthcare benefits around the world.
In Norway, citizens in the highest income bracket are taxed at a rate of 47.8%, which can be round up to 50%. In France, residents in the highest income bracket are taxed at a rate of 45% which is also close to 50%. In Switzerland, high income residents are also taxed heavily at 40%.
Even though people in these countries are heavily taxed, the taxes which they pay funds generous social welfare programs which help defray the costs of retirement, unemployment and healthcare.
In much of Europe, residents do not need to worry about their healthcare needs. In Norway, patients admitted to hospitals enjoy fully subsidised treatment with no cost sharing charges imposed. In France, 75% of the healthcare costs are covered by social subsidies funded by taxation and sources, with the patient paying only a small fee.
Over at the unemployment front, European residents enjoy substantial benefits as well. In Norway, unemployed residents may receive cash payments over a period of about 2 years with the amount disbursed depending on the last drawn salary. In Switzerland, unemployed residents receive 70% of their last drawn salary. The benefits even extend all the way to the retirement domain where many European residents qualify for monthly pensions and senior citizen benefits.
Few would dispute the assertion that Singapore residents do not enjoy social benefits of a similar magnitude. The Singapore government maintains a singular belief in the value of self-reliance and independence. Thus, it maintains a policy of providing relatively fewer social benefits but a much lighter tax burden. In fact, the maximum tax rate for high income earners in Singapore is only 20%, less than half the average rate in Europe.
With a significantly lower tax rate compared to Europe, it is normal for the government to provide less generous subsidies and benefits in the area of healthcare, unemployment and retirement. It follows that Singapore residents are expected to save and make their own arrangements for their future needs. Remember that the high taxes imposed in Europe and Scandinavia help to fund the generous social programs.
While we know that we are expected to save more, we still have not answered the question: How much? Should I save 10%, 20% or even 30%? At IPP, we feel that most people should be putting away at least 50% of their income, which includes CPF contributions. Of course, the amount saved should depend on one’s unique financial circumstances. However, most people would be well-served following the 50% rule.
So how do we come up with the 50% number? In Scandinavia and much of Europe, residents are able to rely on a cast-iron social security net for their healthcare needs and as a result, do not need to set aside much for these needs. However, in Singapore, we are obliged to provide for ourselves. If we assume that in Europe, taxes of 50% go towards funding social programs for healthcare, unemployment and retirement, it is logical that we in Singapore should be saving a similar percentage to run an individual ‘program’ that is entirely self-funded.
Most people will recoil at having to save 50% of their income. Many people are already burdened with the obligation of having to service car, house and credit card loans on a monthly basis. These loans often constitute at least 10% of one’s income. Some individuals even spend beyond their means by overspending on their credit cards and taking out pawnshop loans to fund their discretionary expenses.
Take heart! The 50% rule does not require you to save 50% of your take home pay. If you are an employee, you contribute about 20% of your gross salary to your CPF accounts by law. In addition, your employer contributes about 16% of your gross salary to your CPF accounts. The sum of these contributions is 34%. This means that to attain the 50% target, what is left for you to do is to set aside 14% of your take home pay, which is definitely attainable. In fact, we would encourage you to save 20%, a round figure which is easy to remember.
To illustrate how easy this it, if you draw a gross salary of $3000 (with a take home salary of $2400), you only need to set aside $480 if your intention was to save 20%.
Some practical steps to follow:
- Determine your current gross salary and take home pay
- Divide your take home pay by 5 to calculate the amount you need to save
- To help yourself stick to your savings goal, you may wish to ‘Pay Yourself First’. This involves setting up a secondary account linked to your main bank account. Every month, the amount to be saved is automatically transferred from the main account to the secondary account.
You will be surprised at how you can build your wealth in the long run.
In Singapore, we do not benefit from the generous social security programs in Europe. It is up to us to take control of our destiny and put our finances in order, in preparation for the future.
With the 50% rule and with some advice from your financial planner, you could be on your way to a worry-free future.