Dec 28, 2009

The Supplementary Retirement Scheme

Oops, it's that time of year again. Need to rush down to the bank and deposit the usual $11,475, before the 31 December deadline. This will reduce my income tax by exactly $2,295 next year.

Yes, I am referring to the Supplementary Retirement Scheme. For full details, click this link - you'll get the Finance Ministry's official explanation of the SRS.

The SRS is nothing new - it was introduced about a decade ago - yet many Singaporeans do not seem to know about it. Briefly, it's a voluntary government scheme which provides tax benefits to encourage people to save and invest for their own retirement years.

I think that the SRS is a good idea. Not necessarily for all people (because everyone has his or her own unique financial circumstances). But the SRS could definitely be a good idea for many people.

However, I realise that the SRS might not be that easy to understand. Take for example the blogger at Salary.Sg. In general, his articles are very informative and well-written, and I've enjoyed reading many of them. However, his recent post about the SRS - entitled What's Not Good about the SRS - struck me as a little disastrous.

The blogger discussed the SRS and concluded that it was basically a terrible thing and you would be foolish to use it. However, his explanation was not convincing and he clearly didn't know (or didn't appreciate) the finer points of what you can do with your SRS monies. (On the plus side, several of his readers did respond with good comments, to correct the shortcomings of the article).

In general, the SRS works best for (1) the higher earners, and (2) people who are interested and committed to a long-term plan of building up their retirement funds. It may also make sense for working people who are, say, already in their 50s and do not foresee having to meet any major financial expenses between now and their retirement age.

Also, the SRS has some uses for income earners who foresee that in the future, there will be a year, or two, or three, when their taxable income will dwindle sharply (for example, the person might be planning to temporarily stop work to pursue higher studies, or to look after the kids at home).

My advice to you is to at least find out how the SRS works. Then you can make an informed decision as to whether it is for you or not.

26 comments:

kate said...

Wah Mr Wang! You earn more than $320k a year!

Anonymous said...

kate

Now you know why PAP need to pay so much more to persuade talents to enter politics to be MPs and ministers, and even then these talents are very reluctant or even reject it outright!

But at least Mr Wang bother to blog.

Anonymous said...

Nope. Why Mr Wang sold his flat and rented a room if he made so much money in a year?

Anonymous said...

He probably wants to lock in his profit since the HDB market is very high now, but is likely to come crashing down soon.

Later he will use the sale proceeds to prepay his mortgage for his big new house (which he bought at the bottom of the private property market).

Mr Wang buys low, sells high, and rents when the rental market is weak. A most clever man. ;)

Incidentally, capital gains from the sale of real estate are not taxable income. So his > $320K annual income excludes any profits made from his property transactions.

Tat said...

$320k is not very much. I would have expected Mr Wang to be earning more with his qualifications and years of work experience. For example, a partner in a law firm can easily make $600k a year.

Anonymous said...

Average household income in Singapore is about $7000 per month.

That may be one reason why PAP has at least 66% support at every election.

Anonymous said...

Mr Wang does earn more than $320K.
The figure of $2,295 in SRS savings merely tells you two things.

Firstly, that he falls into the highest IRAS tax bracket (which is for people earning more than $320,000).

Secondly, that he earns at least $11,475 more than $320,000 (meaning that he earns at least $331,475).

That's all you can deduce from Mr Wang's post. Whether a Singaporean earns exactly $331,475, or much, much more, the maximum tax savings per year that the SRS allows is $2,295.

Anonymous said...

Did some rough calculations, for illustrative purposes.

In a household earning $7,000 per month (and assuming there's one breadwinner), the annual income is $84,000.

If the breadwinner makes no SRS contribution, the tax payable would be $4,860.

If the breadwinner contributes $11,475 to his SRS, the chargeable income would be $84,000 - $11,475 = $72,525. He falls into a lower tax bracket and ends up paying about $$3,604.

So the tax saving is $4,860 - $3,604 = $1,256.

Of course the disadvantage is that the money has to be set aside for retirement savings and cannot be used for other purposes. If you withdraw early, there is a penalty.

dsea said...

@anoymous

CPF deduction (minimum SGD 10800 and sgd 15300) was left out.

Rush said...

capital gains on SRS monies attract income tax during the year of withdrawal. i'm not too clear on the withdrawal rules, but if I am not wrong you have 10 years, from date of first penalty free withdrawal. The date of first penalty free withdrawal should be the official retirement age at the point of first contribution.

withdrawals from SRS during the allowed period (i.e. non-penalty attracting withdrawals) attract tax on 50% of the withdrawn amount, at the prevailing tax rate. capital gains from SRS funds are thus taxed (albeit only half of the capital gains are subject).

capital gains derived from a source in singapore are otherwise not taxable. (e.g. capital gains from property, stocks, etc are not taxable, unless IRAS deems it such according to the ITA.)

while tempting to infer that the yield is 9.6% (calculated by "saving" $2,295 by "investing" $11,475) it is only true if you assume you withdraw your SRS at a rate where you do not attract any tax.

this is probably not possible because if you are at the bracket where $2,295 is saved, you will likely have other sources of income and not reside at less than $24,000 chargeable income bracket (or, whatever the tax free bracket happens to be at) during your retirement.

thus, while indeed saving $2,295 in the year of assessment, actual savings cannot be determined until you completely withdraw all your SRS monies after retirement. And in my opinion, the actual savings may not be substantial relative to the commitment of time required for most young individuals.

Mr Wang Says So said...

Hi Rush:

Regarding this -

"while tempting to infer that the yield is 9.6% (calculated by "saving" $2,295 by "investing" $11,475) it is only true if you assume you withdraw your SRS at a rate where you do not attract any tax.

this is probably not possible because if you are at the bracket where $2,295 is saved, you will likely have other sources of income and not reside at less than $24,000 chargeable income bracket (or, whatever the tax free bracket happens to be at) during your retirement."


... the 9.6% yield figure from Salary.Sg is based on Example 2 from the Finatiq website. This is in turn based on a hypothetical Singaporean citizen whose chargeable income is about $82,200, after CPF deductions but before making a SRS contribution.

The "yield" figure would be considerably higher, if the man was in a higher income tax bracket. Eg in the highest tax bracket, the "yield" would be 20%, slightly more than double of 9.6%.

The Finatiq example also doesn't take into account what the man could have done with the $1,096 sum (if he had invested it for the next 20 years, instead of paying it to the government in taxes).

As for capital gains, let's look at this way:

You can only contribute a maximum of $11,475 per year anyway. At any point, (say, in Year 5, or Year 9, or Year 16 or Year 22), let's say that your SRS monies (plus investment returns) have grown so much that you foresee that you might have problems later withdrawing all of it (over the 10-year period starting from your retirement age) at zero or nominal tax rates.

Well then, at that point (in Year 5, or 9, or 16, or 22), you can choose to stop making your annual SRS contributions. (Or you could reduce your SRS contributions).

Anonymous said...

When you're making more than $320k a year, why go through the trouble to save a measly $2,295? :)

Salary.sg said...

The "yield" figure would be considerably higher, if the man was in a higher income tax bracket. Eg in the highest tax bracket, the "yield" would be 20%, slightly more than double of 9.6%.

You forgot to take into account the time value of money.

Let's assume the time horizon is 20 years; and that the yearly tax saving of $2,295 is invested and compounded at 5%. At the end of 20 years, you will have $75,886 from the investments.

Let's assume the SRS account earns you 2.5% interest a year. In 20 years, your SRS will have $293,125.

At end of 20 years, tax savings + SRS = $369,011.

It's a sizable amount, but you would have achieved a slightly better outcome had you invested the yearly streams of $11,475 and achieved just a 4.73% per year over the same 20 years.

Mr Wang Says So said...

Not sure why you would use a different projected rate of return, for SRS money and non-SRS money.

SRS money can be used to invest in funds, ETFs, stocks and investment-linked insurance products, the same way as non-SRS moneys. The government leaves it open to the private sector to think of what other products or instruments they may wish to offer to SRS investors.

As far as I know, UOB and OCBC are not charging SRS account holders any special or additional fees. For them, SRS money which is deposited and then left untouched by the customer, is no different from money deposited by a customer in his savings account, and left untouched.

Being SRS institutions, these banks do get the chance to pitch products to their SRS account holders. But whether you buy or not is up to you.

Whether you open an account with UOB, OCBC or DBS, you can use the SRS money to invest via other firms too eg Dollardex, Finatiq, Fundsupermart, or a financial advisory firm (if you are using one).

Anonymous said...

You said it yourself.
This is mainly for high earners.

Anonymous said...

"Also, the SRS has some uses for income earners who foresee that in the future, there will be a year, or two, or three, when their taxable income will dwindle sharply (for example, the person might be planning to temporarily stop work to pursue higher studies, or to look after the kids at home)."

Can you elaborate on this and how it would be useful ? Sorry, new to the SRS...thinking of starting next year and maybe going part time to care for kids too.

Mr Wang Says So said...

Okay, you need to do your own calculations to see if it works for you. But here is an illustration.

- Suppose you are clearly in the 14% tax bracket.

- In 2008, you contribute $10,000 to your SRS.

- In 2009, you contribute another $10,000 to your SRS.

- Your total tax savings are 0.14 x ($10,000 + $10,000) = $2,800

In 2010, you stop work and have no other income. However, there is $20,000 + a little interest in your SRS account.

You withdraw about $20,000 and leave a little interest in the account (there's a technical reason why you should leave at least $1 in your account, but I won't go into details).

As this is an early withdrawal, you have to pay a penalty of 5%, and you will also be taxed on the $20,000 withdrawal. The $20,000 sum is considered your income in 2010.

5% penalty on $20,000 is $1,000.

$20,000 is taxed at zero (this is because the tax rate for the 1st $20,000 of income is zero).

So you get $19,000 back, after paying the 5% penalty.

Your earlier tax savings was $2,800. After paying the 5% penalty, you still make $1,800.

---------------

The work involved in making the $1,800 profit was:

(1) writing one cheque in 2008;
(2) writing one cheque in 2009;
(3) withdrawing your $19,000 in 2010.

That's really not much work. It's difficult to find other ways to make $1,800, with so little work.

Mr Wang Says So said...

"This is mainly for high earners."

Not sure how high means high to you. But anyway, here's a simple illustration for a Singaporean whose monthly salary is about $5,000.

After CPF deductions, he earns about $4,000 per month.

Assume 1 month bonus. So for the year, he earns about $4,000 x 13 = $52,000.

After a couple of tax reliefs, let's say his chargeable income is $49,000. That puts him in the 8.5% tax bracket.

His income tax would work out to:

$900 (on the first $40,000)

plus

8.5% x the next $9,000 = $765,

meaning he has to pay a total of $765 + $900 = $1,665, in income taxes.

Now let's say that he had decided to contribute $10,000 to his SRS.

His chargeable income would now become $49,000 - $10,000 = $39,000. Now he falls into a lower tax bracket (the 5.5% tax bracket).

His income tax works out to:

$350 for the first $30,000

and

5.5% on the next $9,000

meaning he pays a total of $350 + $495 = $845, for his income tax.

So his tax savings (thanks to the SRS) is $1,665 - $845 = $820.

--------

Again $820 may or may not seem to be a lot of money to you. But the way I see it, to make the $820, the chap would only need to go to the bank, fill up an application form to open an SRS account, and deposit $10,000 into the account.

That secures the $820. It's not a lot of work.

The $10,000 is for his own old age anyway. Contributing $10,000 for the year, works out to setting aside about $833 per month, or roughly about 20% of his take-home pay.

If setting aside $833 is too difficult, then he can choose to contribute a lesser amount. (of course his tax savings will also reduce).

Salary.sg said...

Not sure why you would use a different projected rate of return, for SRS money and non-SRS money.

Since the SRS money has certain restrictions (e.g. investing in property is not allowed), I think it's reasonable to assume a lower return for SRS money.

Mr Wang Says So said...

I understand your point -

but the practical reality is that if a person's reason for not contributing $11,475 to his SRS is that he would rather use the money for direct property investment,

then he is probably very faraway from being a direct property investor anyway.

Simple illustration:

Downpayment for a $1m apartment is $200,000. But $11,475 is small change, compared to $200,000.

$9,000+, which is what remains of the $11,475 after paying the income tax, is even smaller change, compared to the $200,000.

And accumulating enough cash to make the downpayment is, after all, usually the biggest barrier for people who want to invest directly in property (as mortgage payments can be covered by rental income).

(Note - by "property investor", I mean a person who owns at least one property, other than his own residential home.)

Rush said...

thanks for the insight. My mistake on the 9.6%. (it is indeed closer to 20%!)

the 5% early withdrawal penalty relative to the tax saved in previous years is indeed a net win if you had saved at least 5% in tax upon contribution.

If you plan to only have SRS income during your retirement, while working, perhaps you can amass up to:

$20,000 (current 0% tax bracket)
* 10 years (maximum withdrawal window)
* 2 (because only 50% is taxed)
= $400,000 in your SRS account (ignoring personal reliefs and interest within the 10 year window for simplicity).

Any amount above $400,000 will attract tax, at the marginal rate, which (currently) can be as low as 3.5%.

So maybe individuals should work with this yardstick in mind when contributing to SRS over the years?

Mr Wang Says So said...

Yes I think that this yardstick would work very well for most people.

However, there is still one more feature to mention. Any amount above $400,000 will attract tax, but there is still a 50% concession on that amount.

So for instance suppose there is $440,000 in your SRS account. You withdraw $400,000 of it, tax-free over 10 years.

At the end of 10 years, the remaining $40,000 will be taxed as if it were $20,000. That means it would still attract zero (since zero percent tax applies to your 1st $20,000 of income).

So actually your $400,000 figure should more accurately be reflected as $440,000.

contrarian said...

There is one very important assumption in the SRS: that the future government at the time of withdrawal many years later will keep the SRS scheme constant.

For example, the SRS withdrawal age is 62. But if you were 32 and participate, you are taking the risk that 30 years later, the future government will allow withdrawals in the same way as today's rule.

If you have seen how CPF changes over time from 1955 to today, you will realise that 30 years is a long time as far as a future dated obligation goes. Or if you have bought a long term life insurance policy and seen the expected payouts change over decades, you would also come to a similar conclusion. The future benefit as projected today is not guaranteed, it is only promised and expected.

serendib said...

I've been contributing to SRS for a few years now, but the recent tweaking of SRS rules has made me ponder whether the effectiveness of this scheme.
The allowed period for withdrawals now starts at retirement age, not a firm 62. So if the retirement age increases, so does one's wait to withdraw - and one could argue that the longer the time horizon, the higher the chances that
a) your SRS balance would be over $400k and
b) you might need to exercise an early withdrawal and
c) the SRS rules and/or tax regime would have changes against your favour

Secondly, look at the issue of how much tax one is saving - at the 14% bracket, the saving is $1606, which translates into no more than 1.76% of your _taxable_ income (as your taxable income will be at least $91,475). At the 8.5% and 20% brackets, the savings are no more than 1.89% and 0.69% respectively.

So by annually putting aside $11475 + an additional 2% of one's taxable income (but this 2% must be realised thru cutting on expenses, not other savings)into a long-term invest plan, one can replicate the "benefit" of SRS.

Finally, I'm afraid trying to invest SRS funds into stocks means one is restricted to either locally offered unit trusts, ETFs or whatever's listed locally. For an investor wanting to create a globally diversified SRS portfolio will have to contend with unit trusts and ETFs which have high sales/brokerage charges and annual fees in comparison with whats available say in US/UK markets. So expect the CAGR of your SRS porfolio to lag 50-100bps behind a similarly diversified non-SRS porfolio.

Mr Wang Says So said...

"The allowed period for withdrawals now starts at retirement age, not a firm 62. So if the retirement age increases, so does one's wait to withdraw ..."

Actually, if you read the SRS rules, the applicable age for withdrawals to start is the official retirement age prevailing at the time you made your first SRS contribution. If it's age 62 for you, it will be age 62 for you, even if the official retirement age is later adjusted.

serendib said...

Actually, if you read the SRS rules, the applicable age for withdrawals to start is the official retirement age prevailing at the time you made your first SRS contribution.

thanks, you're right about this point. Let's just hope they dont move the goalposts on this one - I imagine the CPF rules 30years ago must have been very different to what they are today.