Maximising the Benefits from SRS

In last week's blog post on SRS Exit Strategy, I mentioned that the Supplementary Retirement Scheme (SRS) would benefit most investors except for super-investors in lower-income groups who could grow their portfolios by leaps and bounds. This is actually only a high-level analysis. The truth is, everyone, including the super-investors mentioned above, could benefit from SRS at some stage. Before we go into the details, let's recap this chart from the previous blog post, which shows that super-investors in lower-income groups actually benefit less from SRS compared to fellow investors in the same income group who do not invest as well. It is worth investigating the case of the super-investor in the $60,000 income group to understand why this is so and how everybody could maximise the benefits from SRS.

Change in Portfolio Value Due to SRS Assuming 35-Year Investment

The assumptions for the super-investor in this case study are as follow:

Investment Period	35 years
Withdrawal Period	10 years
Annual Income	$60,000
Annual SRS Contribution	$12,000
Annual Rate of Returns	12%

The table below compares the difference in the portfolio value of an annual after-tax investment in a non-SRS account and an annual tax-deferred investment in the SRS account for each year of contribution.

Benefits from SRS for each Year of Contribution

For the non-SRS portfolio, the tax on a $12,000 pre-tax investment is $840 per year. For the 1st year, the after-tax investment of $11,160 compounding at an annual rate of 12% would result in $589,244 by the end of 35 years. In contrast, if this investment is made in a SRS portfolio, the full pre-tax amount would compound to $633,595 by the end of the same period. However, half of this amount is subject to tax. Assuming equal withdrawals over 10 years, the taxable amount each year would be $31,680, attracting an annual tax of $259 or total tax of $2,588 over 10 years. The post-tax portfolio value for this 1st year's contribution would be $631,008, or $41,764 more than the non-SRS portfolio.

Likewise, for the 2nd year, the after-tax investment of $11,160 would compound to $526,110 in the non-SRS portfolio by the end of the 35-year holding period. For the SRS portfolio, the pre-tax portfolio value for the 2nd year's contribution would be $565,710. However, the total value in the SRS portfolio now increases to $1,199,306. This pushes up the total tax payable to $19,476 over the 10-year withdrawal period. Because $2,588 of this tax is due to the 1st year's contribution, the additional tax due to the 2nd year's contribution would be $16,888. The post-tax portfolio value for the 2nd year's contribution would be $548,822, which is still $22,712 more than the non-SRS portfolio. 

As you can see, the benefits from SRS decreases for each year of contribution, until it turns negative for this super-investor by Year 6. The main reason is the value in the SRS portfolio accumulates with each year of contribution, which pushes up the marginal tax rate. If he continues to invest through his SRS portfolio for the full 35-year period, he would gain only $36,469 compared to his non-SRS portfolio. This explains the drop in benefits from SRS compared to fellow investors in the same income group who do not invest as well. On the other hand, if he stops contributing to his SRS account by Year 6, he would have gained $87,710, or $51,241 more. Thus, even a super-investor in lower-income groups would stand to gain from SRS at some stage. The key is knowing when to stop contributing to the SRS account. 

Mathematically, the after-tax value in a non-SRS portfolio for an investment amount is as follow:

[Contribution * (1 - Current Tax Rate)] * (1 + Rate of Return) ^ (No. of Years)

For a SRS portfolio, the after-tax value is as follow:

[Contribution * (1 + Rate of Return) ^ (No. of Years)] * [1 - Future Tax Rate/2]

Thus, investors will benefit from SRS if the current tax rate is more than half of the applicable future tax rate at the time of withdrawal. While current tax rate is known, it is difficult to estimate the applicable future tax rate even if tax rates remain the same. This is because the applicable future tax rate depends on the portfolio value at the time of withdrawal, which is dependent on the contribution amount, investment period and rate of returns. A higher contribution amount, longer investment period and higher rate of returns would all push up the applicable future tax rate, making investment through the SRS account less attractive.  To get the most out of SRS, every investor who invests through SRS would need to assess the benefits from each year of contribution.

While the above analysis can be tedious as it take some guesswork to estimate the rate of returns, there is some certainty for investors in higher-income groups. The highest marginal tax rate is 20% currently. Assuming this highest marginal tax rate remains unchanged at the time of withdrawal, it means that investors who are currently paying marginal tax rates of 10% or more will definitely gain from SRS, regardless of their rate of returns. Currently, this means that those whose taxable income (after SRS contribution) is more than $80,000 will definitely gain from SRS. The higher the marginal tax rate, the larger is the benefits from SRS.

In conclusion, SRS contributions will generally result in benefits for most people. Even super-investors in lower-income groups will stand to gain from SRS at some stage. However, to fully maximise the benefits from SRS, you will need to assess the benefits for each year of contribution.


See related blog posts:

• SRS Exit Strategy
• Minimising the Costs from SRS and CPF Investments
• Deciding How Much Tax You Want to Pay