The Supplementary Retirement Scheme (SRS) was started in 2001. I first learnt about it around 2003. Still, it took me a good 3 years before I made my first contribution. The reason? I had not figured out an exit strategy from the SRS scheme. Although SRS contributions are tax-deferrable and only 50% of the withdrawals after the age of 62 would be taxed, there was a lingering concern that I could still end up paying more tax if I could achieve a good rate of returns on the SRS funds. After 8 years of contributing to the SRS account, I finally got around to carry out a sensitivity analysis to determine whether my concerns were valid.
The analysis compares the difference in the portfolio value of an annual tax-deferred investment in the SRS account and an annual after-tax investment in a non-SRS account. The analysis is carried out based on the following assumptions:
The analysis compares the difference in the portfolio value of an annual tax-deferred investment in the SRS account and an annual after-tax investment in a non-SRS account. The analysis is carried out based on the following assumptions:
| Investment Period | 30 years |
| Withdrawal Period | 10 years |
| Annual Income | $30,000 - $120,000 |
| Annual SRS Contribution | $12,000 |
| Annual Rate of Returns | 0% - 12% |
The tax rates used for the analysis is based on the current tax rates, which can be found at IRAS' website. The analysis further assumes there are no tax deductibles or reliefs for computation of the tax payable.
The results of the analysis is shown in Fig. 1 below.
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| Fig. 1: Change in Portfolio Value Due to SRS Assuming 30-Year Investment |
Based on the chart above, SRS will result in savings for most income groups. The exception is the income group earning an annual income of $30,000 or less. For this income group, an investor who is able to invest his SRS funds at a annual returns of 8% would actually end up with a lower portfolio value if he had contributed to his SRS account. The higher his rate of returns, the lower is his portfolio value. For this person, he is better off paying the tax upfront (i.e. not contribute to his SRS account) and invest his after-tax income.
The reason is because, for this income group, the marginal tax rate is only 2%. The annual tax savings from SRS for a $12,000 contribution would be only $200. But when an investor is able to achieve an annual returns of 12% (let's call him a super-investor), his SRS portfolio at the end of 30 years would be worth a whopping $3.24 million. Spreading the withdrawal evenly over 10 years and only half the withdrawal would be taxed, his taxable income would be $162,000 per year. This puts him in the marginal tax bracket of 17%. He would end up paying $14,320 per year in tax, or a total of $143,200 for 10 years, thereby reducing his SRS portfolio value to $3.10 million. Had he not taken advantage of the SRS scheme, his non-SRS portfolio (based on annual investment of $12,000 minus tax of $200) would be worth $3.19 million, or $89,000 more than his SRS portfolio.
The reason is because, for this income group, the marginal tax rate is only 2%. The annual tax savings from SRS for a $12,000 contribution would be only $200. But when an investor is able to achieve an annual returns of 12% (let's call him a super-investor), his SRS portfolio at the end of 30 years would be worth a whopping $3.24 million. Spreading the withdrawal evenly over 10 years and only half the withdrawal would be taxed, his taxable income would be $162,000 per year. This puts him in the marginal tax bracket of 17%. He would end up paying $14,320 per year in tax, or a total of $143,200 for 10 years, thereby reducing his SRS portfolio value to $3.10 million. Had he not taken advantage of the SRS scheme, his non-SRS portfolio (based on annual investment of $12,000 minus tax of $200) would be worth $3.19 million, or $89,000 more than his SRS portfolio.
We always hear that it is better to invest early for the magic of compounding to take effect. How would the above analysis change for investors who start making SRS contributions earlier and for longer periods? The results are shown in Fig. 2 below.
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| Fig. 2: Change in Portfolio Value Due to SRS Assuming 35-Year Investment |
The effects of a longer SRS contribution and investment period would reap benefits for the higher-income groups but not for the lower-income groups. Although a longer investment period would increase the portfolio value at the end of the investment period, the withdrawal is limited to only 10 years, thus increasing the taxable income per year of withdrawal. For the super-investor in the lower-income group, the net effect is a greater reduction in his after-tax SRS portfolio value. In fact, we start to see similar effects for the super-investor in the $60,000 income group.
In conclusion, SRS contributions will result in tax savings for most people. The only exceptions are super-investors in lower-income groups. Nevertheless, I guess they probably would not mind paying more tax if they could grow their SRS portfolios to $3.10 million! Have you made your SRS contributions for the year already? If not, better hurry, before the year ends.
See related blog posts:
Hi Chin Wai,
ReplyDeleteThanks for the sharing. I like SRS because my company matches 50% of my contribution up to a certain limit.
I see it as an immediate 50% gain. Even if I need to draw out and pay a penalty, I figure the net outcome will still be a gain for me.
It's a winning situation with no downside.
Hi S-Reit System Investor,
DeleteGood for you. You're a lucky guy!
Another thing to consider for the lower income group is the SRS fees. Just considering DBS's account. There's a $2 charge per counter per quarter. They could introduce more fees anytime and your money is stuck there (subject to withdrawal penalty). So might as well pay the $200. (There's also tax reliefs, so the net tax paid would be less).
ReplyDeleteThanks for highlighting this important point.
DeleteJust came across this article and it seems to fit in what i thought about this issue when in 2011.
ReplyDeletehttp://forums.salary.sg/education-personal-growth/1227-supplementary-retirement-account-does-always-work-out-better-you.html#.V0QPmTV97Dc
You gave me a different scenario analysis in the sense that you compared SRS against holding cash and deriving the same gains.
But i think our conclusion are similar.
An additional point that i recently noted :
SRS recently has allowed equity holders to withdraw their holdings in non cash at current market valuations. In a downturn economy (during withdrawal stage), an SRS holder can withdraw a lot of his portfolio at min tax cost. Of course, it also means that his portfolio was badly hit. But if he is holding for the LT and there is recovery, he would have just further reduced his tax cost.
Hopefully, that gives comfort to those whom are holding positions in equity now.
Hi Lazy Plane,
DeleteThks for the link. It validates what I have mentioned above. I have another post at Maximising the Benefits from SRS which shows a year-by-year analysis on the incremental benefits of contributing to SRS. It shows that even a super-investor in a lower-income group could benefit at some point in time.