Should a person open an SRS account?
If a person already has an SRS account, should he make a contribution this year?
How should an SRS account be managed?
When should a person withdraw the monies in his SRS account?
What are the usual misconceptions?
What is the Supplementary Retirement Scheme?
The SRS is a voluntary scheme to encourage individuals to save for their retirement. It supplements the Central Provident Fund, or CPF, savings.
SRS's voluntary nature forces an individual to think about whether to start an SRS account, and whether to make a contribution in any year after he has opened an SRS account. It may not make any sense for some individuals to open an SRS account or to make a contribution to their SRS account in some years.
SRS's main attraction is that contributions to an individual's SRS account are eligible for tax relief in the year of assessment following the contribution. The effect is to reduce his chargeable income of the year in which the contributions are made (since tax is assessed in arrears in the year after it is earned).
An individual may contribute to his SRS account for as long as he wants, until he makes the first withdrawal either (a) after reaching the statutory retirement age, or (b) on medical grounds.
The maximum annual contribution this year (2011) is $12,750. This is 15 per cent of the income base. The income base is 17 times the CPF monthly salary ceiling of $5,000. ($5,000 x 17 x 0.15 = $12,750.)
No tax is payable on SRS contributions or SRS monies until the SRS monies are withdrawn. That is, tax is deferred.
When an individual withdraws his SRS monies after reaching the statutory retirement age that was prevailing at the time when the first contribution is made (currently 62 years old), half of the amount withdrawn is treated as income and will be liable to tax in the next year of assessment.
Withdrawals may be made over a period of not more than ten years from the date of first withdrawal. Half of any amount remaining in the SRS account at the end of ten years will be liable to income tax. One exception is life annuities from the SRS account, which may stretch over more than ten years, with only half the annuity receipts being liable to tax; but a life annuity policy may not be surrendered after the SRS account is deemed closed ten years after the first withdrawal.
If an individual withdraws any part of his SRS monies before reaching the statutory retirement age, the amount withdrawn is treated as income and will be liable to tax in the following year of assessment. In addition, he has to pay a penalty of 5 per cent of the amount withdrawn.
There is no penalty for early withdrawal on death, medical grounds or bankruptcy.
Withdrawals have to be made in cash (i.e., not in specie).
An individual may invest his SRS monies in a range of financial products e.g., time deposits, equities and some life insurance products etc. Direct property investments are not allowed.
An individual's SRS monies are not protected from creditors in the event of his bankruptcy, unlike monies in his CPF account.
Capital gains, interest and dividend from investing SRS contributions are liable to tax
Investments of the SRS monies generate (hopefully positive) returns. When the SRS monies are withdrawn, half the amount withdrawn (including investment returns, whether positive or negative) is taxed as income.
Some people view this as a major disadvantage of the SRS inasmuch as investment gains and income are not liable to tax otherwise.
However, this is not an additional burden, in most cases.
To see this, consider the case of an individual who is deciding whether or not to contribute $10,000 to his SRS account. Assume he can obtain a return of 500 per cent over the relevant investment period, and his marginal tax rate is 15 per cent at the point of contribution and at the point of withdrawal.
Alternative A. If he doesn't contribute to his SRS account, he pays $1,500 tax and has $8,500 after tax, which will grow to $51,000.
Alternative B. If he contributes to his SRS account, he has the full $10,000 to invest. This will grow to $60,000. When he withdraws this, he pays tax of $4,500 (15 per cent on half of $60,000) and is left with $55,500. This is more than what he would have if he didn't contribute to his SRS account.
The secret is this: with SRS, an individual invests not just the $8,500 but also the $1,500 tax which he would otherwise have had to pay upfront, but is now deferred. Although the $60,000 (which includes investment gains and income) is taxed when it is withdrawn, the $1,500 deferred tax and its related investment gains and income will be more than enough in most cases to pay the SRS tax, because only half the SRS monies withdrawn are liable to tax.
The exception is if his marginal tax rate when making withdrawals is more than twice his marginal tax rate when contributing. However, this is unlikely for two reasons.
First, the highest marginal tax rate is 20 per cent now, so anyone whose marginal tax rate is higher than 10 per cent when making contributions will not be affected. Moreover, income tax rates have been coming down, although an individual can never be certain that income tax rates will not be higher when he withdraws his SRS monies than when he made the contributions. For many individuals, the 20 to 30 years or more between contributing and withdrawing is an extremely long period to make this assumption.
Second, an individual can usually choose to start withdrawing his SRS monies when his chargeable income is lower or even zero (before taking into account the SRS withdrawals) and is allowed to withdraw his SRS monies over ten years. (An individual cannot choose when or in what amounts to withdraw his SRS monies if he dies suddenly — see below.)
The higher the investment returns, the higher the tax payable on withdrawal
Consider an individual who makes 40 annual contributions of $10,000 to his SRS account, saving tax of $1,500 per year, or $60,000 in total (assuming his marginal tax rate is 15 per cent). She invests wisely and grows her SRS funds to $2 million, which she withdraws in ten $200,000 instalments, paying tax of $20,750 a year, or $207,500 in total.
She finds that, with SRS, she pays more tax than she has saved, and blames this on the tax on investment gains and income. She regrets that she did not keep the investment returns on her SRS monies as low as possible so as to minimise the tax upon withdrawal. She could have invested her SRS monies in low-yield securities or delayed investing her SRS monies until she approached retirement or both.
Her reasoning is flawed.
First, the time value of money for cash flows spanning several decades should not be ignored. The value of $1,500 a year over 40 years cannot simply be compared to $20,750 a year over 10 years (the last 10 years of the 40 years). Otherwise, erroneous conclusions may be reached.
Second, it is meaningless to compare tax saved with tax paid, even with the time value of money taken into account. Tax saved is a function of SRS contributions, whereas tax paid is a function of how much the SRS contributions have grown. The higher the investment returns, the more tax is paid, but the individual also has more after paying the tax, simply because her SRS funds have grown more.
The cumulative investment cash flows should be compared instead. As discussed above, the cash flow is superior when using SRS than when not using SRS (subject to the exception noted above).
Minimising the investment returns on an individual's SRS monies so as to keep taxes on withdrawals low is like choosing to earn a low salary just to pay less income tax.
A individual should contribute to her SRS account if she has surplus long-term savings and if the amount of tax saved upfront is meaningful to her. Then, she should aim to maximise the investment returns.
How an SRS account should be managed
The earliest date when a individual can make a withdrawal from his SRS account without incurring a penalty is after he has reached the statutory retirement age that prevailed at the time when he made his first contribution. To lock in that date, he should open an SRS account not later than the last banking day of the year immediately preceding the year in which the retirement age will be raised (this is the theoretical latest date, but he runs the risk of banks not being able to process his application in time if he tries to open an SRS account during the last days of December). This may be done with an SRS contribution of a nominal dollar amount, although he should take into any account annual charges for maintaining the SRS account.
An individual should note also that the last day in December when his SRS bank will accept SRS contributions may not necessarily be the last banking day in December.
Like CPF contributions, SRS contributions are long-term savings. Unlike CPF contributions, they are voluntary, and an individual should be certain that he will be very unlikely to withdraw his SRS monies before he reaches the statutory retirement age.
An individual may not find it meaningful to make SRS contributions in any year if the marginal tax rate applicable to him in the following year of assessment is low. This is particularly so if he is considering making a small contribution, as he may just enjoy a very small tax relief in dollar terms.
Contributions are eligible for tax relief in the year of assessment following the contribution. It makes sense for an individual to delay making contributions until late in the calendar year when he can reliably estimate the marginal tax rate applicable to income earned by him that year. It may not make economic sense to make an SRS contribution in any year if he knows that the applicable marginal tax rate will likely be very low — for example, he retires, takes an extended no-pay leave to fulfil some personal goals, pursues a full-time course of study or stays at home to look after a young child.
Investing with SRS/CPF monies may incur additional transaction and holding costs. If an individual has other forms of savings, he should consider using his SRS/CPF monies for investing in products which he is likely to hold long term, and use his non-SRS/CPF monies for short term investments or trading.
The interest rate paid on SRS balances is usually very low, probably because the SRS banks know that most people find it very troublesome to transfer their SRS account to another SRS bank. An individual should not leave his SRS monies idle in his SRS account, except when he is waiting for a suitable investment opportunity.
Withdrawals should be managed to minimise tax payable. An individual should withdraw his SRS monies after reaching the applicable statutory retirement age and when the marginal income tax rate applicable to him in the ten years of assessment following the first withdrawal is low (or at least as low as he can reasonably anticipate or project it to be). Once he makes his first withdrawal, he has ten years to complete his withdrawals. If he thinks there is a possibility that he may rejoin the workforce any time, he should consider carefully whether he should make the first withdrawal. Once he has made his first withdrawal, he is precluded from making any further SRS contributions.
For income tax purposes, an individual is deemed to have withdrawn the entire balance in his SRS account on the date of his death. If his death is imminent and his SRS balance is substantial, it may be advisable to accelerate the withdrawal of his SRS monies to reduce the tax impact of a large (deemed) withdrawal when he dies.
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Much of this article is drawn from discussions with friends who wanted to know whether they should open an SRS account. Some of the above may not apply to permanent residents or foreigners. Readers are advised to refer to official information from Ministry of Finance or Inland Revenue Authority of Singapore or their SRS bank.
Chanced upon this. Great article. Tks for the info/analysis.
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