SRS

So far, we have talked about Insurances. As we have mentioned there are 8 aspects to financial planning, we would like to move towards another aspect. Here, we look at one particular tool that many find helpful in managing their finances. It's called the Supplementary Retirement Scheme (SRS).

What is it?

First launched in 2001, the SRS scheme helps Singaporeans save more for their old age. Unlike CPF, SRS contribution is a voluntary scheme. To encourage residents to plan and set aside money to meet retirement needs, contributions into SRS are eligible for tax relief. On top of that, investment returns are tax-free before withdrawal, making it an attractive tool. The final sweetener is that only 50% of the withdrawals from SRS are taxable at retirement.

The Mechanism.

To be eligible for SRS contribution, you must meet the following conditions:

1. At least 18 years of age;

2. Not an undischarged bankrupt;

3. Not suffering from a mental disorder; and

4. Capable of managing yourself and your affairs.

Yearly maximum SRS contribution is capped at $15,300 for Singapore citizens and Permanent Residents and $35,700 for foreigners, as at 1 Jan 2017. The full amount contributed into your SRS will be eligible for tax reliefs, if you are a tax resident for that Year of Assessment.

What is the absolute amount that you can save in taxes when you contribute to your SRS account? That depends on your annual income and the applicable tax reliefs. But let's do a case study using Joe, to see how much he can save.

Assume that Joe’s chargeable income is S$54,000. Referring to the income tax table in Fig 1 below, his gross tax payable will be S$550 + (S$54,000 - S$40,000) x 7% = S$550 + S$980 = S$1,530 for that year. This works out to be an effective tax rate of 2.83%.

If Joe contributes the maximum allowable amount of S$15,300 into his SRS account, it brings his chargeable income to $38,700. His gross tax payable becomes S$200 + (S$38,700 - $30,000) x 3.5% = S$200 + S$304.50 = $504.50. This works out to be an effective tax rate of 0.93%, significantly lower than 2.83%.

By setting aside $15,300 in your SRS account, Joe immediately saves $1,025.50. How cool is that?

Even if you were to leave your money in the SRS account and do not invest it, your tax savings alone would have reaped a handsome return of 6.7% for that year.

Joe doesn’t have to contribute the entire $15,300. In fact, he can choose to contribute any amount from $0 to $15,300. Options always make the decision far more complicated. Should Joe contribute $15,300 to save $1025.50 in taxes, or should he contribute less, for example, $14,000? By contributing $14,000, he saves $980 in taxes (still a nice amount) vs $1,025.50; a difference of S$45.50.

If you are Joe, would you want to contribute $1,300 more into the SRS account to save on an additional $45.50 of taxes?

The ‘catch’

So it seems like a sweet deal. SRS reduces our taxes, and it is not into some black hole that we have no control over. What is the drawback and how does this scheme fulfil the government’s aim of encouraging people to save more for old age?

The ‘catch’ is in the withdrawal. You can withdraw funds from your SRS account anytime. However, if withdrawal takes place before the penalty free withdrawal age, 100% of the amount withdrawn will be taxed. In addition, a 5% penalty is imposed on the withdrawal amount. This measure forces you to recognise that the use of SRS is meant for retirement; it is not meant as a savings plan for general purposes.

If you withdraw after the penalty free withdrawal age, only 50% of the amount withdrawn will be taxed, and there is no penalty. The withdrawal from your SRS account can be made over a ten years period. The below example shows you how it works.

Assuming SRS money is your only source of income after retirement, based on the current prevailing tax rate, you can withdraw as much as S$40,000 a year without taxes. That is because when you withdraw $40,000, only 50% (or $20,000) is subject to tax. And as the first $20,000 is taxed at 0% (see fig 1), there will be no income tax payable for the year.

The penalty free withdrawal age is dependent on the prevailing retirement age at time of first SRS contribution. Currently, it is 62. Hence anyone who opens a SRS account today, and contributes an amount, the penalty free withdrawal age is 62. Should he delay in contributing to his SRS account, and the government announces an increase in retirement age, the penalty free withdrawal age would then follow the new increased age.

The full potential

Of course the tax savings is a key reason to utilise the scheme. However, if you choose to leave the money in the account without doing anything, the interest earned is very minimal, currently it hovers around 0.05%. By not using the monies inside the account wisely to achieve better returns, your money will succumb to its greatest enemy; inflation. Inflation devalues your hard earned money over time. In today’s climate, the banks’ interest is often insufficient to fight off inflation.

So what should you do? Consider growing this money through various investment tools available. Unlike CPF, restrictions on SRS investments are minimal, with exceptions of direct property investments and certain insurance products. Because of the wide range of available instruments, and a considerable time frame, you will need to structure a portfolio and adjust it over the years. In our next article, we will be exploring some tools for SRS investments.

In conclusion.

If you take the first step and make a contribution to your SRS account, you will immediately save on taxes. You have also taken small steps towards accumulating assets for retirement. How much to contribute really depends on your tax level as well as current economic situation.

But if you choose to contribute, you will need to determine how to use the funds in the account, to avoid inflation eroding your value.

Finally, even the withdrawal needs to be planned in conjunction with the income tax rules of the time of withdrawal. This is to avoid paying taxes when you are retired and drawing on SRS funds.

So while the use of SRS is simple, the ability to maximize its benefits is not.