Not just Some Retirement Scheme

Beyond the tax carrot, think of the SRS as insurance against having no income

'I HAVE finally set up my SRS account!" I texted some friends and colleagues excitedly after putting some money in the Supplementary Retirement Scheme (SRS), a little-known and widely misunderstood government savings and investment vehicle that gives attractive tax benefits.

Those I asked were financially savvy people in upper middle-income jobs earning an income which makes the scheme's tax savings worthwhile.

They could also use the money saved inside to invest in the stock market, which some already do.

But their replies weren't too encouraging.

"What's that?" was a standard response.

"This is a US thing?" said one.

"This is the one for your parents?" asked another.

"I don't have a DBS account," someone said.

"I need the money to buy a house," was another common reply.

After 13 years in existence and numerous articles about it online and in print, the SRS is still largely unknown among the general populace.

Even if people know that it is linked to retirement, they have very little idea how it works or how they can benefit from it.

This is a pity. Setting up the scheme takes just minutes if you have an Internet banking account, but the benefits can last a lifetime.

As long as you contribute to it before the end of every year, you will be eligible for tax savings for the following year of assessment - hence the timing of this column, before people go off for their year-end holidays.

The biggest misunderstanding of the scheme is that you cannot withdraw your SRS monies early.

You can actually withdraw anytime. But if you withdraw before the statutory retirement age from the time of your first contribution - currently age 62 - the full sum will be subject to income tax, and an additional 5 per cent penalty is imposed.

Thus people think the penalties are too onerous. Why lock up your money when so much is already locked up with the Central Provident Fund (CPF)?

But they are missing the point. The SRS can be used to buy stocks, funds, and even life annuities. It is, at first glance, a long-term savings and investment scheme with a tax bonus.

While money used to top-up CPF accounts can also give you a tax benefit, CPF monies are harder to get out than SRS monies.

For many income-earners, the benefits from tax deferment, especially from the tax exemption for half of monies withdrawn upon retirement age, should outweigh the disadvantages of the early withdrawal penalties. The scheme, explained in the other story, is especially powerful in Singapore where there are zero or low taxes on a substantial amount of annual income.

In fact, if you consider yourself a long-term investor with a time horizon of 20 to 30 years, the psychological deterrent of early withdrawal can actually work in your favour. You will not be as tempted to sell at the bottom and buy at the top. Your SRS portfolio might outperform your regular portfolio, simply because stocks are more likely to be left alone to generate dividends and grow.

The three local banks operate the SRS scheme. Right now, they are offering vouchers or cash incentives for people to sign up.

Sometimes, they will take the opportunity to persuade you to buy insurance or unit trust products with your SRS monies. Think carefully if they are suitable for you.

But if you buy stocks with them, the transaction charges are lower compared to most online brokerages. However, there are service fees of S$2 per counter per quarter. So it is not advisable to buy an excessive number of counters for your SRS portfolio.

Worst-case scenarios

What are the worst-case scenarios for someone using the SRS? There are a number that come to mind.

The first is where a worker suddenly needs the money before retirement but is still liable to pay taxes in the same bracket.

In that case, he will not only have to incur the 5 per cent early withdrawal penalty, but will also be taxed on the amount he withdraws. This means he has effectively made a 5 per cent "loss" on his decision to use the scheme.

The second is more unusual, but not beyond the realm of possibility. This is the "late bloomer" scenario where you may have hit retirement age, but still continue to work and earn far more than what you previously did when you first contributed to the SRS. At the same time, tax rates move up.

Suppose when you are 65, you are the director of several company boards, on top of a salaried position that gives you a substantial paycheck.

You are at the peak of your career. But at that time, increasing social welfare expenses, severe income inequality and a change in political sentiment force the government to raise marginal taxes on high-earners like you to, say, 40 per cent.

Suppose you have steadily put in S$12,750 a year from age 30, and the money compounds at 5 per cent a year. You will have S$1.15 million by the end of your 65th year.

If you need to withdraw the money in one lump sum, you will be taxed on half your money withdrawn. If your marginal tax rates are 40 per cent, your effective tax rates are 20 per cent. If you haven't spent too much time contributing to the SRS from the 20 per cent tax bracket, you will be worse off, even with the tax concession.

High-balance problems

This leads us to the third worst-case scenario. This is when you are wildly successful with your SRS investments even though you put in relatively little in the beginning.

If you make millions of dollars with your SRS monies, then you are effectively letting yourself be taxed heavily on the capital gains when you withdraw what you have made - as income. In that scenario, you would have been far better off investing outside of the SRS system, where there are no capital gains taxes.

This is the "implicit capital gains tax" problem that was hotly discussed when the scheme was first introduced. But the Ministry of Finance had pointed out then that investors are putting in pre-tax dollars with the scheme as opposed to after-tax dollars outside. And the 50 per cent concession on what is taxable upon retirement means most retirees are unlikely to pay any taxes, it said.

If you have a high balance, one possibility to save on taxes is to buy a lifetime annuity product to spread payments out. But you will still be effectively taxed on half the annuity's payouts every year.

Your SRS monies also form part of your estate upon death, with 50 per cent of the withdrawal subject to income tax. The withdrawal happens in one lump sum. This may not be the most tax-efficient estate planning vehicle.

There are other minor problems to watch out for.

For example, you might have already hit the maximum contribution cap for the year, and are fully invested in a company. But the company does a rights issue. In that event, you will have no choice but to sell your rights entitlements and suffer dilution, or sell some other investment to free up cash to subscribe to the rights.

The best-case scenario appears to be for a high-income earner to get the maximum tax benefit every year, and reach age 62 with around S$400,000 in his account. Assuming this high-income earner stops working immediately at age 62 with no further income, and assuming whatever is left does not grow further, he can enjoy S$40,000 a year tax free if he spreads out the withdrawals evenly over the maximum 10 years.

This explains why the SRS is more popular with those in their 40s and 50s. They are more likely to be in a situation where they reap substantial tax savings, while they are not too far away from the retirement age. So they are not likely to run the risk of having too much in their accounts.

SRS is insurance

Given these worst-case scenarios, it might be more helpful to think of the SRS as a form of disciplined saving, and as an insurance mechanism to guard against having no income.

After all, most people do not know if a job will still be waiting for them several decades from now.

Having some cash "locked up" in this fashion will help. You don't even need to invest the money, to be safe.

Should a person become physically or mentally handicapped, they will also be able to withdraw their SRS savings penalty-free with a 50 per cent tax concession, regardless of age.

Even before you turn 62, there might be years when you will not be earning any income. For example, you might want to quit your job to look after the kids. This can happen when you are in your 30s or 40s.

In that case, if you have made SRS contributions from a marginal tax rate bracket of 7 per cent or more, the 5 per cent early withdrawal penalty will still make the scheme worth it as long as you do not incur any other income tax from withdrawal. This is the case if you withdraw just S$20,000 a year.

If you have no income, and have been contributing from a tax bracket of 7 per cent a year, you can arguably benefit even by withdrawing up to S$45,000 a year - where you have an effective income tax rate of 2 per cent on top of the 5 per cent penalty.

The higher your income tax bracket when you contribute, the more you can withdraw and still benefit despite the 5 per cent penalty.

Ultimately, the SRS is not an easy scheme to understand. But there are reasons even beyond the attractive tax benefits for Singaporeans to consider having some money in it.


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