Sunday, December 5, 2010

Supplementary Retirement Scheme works best for the rich

Dec 5, 2010

I refer to the article, 'Saving a little today will go a long way' (Nov14), which shows how the Supplementary Retirement Scheme (SRS) helps taxpayers save on taxes.

SRS works best for high-income earners. For the rest of us, the savings are uncertain and the scheme can even result in some paying more taxes, as I will explain.

SRS contributions are tax-free up to $11,475 per year, but only for money that goes in. Unlike the Central Provident Fund, you must pay taxes - on half the money - when it comes out. Withdrawals are over a 10-year period beginning at the statutory retirement age, which is now 62.

Why does SRS sometimes result in little or no tax savings? There are two key reasons.

First, the article explains that withdrawals before age 62 entail a 5per cent penalty plus taxes on 100 per cent of the money withdrawn, which 'includes whatever capital gains you might have made from your investments using your SRS funds'.

Actually, non-early withdrawals also entail a capital gain tax. SRS also taxes dividends and interest. All of these are normally tax-free.

Second, the article says: 'For a person with a taxable income of $100,000, a $10,000 contribution works out to him paying $1,400 less tax based on current tax rates.'

Yes, but that is only one side of it. It's the tax savings when you put money in. How about when you take the money out? Could you pay even more taxes then?

Yes. Suppose $10,000 per year goes into the SRS from age 22. At 7per cent interest, it will grow to $2million by age 62 and one would withdraw roughly $200,000 per year for 10 years and pay taxes on half, which is $100,000 per year.

[If you're making $100k at age 22. I think that qualifies as rich.If you can consistently get 7% interest for 40 years, you are incredibly savvy investor. This is about what the highly risky mini-Bonds were offering. Now either 7% returns incurs that kind of risk, or the mini-Bonds were wrongly assessed in terms of risk. But at this point there are few investments that can steadily offer that kind of returns. And if you can withdraw $200k per year for your retirement out of a nest egg of $2m, I think you rank in the well-off if not rich category. Most likely, a 22 year old will not be making enough to contribute to the SRS. There are too many discretionary expenditure at that stage in life. Even at 35, most people may not have the means to save to the SRS consistently. But never mind.]

It incurs total taxes of $7,100 x 10 years = $71,000, which exceeds $1,400 x 40 years = $56,000 in tax savings.

[I don't know how he arrives at $7,100 taxes per year for 10 years, but for a so-called financially-savvy adviser, he totally ignores concepts of present values and future values. Put another way: Would you agree to have $56k now which you don't have to repay for 40 years, and at the end of 40 years, you will pay back $71k in fixed installments of 10 years. Ok, that's not exactly fair either. It should be $1,400 per year for 40 years, after which you pay back $7,100 per year for 10 years. Note that this $71,000 is based on his computation that said saver/investor will turn $400,000 to $2m over 40 years based on an investment return of 7%. I suspect that the figure will work out to less than that for most people because they will save for less than 40 years, and their returns will be less than 7%. ]

Why? The reason comes back to SRS taxing your capital gains, dividends and interest income.

In general, SRS works best for the rich. It offers a good chance of paying lower taxes if your tax bracket is (i) high when the money goes in, (ii) low when it comes out and (iii) if you invest late in life in low-yield securities, such as bonds.

Larry Haverkamp

[I usually like his analysis of financial and investment issues, but this is just biased and unrealistic. Perhaps he has an agenda - people are foregoing investing with him in order to squirrel away their savings in SRS? I don't know.

A rebuttal of sorts below.]

Dec 19, 2010

Why SRS accounts are a good way to save

While some dispute benefits of supplementary retirement scheme, it's possible to enjoy good return on investments

Around this time of the year as the annual bonus payout approaches, I find myself promoting a little-known savings programme known as the supplementary retirement scheme (SRS).

This is a scheme established in 2001 to complement the Central Provident Fund (CPF), which allows a saver to put up to $11,475 a year into a special account that can be opened at DBS Bank, OCBC Bank or United Overseas Bank and enjoy a tax relief on his contribution.

As Singaporeans live longer and healthier lives, relying solely on their CPF to keep them comfortably retired during their golden years may not be sufficient, especially if a big chunk of it is used to service monthly housing instalments.

What SRS offers as an incentive to savers is the tax savings they get from the money they put away into an SRS account.

Let me explain.

If you have a taxable income of $100,000 and you put away $10,000 into your SRS account, you can enjoy savings of $1,400 on your income tax bill the following year.

It is a tidy sum not to sneeze at, especially if you have the discipline to keep squirrelling away the same sum into your SRS account every year.

After 10 years, you will reap considerable savings of $14,000 on your income tax and that is not including any interest or investment returns which you might have earned from those savings.

After reaching the mandatory retirement age - now fixed at 62 - you can withdraw up to $40,000 tax-free from your SRS a year.

This works out to a maximum tax-free sum of $400,000, as SRS withdrawals can be staggered over a period of 10 years after retirement.

Data furnished by the Government shows that the effort to popularise the SRS is slowly bearing fruit.

Between 2007 and last year, the number of SRS account holders jumped by 12,322 - or 30 per cent - to 53,656, as more Singaporeans learnt about the scheme and decided to sign up.

This is a significant improvement over earlier years when the number of account openings languished at a sluggish pace.

Still, this number is a far cry from the 400,000-odd taxpayers, earning more than $60,000 a year, and who may reap some tax savings by putting some money into an SRS account.

When a saver squirrels away some money into an SRS account, he does not need to keep it locked up in a cash deposit. He can use the money in the SRS account to buy unit trusts, insurance policies or even stocks listed on the Singapore Exchange.

But the few times I had written to raise public awareness of the SRS, I received feedback from a few disgruntled readers who disputed the benefits it bestowed on the ordinary saver.

One reader noted that there was a 5 per cent penalty charge for early withdrawal. The sum withdrawn would also be treated as part of his taxable income for that year.

Doesn't this smack of a disguised capital gains tax, he asked.

There was another reader who griped that the SRS was useless for savers who were not interested in buying financial products from banks.

'If you already plan to buy things like unit trusts from that pretty girl in the bank, you can consider putting money into SRS, enjoy some tax savings and make her very happy for closing the sale and getting a commission out of it,' he wrote.

A third reader raised the intriguing possibility that a successful investor may actually end up footing an even bigger tax bill on the monies he withdraws from his SRS account after retirement.

While not disputing the merits of the points they raised, I can use only my experience as an SRS account-holder to point out some of the benefits.

I have been diligently putting money into my SRS account every year since its inception.

Going through the SRS data furnished by the Government, this decision is hardly surprising. I belong to the age group, between 36 and 55 years, which form 70 per cent of all SRS contributors.

In general, wage-earners in this age group would have a steady job and a steady income, with some cash to spare - after servicing their home mortgages and car loans.

After 10 years, I can attest to the considerable sum I reaped on the tax savings I enjoyed from the SRS contributions.

The incremental benefits add up. The total tax savings that I received over the past decade were sufficient for me to make the maximum SRS contribution of $11,475 for this year - and still have cash left over.

And unlike some SRS account holders who complain that they are lured into buying unsuitable insurance policies or financial products, I am glad to report that my experience has, so far, been a happy one.

In my 10 years of putting money into my SRS account, I have never once been pursued by an insurance agent or financial adviser on how to invest the funds.

Partly, this is because I know how I want to invest the money. That is surely the maxim which any investor should apply on all his investments, and not simply those related to SRS.

As I have no intention of making any premature withdrawal from my SRS account prior to retirement and attracting the 5 per cent penalty charge, I can afford to take a long-term view on selecting the investments. This has served me well.

My SRS account now has a couple of blue chips that were accumulated when they fell to attractive levels during the 2003 Sars crisis and the more recent global financial crisis two years ago.

I am also perfectly happy to keep the SRS contributions parked in cash in some years when I could not find any stocks worth my while to invest in.

Despite the market upheavals over the years, I have enjoyed an annual return of 12 per cent on my SRS investments. All in, my SRS account has outperformed the benchmark Straits Times Index in the past decade.

But unless I enjoy an extraordinary stroke of good luck in my investments, it is unlikely that I would ever hit the $400,000 tax-free savings ceiling limit for the SRS account by the time I retire.

I believe that this is an experience which most SRS savers are likely to share, since they keep their SRS monies in ultra-safe investments like blue chips, bonds and insurance products.

For us, the benefits in having an SRS account are obvious.

What is needed is for the scheme to be given a makeover like a catchy name change to attract more savers to its fold.

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