When it comes to the Supplementary Retirement Scheme (SRS), three of the most common questions that are asked on forums and websites like Seedly and HardwareZone are the following:
“At what tax bracket would it make sense for me to contribute to my SRS account?”
“At what age should I start contributing to my SRS account?”
“How do I maximise tax savings yet minimise future tax expenses when I withdraw from my SRS account?”
If you are just here for the answers to the above, scroll down to the end of this article and use the sensitivity tables to conclude if SRS top-ups make sense for you. You just need to know your tax bracket, your age, and investment return expectations before you can use the tables. Anyway, you will still need time to understand how the trade-offs work for you. There is no shame in being efficient with your time for this.
As a former analyst in a private equity fund, I understand that these questions are something that can be better understood mathematically through a spreadsheet using a financial model. Let us recall what we have learned from our secondary school teachers as we explore this Math problem together.
Then again, it’ll probably be easier to understand this by making this a PSLE type problem sum question. Don’t worry, you won’t need to solve this since I’ll be doing it, but the solution will certainly help you. Here goes:
The Problem Sum
John is 35 years old this year, and he is earning a modest income that puts him inside the 7% tax bracket. He wants to maximise the tax savings by utilising his SRS account, putting in the maximum $15,300 for tax relief. He intends to withdraw his SRS account over 10 years past his retirement age. He thinks that he can make a 7% return on his investment. Would topping up his SRS account now make him better off financially, assuming that the income tax rates will not change?
Tackling the Problem Sum - the Independent Variables
Moving ahead to secondary school math (yes I am cheating), the above Primary 6 Problem Sum can be converted into the below formula.
J= ax+ by-cz
The independent variables, or the values x, y, z in the above formula, is fairly simple. These will be things like John’s
- Tax bracket
- 7% returns on investments
For the purpose of making this analysis simpler, we will assume that figures like the $15,300 committed in SRS, income tax rates are fixed numbers (or a, b, c in the above formula).
Defining the Answer - the Dependent Variable
The dependent variable, or the outcome that we are trying to model, is to see if John is better off topping up or not topping up the SRS account. To ensure that an apple to apple comparison is made, let us assume that John is only willing to commit $15,300 of pre-tax savings to invest.
Fleshing out the workings for the dependent variable:
Let H be 10-year yearly cash flow, net of taxes that John’s SRS account will give him when he withdraws his SRS monies while staying invested
Let I be 10-year yearly cashflow, that John’s post-tax cash account will give him.
H – I = J where J is the upside (or downside when the value is negative) from investing through SRS rather than using post-tax monies.
For H, Do note that since John would likely have put in a huge sum of money in SRS, and given that it compounds at 7%, his portfolio would have grown to $1.14 million by the time he is 62 years old. Even though only 50% of the amount withdrawn from the SRS account is taxable, the sheer size of John’s portfolio means that he will be taxed.
Remember that in the case that John paid his taxes, being in the 7% tax bracket, he would be left with $14,229 to invest in a portfolio that compounds at 7% return over the 26 years
When John is 62 years old, his SRS account will grow to $1.14 million. Net of income tax, John will have a yearly cashflow of around $159,000 liquidating his SRS account over 10 years.
If John were to invest using post-tax monies, John’s portfolio will grow to $1.06 million. John will have a yearly cashflow of $151,000 investing with post-tax monies.
John (or value J) is better off by $8,000 (rounded up) a year, just by investing through SRS instead of investing through post-tax monies.
Making it more relevant to you
Of course, you are not John – your tax bracket is different, your age is different, your expectations of investment returns is also most likely different as well. The easy part of solving math problems on excel rather than through paper and pen (as with the case of Primary 6 exams) is that I can use sensitivity tables for the analysis. With a range of values for the independent variables, I can give you a personalised perspective of how SRS can work (or not work) for you. The sensitivity tables are as shown below (red highlights are cases where it does not work for you):
John’s case (35-year-old, 7% tax bracket, 7% return) is highlighted in yellow above. As you can see from the above table, the higher your tax bracket, the more you save through SRS, even though you may be paying more taxes on an absolute basis. Just like how a dollar now is worth more than a dollar in the future, a tax dollar saved now is worth more than a tax dollar paid in the future. This is because the tax savings can be compounded and grown to pay for higher taxes in the future. Let that concept sink in!
Do look to see how starting at different ages affects the upside that we can get
However, the same does not apply for investment returns. The higher the assumed return on investment, the worse off you are. The intuition behind it is very simple – as the SRS account is a tax deferral scheme, if you are expecting a high investment return, better to be taxed now and invest than invest now, get your wealth grown significantly and be taxed later.
Well that was a long article, but hopefully the sensitivity tables can help you rationalise your own personal circumstances better. Let me highlight that you should not top up your SRS account and invest just because you will be better off in the long run. SRS is ultimately a long-term commitment where your funds are locked in until retirement age. You should look at your medium to long term large ticket expenses(buying a new property, a new car, for example) before you commit to topping up your SRS account.
At Endowus, we believe in not just offering you institutional class investment products, but also institutional level advisory services. The Endowus advisory team have experience serving institutional clients in our previous careers in asset management, wealth management, private banking and private equity firms. We will also be building out our advisory services into our holistic financial technology platform so please look out for new features throughout 2020 as we provide the best personalised advice to help you make better financial decisions through technology.
Anyway, if the above analysis makes sense to you, hurry set up your SRS account or top it up now to reduce your 2019 taxable income! You can set up an account online and fund it immediately with the local banks.
Do you have another angle that you want to tackle the SRS top up problem? Write to me at firstname.lastname@example.org, and the best question(s) stand to win a $20 Grab voucher, a secret gift, and an article written for them. Keep the entries coming!