Over the past few years, ever since I got to know about the Supplementary Retirement Scheme (SRS) and its benefit of deferred taxation, I've always assumed that it would make sense to do so only when one is on a higher tax bracket. Should I have started SRS once I had a taxable income, or should I have waited till I hit a higher tax bracket, like 17%? My instincts told me it shoud be the later. So, I decided to work out a spreadsheet to analyse further if indeed this was correct.
Scenario 1(a) - It's good to start early
I made several assumptions for the analysis. I assumed that one starts contributing to SRS from the age of 25, with an annual taxable income (pre-SRS) of $30,400, with income increasing at 10% per year [decreasing to 5% after age 45, 3% after age 50, and 0% after age 55; excellent performer who is well rewarded initially!], contributing 10% of that income each year into SRS (but never exceeding the limit of $11,475). The SRS contribution is then invested, generating a return of 6.5% annualised. At age 60, the SRS investment is adjusted to a more conservative profile at 4% annualised. Based on these, at age 65 (retirement age), the SRS investment portfolio would have grown to $1.34 million. Not bad at all! But that wasn't the point of this study.
The total tax avoided as a result amounted to $59,800. Presuming the $1.34 million SRS portfolio is then drawn down at 1/10th a year, the amount of tax paid over the 10 years would be ~$92,750. This is far higher than the $30,400 of tax avoided in the years of contribution. So indeed, it would seem that it isn't worth starting on SRS when the tax brackets in initial years are low as one would end up paying more tax than that avoided.
Scenario 1(b) - Start early, save every cent, invest every cent
However, what if the savings from tax avoidance is invested in a cash-based portfolio at the same rate of return of 6.5% annualised? It turns out that this cash portfolio would be $175,000 by age 65 (and tax free)! That certainly outweighs the tax to be paid during SRS draw down.
Scenario 2 - Accumulation begins at 40
I reworked the same scenario. This time, SRS contribution begins only at age 40, contributing the full $11,475 annually. The total tax avoided works out to $50,000. Given the lower contributions, the SRS portfolio grows only to $680,000.
In comparison, the tax to be paid during the 10-year draw down upon retirement works out to $29,100. This is less than the amount of tax avoided.
If the tax avoidance savings was invested, the cash portfolio works out to $111,000, positively widening even further the benefit from contributing to SRS.
So, it seems my initial assumption was correct (Scenario 2). However, if one were to start early, and consistently take the savings from tax avoidance to invest (Scenario 1(b)), it turns out to be an equally rewarding approach as well.
Disclaimer: There are of course many permutations that could be explored since there are so many parameters involved. I didn't get round to testing out the various possibilities, so there could be other outcomes depending on the parameters/assumptions used.
SRS: A Brief Analysis (from "A Singaporean Stockmarket Investor" website)