With the year coming to an end, now might be a good time to take stock of your payable income tax. And more importantly, look at ways to reduce it.
For those unaware, tax reliefs have to be accounted for before the end of 31st December each year. Else, any tax reliefs would instead be applied on your upcoming year’s taxable income.
Now you might be asking, is it really necessary to reduce my income tax if it is currently negligible?
My answer to that is no.
However, as we continue advancing in our careers, our income tax would most likely increase to a point where it becomes a substantial figure. Thus, knowing how to reduce it now might be useful knowledge for the future.
Besides, some of the ways to reduce income tax can also contribute to your retirement goals.
With that said, I would be sharing three ways in which I reduce my payable income tax annually.
How is income tax in Singapore calculated?
Before discussing ways to reduce your income tax, it is good to know how it is calculated in the first place.
Singapore’s income tax is based upon a progressive tax structure. This means that higher earners will pay higher amount of taxes.
As seen above, the gross tax payable only starts getting substantial after the first $40k. Do note that chargeable income refers to the amount after accounting for tax reliefs and employee CPF contributions.
In addition, individuals with chargeable income of $20k or below are not liable for any income tax. This bodes well for those who are just entering the workforce or lower-income earners.
Now that you know how much tax you would be paying, time to look at ways to potentially reduce it.
1) Contributing to CPF
Making cash top-ups to CPF is by far the easiest way to reduce income tax. This is done by topping up either your own personal CPF account or that of your family members. Family members in this instance refer to parents/parents-in-law, grandparents/grandparents-in-law, spouse or siblings.
Do note that there are caps and restrictions when it comes to the eligibility of tax reliefs for CPF cash top-ups. For instance, the current total annual tax relief limit for CPF cash top-ups is $14k, $7k for self and another $7k for family members.
With regards to your spouse or siblings, CPF cash top-ups would only be eligible for tax relief if they are earning less than $4k in annual income.
Lastly, when it comes to CPF cash top-ups, you would need to check if the recipient’s Special Account (SA) or Retirement Account (RA) has hit the Full Retirement Sum (FRS). Any cash top-ups to CPF accounts that have hit or exceeded the FRS would not be eligible for tax relief. Currently, the FRS for 2021 stands at $186K (this amount rises by around 3% each year).
Besides the obvious benefit of lowering your payable income tax, doing CPF cash top-ups has its other perks.
You can save for retirement
As most would know, the base interest rate for SA and RA stands at 4%. This already far exceeds anything that banks can offer.
Although returns from the stock market could potentially beat this 4%, CPF is practically a risk-free product and you need not contend with the ups and downs of the market.
Furthermore, there is also the added assurance that the funds would definitely increase over time if left untouched. This provides a sort of safety net when it comes to planning for our retirement.
By topping up cash to your own CPF accounts, you would be enjoying the dual benefits of tax relief and building up of your retirement savings.
We can assist in our parents’ retirement
In Singapore, there is a non-written rule where working adults provide their parents with a monthly allowance. While many of us typically provide this in cash, contributing to their CPF accounts would be a wiser choice instead.
For one, it is a small way for us to help build up their retirement savings.
Personally, as my parents are not very financially literate, I realized that they leave huge amounts of cash in their bank accounts as savings. Thus, instead of continually contributing to this pool of money which earns paltry interest rate, it makes more financial sense to take advantage of the 4% interest rate from CPF instead.
Besides, leaving money in bank accounts would only lead to it being eroded by inflation. As such, why not contribute it to CPF instead to ensure that your parents’ retirement funds can beat the yearly inflation rate?
Of course, only contribute to your parent’s CPF if they are not relying on your monthly allowance for daily sustenance. You would not want a situation where your parents are CPF rich but struggling with their daily expenses. This is especially true if they have yet to reach the CPF withdrawal age.
Having looked at the benefits of CPF cash top-ups, I will now highlight the one major constraint about it.
The opportunity cost of money
It is no secret that funds in our SA can only be accessed at the age of 55. Even then, it is still dependent upon whether the prevailing FRS has been hit or not (only excess funds exceeding the FRS can be withdrawn). As such, cash used for CPF top-ups would effectively be stuck with earning a 4% interest rate at least till the age of 55.
This gives rise to the issue of the opportunity cost of locking up your money in CPF.
For those that regularly invest, you would know that a 4% return per annum can be beaten with slightly riskier products. Hence, if we contribute a majority of our funds to CPF, we are missing out on opportunities for potentially higher returns. Furthermore, savings in CPF is also highly illiquid as compared to other forms of investments.
Does this means that one should not contribute to their CPF at all?
Well, I would say it is down to finding the right balance and your own life circumstances. For younger salaried workers, doing cash top-ups to CPF for tax reliefs might not be the wisest choice to make. This is due to the long investment horizon we have and relatively low taxable income. Hence, we would be better off investing in riskier products with higher returns.
However, if you are reaching retirement soon or in your 50s, you might be more inclined to do cash top-ups to CPF to take advantage of the practically risk-free interest rate and tax benefits at the same time.
Thus, before doing cash top-ups to CPF, consider whether the benefits outweigh the barriers to accessing your CPF funds. Personally, I do not do cash top-ups to my personal CPF account as I prefer having liquid cash for other investment opportunities.
2) Using the Supplement Retirement Scheme (SRS)
Besides contributing to CPF, another way to get tax relief is through the supplement retirement scheme (SRS).
To make use of SRS, you first have to sign up for an SRS account with any of the three local banks (DBS, UOB or OCBC). Thereafter, you would be entitled to dollar-per-dollar tax relief for any amount contributed to the SRS account. The current SRS contribution limit stands at $15.3k per year.
You might be asking what exactly is a SRS account? Well, it is a retirement cash account with extra bells and whistles to it.
What is SRS all about
The main gist of having an SRS account is for the tax relief and retirement planning.
Besides the dollar-per-dollar tax relief on SRS contributions, only 50% of the sum withdrawn would be taxed. So if you withdraw $40k from the account, only $20k would be added to your prevailing year’s taxable income.
However, this only applies if you withdraw at or after the withdrawal age. If you withdraw before the withdrawal age, 100% of the withdrawn sum would be taxed and an additional 5% fee would be incurred. The withdrawal age is based upon the prevailing retirement age, which is currently 62 years old.
The good thing about the SRS is that the withdrawal age is determined by your first contribution to the SRS account. This means that even if the retirement age increases to 65 in the future, your withdrawal age would still be based upon when you first made your SRS contribution. So if you are looking to lock in your withdrawal age for SRS, just contribute $1 to it.
You must invest your SRS
Before pouring funds into SRS for tax relief, do note that you DEFINITELY NEED to invest your SRS savings! This is due to the paltry 0.05% interest rate that the SRS account gives.
What investment options does the SRS provide? Well, you can purchase local shares and bonds on the stock market with SRS. Otherwise, you could also buy single premium insurance or unit trusts with it (although I would highly not recommend it).
Also, if you invest with your SRS, you would be ‘forced’ to use the brokerage fees of our local banks. This means that the trading fee would amount to at least $25 per trade made with your SRS funds.
Is SRS worth the trouble?
Given the restrictions when it comes to access funds in SRS account, does the benefit of tax relief outweigh the inflexibility?
I think it boils down to what kind of investor you are. If you are a long term investor who is happy to hold unto investments and let them run their course, SRS might be a useful tool for you. However, if you are an active investor who regularly trades stocks, SRS would definitely not be for you given the high trading fees.
Another point to consider is if you need your investment funds for daily sustenance or not. For investors who depend on dividends for their day-to-day expenses, contributing to SRS would be counter-productive since you would incur a penalty fee with every withdrawal.
If you choose to utilize the SRS, keep in mind that your portfolio should ideally not exceed $400k. This is to ensure maximum tax savings given that there is only a ten-year period to fully withdraw your SRS after the first non-penalty withdrawal. As only 50% of your withdrawn amount is taxed, the ideal amount to withdraw is $40k each year, since there is no tax chargeable for $20k or below.
Personally, I use my SRS account to purchase local stocks that I am happy to hold for the long term. Doing so allows me to get higher returns for my SRS savings and also lessens the need for withdrawal.
3) Contribute to charity
Finally, the last easy way to reduce your tax income is to simply donate.
Currently, donations made to certain charity organizations (not all) are entitled to 2.5 times of tax relief. This means that you are entitled to $2.50 in tax relief for every dollar donated.
Regardless of the presence of tax relief or not, I feel that every individual should contribute to charity if they have the capacity to. This is a bid to make the world a better place to live in as a whole.
Of course, before making any donations always make sure you know how your money would be used. There is no point contributing to charity when the majority of your money is not being directly used to help those concerned. Worse still if it is being used to line the pockets of those managing charity organisations.
If you are looking for which charity organizations to donate to, giving.sg might provide some ideas. As always do your own research, especially as to how the donations are being used. This sounds so much like picking which companies to invest in😂.
So there it is, three easy ways in which to reduce your payable tax income!
Do note that these methods are not the only ways to get tax reliefs. A full list can be found here.
If I were to rank which method to prioritize first, I would say look to contributing towards your parents’ CPF. The other methods would be dependent on how much of payable tax you are looking to save on.
Do you have other ways in which you reduce your payable tax income? Do let me know in the comments below!