Imagine your bank has just introduced a new savings account. For every dollar you put into your account, you receive cash of (up to) 20 cents. So if you deposit $10,000 in this account, you will receive up to $2,000.
There is an annual cap on how much you can put into this account, but the bank allows you to make fresh deposits every year. Each time you do so, you receive the same cash benefit.
As interest rates are currently very low, the bank encourages you to invest your savings in mutual funds and other approved instruments. The returns from your investments are put back into the account. The only snag is that you cannot withdraw any money from the account until you reach 65.
The savings account as described above already exists in Singapore in the form of the Supplementary Retirement Scheme (SRS).
Under the SRS, you can make contributions of up to $12,750 each year to your account at one of the three local banks. These contributions are tax deductible: whatever you put into your SRS account up to the cap is not taxed.
Since the highest marginal tax rate for personal income tax in Singapore is 20 per cent, the maximum tax savings each year is $2,550. The SRS is arguably the easiest way for taxpayers to get money from the state in the form of taxes saved; all they have to do is save for their own retirement.
At retirement, your SRS withdrawals enjoy a second tax benefit. Only 50 per cent of withdrawals are taxable. As most retirees have very low marginal tax rates, SRS withdrawals are hardly taxed.
In the debate on what the state can do to bolster Singaporeans' retirement adequacy, the emphasis has been placed on enhancing the Central Provident Fund (CPF) system. Rightly so.
But the SRS has huge potential that is mostly under-utilised. There is much scope for the Government to enhance the scheme's attractiveness to encourage Singaporeans to save more for their retirement - on a voluntary basis.
DESPITE the scheme's significant tax savings, the proportion of working Singaporeans who make regular SRS contributions is quite low. There are at least three reasons for this.
First, the SRS benefits only income taxpayers. About 60 per cent of working Singaporeans do not pay any income tax; there is no incentive for them to make voluntary SRS contributions.
Second, people have strong present-biased preferences. We value current consumption much more than future consumption (which we discount heavily). This makes it difficult for most of us to set aside more for our retirement voluntarily.
Our strong preference for the present also leads to procrastination. People may know they need to save more for retirement. They may tell themselves, quite sincerely, that they want to start saving for their retirement at the end of this year rather than wait till next year to do so. But when the year end becomes today, many find the loss of immediate consumption to be too painful, and so postpone saving to the following year. When next year comes around, the same problem repeats itself.
Third, default rules determine behaviour and are thus extremely consequential.
If you want people to take part in a programme, it is more effective to enrol them automatically, than to give them incentives to take part, even if you keep making the incentives more generous.
Sheer inertia and procrastination will deter or delay participation.
Today, the SRS requires people to make a deliberate decision to set aside monies for their retirement. It is hardly surprising that most people - including many who would enjoy tax savings - do not contribute to SRS.
Reforming the SRS
IN FACT, it will not be difficult to reform the SRS to make it a much stronger pillar of our system of retirement financing.
Doing so involves at least two critical changes.
First, the Government should consider making the current SRS tax deduction a tax credit.
Rather than allow a taxpayer to deduct the $12,750 from his taxable income (and thereby claim a tax deduction), the Government can give a tax credit for that sum to the taxpayer. This credit can be set at, say, $2,000.
Suppose someone has an income which attracts income tax of $1,500. He tops up his SRS account up to the cap of $12,750.
With the proposed SRS tax credit of $2,000, he does not need to pay the income tax of $1,500, and even gets $500 back from the Government in cash.
Allowing those who have low or no tax bills to receive cash from the Government - if they make some SRS contribution - also makes the scheme very attractive to lower- and middle-income earners who currently do not pay any income tax. Policymakers may argue that lower- and middle-income earners are not able to save more for retirement (over and above the CPF), and so there is no need to encourage them to do so. This is flawed reasoning. There is no good reason why the tax system should favour retirement savings by only high-income earners. Indeed, the current SRS regime can be faulted for being regressive - the more one earns, the more he stands to gain from the SRS.
THE second proposal to enhance the SRS would be to change the default rule. Instead of requiring people to make a decision each year to contribute, we should think of ways in which people can be automatically enrolled while allowing them to opt out (thereby retaining the voluntary feature of SRS).
This is already the default rule for our monthly contributions to self-help groups. If Singaporeans can accept automatic enrolment for charitable contributions, surely we should consider having the same default for voluntary retirement savings.
How might this work in practice? To start, employers could be required to sign up their employees for SRS accounts upon their reaching 40 and/or crossing a certain income threshold.
Furthermore, since many working Singaporeans receive a 13th month bonus, it may be acceptable to the majority for part of their bonuses to be automatically credited into their SRS accounts unless they opt out.
This proposal to make annual contributions to SRS the default rule is controversial. Many Singaporeans may rely on their year-end bonuses to meet more urgent needs; saving for retirement may not be a priority. But this objection only means that we should make it extremely easy for people to opt out of making any SRS contributions. Opting out should require no more than a tick and a signature.
The current debate on retirement adequacy, while useful, may be overly focused on how the CPF should be enhanced.
While not a part of the CPF system, an expanded SRS can be an important piece of the retirement financing puzzle.
Rather than limit the tax benefits of the SRS to high-income earners, the Government should make voluntary savings for retirement more attractive and automatic for a much larger segment of the working population.
The writer is associate dean (executive education and research) of the Lee Kuan Yew School of Public Policy, National University of Singapore.
He is the editor of Behavioural Economics And Policy Design: Examples From Singapore and lead author of Hard Choices: Challenging The Singapore Consensus.