Introduction and Methods

Many industrialized countries have retirement arrangements involving tax-sheltered savings. These usually provide for the deduction of limited amounts of savings designated for retirement, from the annual income tax base. The earnings in the accumulating fund are free of income tax, but on retirement the resulting total accumulation, whether drawn as a lump sum or as an annuity, becomes income subject to tax. Savings accumulated in the Central Provident Fund (CPF) of Singapore are excluded from the personal income tax base on contribution, are tax-sheltered as to earnings, but by contrast, do not become taxable on distribution. This chapter explores what would happen to rates of return accruing to CPF savers, if the tax shelter were partially withdrawn under various alternative arrangements.

This study covers the case of each of fourteen taxpayers with various income levels, and alternative CPF contribution periods of 5, 10, 15, 20, 25, 30, and 35 years. The alternative tax arrangements fall into two broad categories. The early part of this study considers modifications to the tax treatment of the contributions, while maintaining the tax-free status of the fund earnings and the emerging benefits. The latter part assumes continuation of the status quo in the tax treatment of contributions and fund earnings, but assumes various possible methods of taxing the lump-sum value of the accumulation. This, latter approach, may be deemed to be a reasonable proxy for the taxation of the annuity flow customary in industrialized countries.

In evaluating the outcome of each alternative tax programme, we assume that the CPF will continue to credit a 3 per cent “real” rate of interest on all sums actually contributed. We distinguish between the 3 per cent “real” credited on CPF balances, and the internal rate of return (IRR) earned on the difference between the CPF contribution and the income-tax saving.