Is the Government taxing capital gains with the introduction of SRS?
SRS is a tax deferral scheme. Under a typical tax deferral scheme where a sum of money is not taxed upfront but instead taxed at a later time after netting off all subsequent capital gains and losses from investments, the individual will be no worse off than if the sum of money was taxed upfront and all subsequent capital gains were exempt from tax.
As an illustration, consider a person who has an earned income of $10,000. Assume his marginal tax rate is 10%. He pays an income tax of $1,000 and invests the balance of $9,000. He makes a capital gain of 3% each year until he reaches the retirement age 10 years later. Assume his marginal tax rate remains at 10% at retirement. At the end of 10 years, he will have a total of $12,095.
Total = ($10,000 0.9) 1.03 1.03 .(for 10 years) = $12,095
Next, consider another person with the same earned income of $10,000 but who invests the sum under a tax deferral scheme. He does not pay income tax on $10,000 and is able to invest the full $10,000. He makes the same capital gain of 3% each year until he reaches the retirement age 10 years later. The capital gains accumulate tax-free in the account. At the end of 10 years, everything in the account is taxed at the same marginal tax rate of 10%. After paying tax, he will also have a total of $12,095.
Total = $10,000 1.03 1.03 .(for 10 years) 0.9 = $12,095
In fact, under the SRS, the individual will be better off, as only 50% of the withdrawals will be taxed. The same person above will have a total of $12,768 if he withdrawals everything in the first year of retirement.
Total = 0.5 ($10,000 1.03 1.03 .(for 10 years))
+ 0.5 ($10,000 1.03 1.03 .(for 10 years)) * 0.9
He will have even more if he spreads his SRS withdrawals over a period of 10 years (or more if the statutory retirement age increases), which is allowed under the SRS.
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