The Legislative Council passed the Inland Revenue and MPF Schemes Legislation (Tax Deductions for Annuity Premiums and MPF Voluntary Contributions) (Amendment) Bill 2018 on March 20. From the year of assessment 2019/20, taxpayers are entitled to tax deductions under salaries tax and personal assessment for their premiums paid to qualifying deferred annuities and contributions made to tax deductible Mandatory Provident Fund (MPF) voluntary contribution accounts. The maximum tax deductible limit is HKD 60,000 each year per taxpayer.
The response to the new tax deduction arrangement has been disappointing since implementation. What benefits can the new arrangement bring to investors? And why do investors seem indifferent to these benefits?
1. An Overview of the New Tax Deduction Arrangement
(1) What is Qualifying Deferred Annuity Policy (QDAP)?
Before understanding QDAP, investors need to understand what an annuity is. An annuity is a tool used to plan retirement, helping policyholders to convert accumulated savings into stable income for a period of time. There are many types of annuities, one of which is called deferred annuity.
A deferred annuity involves an accumulation phase and an annuitization phase. During the accumulation phase, the purchaser pays premiums regularly over a period of time. Usually, there is an interim period between the payment period and the annuity period to allow the paid-up sum to grow through investment by the insurer. Upon annuitization, the annuitant receives regular payments during the annuity period.
Only those deferred annuities that meet the criteria issued by the Insurance Authority (IA) can become QDAP. What are the main criteria for QDAP?
Source: Insurance Authority
(2) What is Tax Deductible Voluntary Contributions (TVC)?
TVC is an additional contribution plan based on the current mandatory contribution plan. Employees can decide whether to participate or not. Eligible persons can open a TVC account in an MPF scheme which offers TVC of their own choice and make contributions directly with trustees. However, it should be noted that participants can only withdraw TVC account balance upon reaching 65 years of age, or on other statutory grounds.
Under the new arrangement, a taxpayer who pays for QDAP or TVC can enjoy a maximum tax deduction of HKD 60,000. Based on the current maximum tax rate of 17%, the maximum annual savings can reach HKD 10,200. In addition, a taxpaying couple are allowed to allocate tax deduction for deferred annuity premiums amongst themselves in order to claim the total deductions of HKD 120,000 which can help to save up to HKD 20,400 per year, provided that the deduction claimed by each taxpayer does not exceed the individual limit. However, the situation is not applicable to TVC.
2. The Effectiveness of the New Tax Deduction Arrangement
But how effective is the new arrangement? Taking a single person with a monthly salary of HKD 20,000 as an example. His total annual income is HKD 240,000. After deducting the mandatory MPF contributions and the basic allowance, he is required to pay HKD 3,760 for tax. If making full use of the new arrangement, he only needs to pay HKD 720 for tax, saving about HKD 3,000. But who is willing to do so as having to deposit HKD 60,000 first? But the key question is how many people can contribute $60,000 for the qualified investment every year? Can people save HK$5,000 every month if his monthly salary is only HKD20,000?
At present, the median monthly salary of Hong Kong employees is only about HKD 17,000. After making full use of the new arrangement, about HKD 1,700 can be saved. For most Hong Kong people, not many of them can capture the full benefits of the tax deduction.
3. A Comparison among QDAP、TVC、Savings / Retirement Insurance Plan and Fund
Source: Insurance Authority, MPFA, iFund/Noble Apex Advisors Ltd.
In terms of investment amount, the investment of QDAP is at least HKD180,000. TVC is allowed to make flexible contributions. And contributions to savings/retirement insurance plans depend on the specific plan, but are usually larger than QDAP and TVC. The amount invested in a fund is determined by individual.
In terms of investment period, QDAP has a minimum contribution period of 5 years. TVC can make flexible contributions. And savings/retirement insurance plans have different requirements for contribution period, but usually no less than 5 years. There is usually no time limit for fund investment.
In terms of liquidity, QDAP only allows annuitization to start from the age of 50 years old or above. TVC can only be withdrawn upon scheme member’s reaching age 65 (or on other statutory grounds). Savings/retirement insurance plans can be drawn on basis of coverage period, and if investors have an emergency fund request, , a surrender or withdrawal can be conducted but this may result losing a portion of your premium paid. . For most occasions, fund investment can be withdrawn freely at any time which is the best in terms of liquidity among these products.
In terms of return, QDAP’s return is relatively stable, and the annuity can be withdrawn regularly after reaching the age required. Generally speaking, the annualized guaranteed internal rate of return is around 2%, and the annualized total internal rate of return is around 4%, but returns vary based on policy period, currency and premium payment models. The return of savings/retirement insurance plans is also relatively stable. Taking a retirement insurance plan in the market for example, its annualized return exceeds 4%, but such plans are not applicable to the new tax deduction arrangement. However, TVC’s return stability is relatively poor. Although the annualized return of the MPF system since inception is 3.2%, it fluctuates greatly with market volatility. When the market conditions are poor, substantial losses can be incurred. The Hong Kong Equity Fund (Tracking Index) has an annualized return of 8.3% over the past 10 years. Although it also fluctuates with market volatility, the annualized return is much higher than the other three products.
In terms of risk, QDAP is an insurance product, so the risk is low. The risk of savings/retirement insurance plans is also low. And the performance of TVC is easily affected by market volatility, therefore the risk is higher than the former two. The risk of fund investment is often related to factors like investment region, industry, fund manager experience, leverage level, etc. But the risk of fund investment is lower than stock investment in general.
In terms of asset inheritance, after the policyholder has passed away, QDAP and savings/retirement insurance plans will compensate the cash value in the policy to the designated beneficiary according to the policy, and the procedure is relatively simple. TVC will be classified as inheritance, and the procedure of dealing with it will be complex. Fund investors can usually designate beneficiary in advance, otherwise the investment will be classified as inheritance as well.
Through the above analysis, investors can easily find that QDAP and TVC are quite similar to saving/retirement insurance plan, but generally with a lower return than the latter. The overall benefits of QDAP and TVC may not necessary be better than saving/retirement insurance plan even accounting for the tax deduction advantages.
4.What Should Wise Investors Choose?
After understanding the new tax deduction arrangement and the differences in related products, investors need to make their investment decision based on their own needs and financial situation. On one hand, investors should try to maximize the tax deduction benefit according to their income level and savings; on the other hand, investors should choose the most suitable financial products for their own, so as to obtain a stable cash flow for retirement in the future.
Returns of QDAP, TVC and savings/retirement insurance plans are always far from satisfaction. In contrast, investing in funds offers higher return for investors over the long-term and it usually subjects to lower risk than single stock investments.
Annualized Return of HSI by Period-31 December 2018
Source: Bloomberg, iFund/Noble Apex Advisors Ltd.
Annualized Return of the MPF System by Period-31 December 2018
Annualized and Cumulative Returns of Equity Funds by Sub-Group and Period – 31 December 2018
# Data not available as no equity funds were classified as China equity funds as at 1 December 2000.
* The sub-group “Hong Kong Equity Fund” excludes funds under the sub-group “Hong Kong Equity Fund (Index Tracking)”.
According to historical data, the annualized returns of equity funds in major markets have exceeded 4% for the past ten years, exceeding the annualized return of the MPF system; and US, Hong Kong, Global, Asian and Chinese equity funds with returns over 6% in the same period outperformed the HSI.
In summary, for most investors, fund investment is an ideal financial management tool for medium and long-term asset allocation. When investing in a fund, it is important to choose a trustworthy fund trading platform. As a self-service online fund trading platform, iFund offers more than 1,000 funds for investors to choose, on which investors can freely establish fund portfolios to satisfy their need and manage to achieve wealth appreciation.