Salary sacrificing, by making before-tax superannuation contributions, is a popular strategy for employees on middle-to-high incomes. The deal is that you increase your superannuation balance (and pay 15% contributions tax) while reducing the amount of income tax payable (up to 46.5%) on your salary or wages.
Before you decide to arrange a salary sacrifice arrangement using superannuation contributions, chat to your accountant about the tax implications, and ensure you do not lose out financially on your employment package.
1. How does salary sacrificing work?
Under a superannuation salary sacrifice arrangement, your employer can make additional super contributions when you arrange for some of your pre-tax salary to be paid into your super fund. Your salary for tax purposes is then reduced while the additional contributions are treated as employer contributions. As employer contributions, you don’t pay income tax on these amounts (although ‘contributions’ tax of 15% is deducted from the contribution, and potentially contributions tax of 30% if you earn more than $300,000 – see Super Fact No 3) and your employer receives a tax deduction.
2. A salary sacrifice contribution is a concessional contribution
Any super contributions made under a salary sacrifice arrangement are treated as concessional contributions and need to be counted towards your concessional contributions cap (see Super Fact No 8). The concessional contributions cap for the 2013/2014 year is $25,000 for individuals under the age of 60, and $35,000 for individuals aged 60 years or over (note special work test rules apply for Australians aged 65 years and over, and voluntary contributions are not permitted for Australians aged 75 years and over).
3. Two special cases for low-income earners and high-income earners
I have some good news, and I have some bad news:
- Since 1 July 2012, if you earn less than $37,000 a year, you may have your contributions tax refunded (for more information see SuperGuide article Superannuation tax refund: 10 things you should know).
- Since 1 July 2012, if you earn more than $300,000, then the contributions tax on your concessional contributions, such as salary sacrifice and Superannuation Guarantee contributions, is 30% rather than 15% (for more information see SuperGuide article Double contributions tax for high-income earners).
4. Your employer may not agree to salary sacrifice
Salary sacrificing is a voluntary arrangement between an employee and employer. An employer does not have to consent to putting such an arrangement in place. If your employer does not consent to such an arrangement then you will not be able to salary sacrifice. Even when your employer refuses to allow you to salary sacrifice super contributions, your employer is still required to make compulsory Superannuation Guarantee contributions on your behalf.
5. Get your arrangement in writing, and have it signed before the contributions commence
A salary sacrifice arrangement is a contractual arrangement between you and your employer and for your own protection, a written agreement ensures you can confirm the terms of the agreement, if there is any confusion. You can even include the timing of the payment of the super contributions in the agreement. Will it be paid at the same time as you receive your weekly, fortnightly or monthly pay, or does the employer intend to pay the super contributions less regularly than your regular pay? For example, some employers pay compulsory Superannuation Guarantee contributions quarterly, and an employer may decide to delay direction of your voluntary super contributions until the business pays SG contributions. Always check the timing of super contributions.
Note: If you’re subject to an industrial award, or workplace agreement, you can’t reduce your salary below the minimum wage set in an award or agreement.
6. Do you have a pretend salary sacrifice arrangement in place?
The law requires an employer to pay the equivalent of 9.25% of an individual’s salary into a super fund under the Superannuation Guarantee (SG) laws. A person’s salary (for the purposes of SG) is generally ordinary hours of work although salary also includes over-award payments, and any shift loading and commissions, but not overtime.
Note that ‘the equivalent of 9.25% of your salary’ can mean different SG amounts depending on how, or if, you negotiate a salary package. Depending on your contract or award, if you earn, say, $80,000 a year, this salary amount may include your SG entitlement or you may receive 9.25% SG in addition to the $80,000 salary. If the $80,000 includes SG entitlement then your cash salary is $73,230 and your SG entitlement is $6,770. If your SG entitlement is in addition to your $80,000 salary amount, then your super fund receives $7,400 in SG contributions, and your total package works out to be $87,400.
A little word like ‘including’ can make a huge difference financially.
7. Don’t lose your SG entitlements
A relatively unknown loophole in the SG rules enables an employer (if they’re nasty) to cut an individual’s SG entitlements when an employee reduces their taxable salary via a salary sacrificing arrangement. If an employer cuts an individual’s SG entitlements when the employee enters a salary sacrifice arrangement, this in effect cuts the employee’s total salary package, unless the employee has a written contract specifying a total amount.
For example, say, Joan earns $90,000 a year plus SG. Joan can expect to receive $8,325 in SG contributions taking her total entitlements to $98,325. Joan has been chatting to her adviser who suggests that a tax-effective way to accumulate more super is to salary sacrifice. Instead of paying 38.5% tax (37% plus 1.5% Medicare levy) on any income that exceeds $80,000 (for the 2013/2014 year), Joan can divert money to her super fund, which means 15% tax is deducted from the before-tax super contributions rather than 37% income tax if she takes the salary as cash. Any taxable income below $80,000 but above $37,000 is taxed at 32.5 cents in the dollar plus Medicare levy (for the 2013/2014 year).
Note: If Joan decides to salary sacrifice $20,000 into her super fund, it is not automatic that her SG entitlement will continue to be based on her original salary amount. She may only receive SG contributions based on the lower cash salary of $70,000. Joan’s employer’s annual SG contributions may well then be $6,475 (9.25% of $70,000) rather than $8,325 (9.25% of $90,000), that is, $1,850 less than the original arrangement. This can mean tens of thousands of dollars less in super over several years.
A better and fairer result would be to retain the original SG entitlements. When the ALP was in opposition, they announced that they intended to change the laws so that an employee’s SG entitlement would be based on an individual’s salary before the salary sacrifice arrangement takes effect. Unfortunately, nothing has yet happened to protect workers from losing SG when choosing to reduce taxable salary via a salary sacrificing arrangement. The Liberal party are also silent on this equity issue.
8. Watch your contributions cap
Your salary sacrificed contributions and your employer’s Superannuation Guarantee contributions and any additional employer contributions count towards your concessional (before-tax) contributions cap.
If you’re under 60 years of age, you can make concessional contributions worth up to $25,000 each year (for the 2013/2014 year), and if you’re 60 year or older, you can make concessional contributions worth up to $35,000, before you have deal with excess contributions issues. Your concessional contributions will be subject to a maximum of 15% tax ( or 30% tax if you earn more than $300,000), which generally means such a strategy is tax-effective only for employees paying more than 15 cents in the dollar income tax.
Note: See Super Fact No 3 earlier in the article for the superannuation tax refund applicable to those who earn less than $37,000, and for an explanation of the extra tax on higher income earners.
If you do exceed your concessional cap, the excess contributions also count towards your non-concessional (after-tax) contributions cap.
Tip: Check when your salary-sacrificed contributions are to be paid into your super fund because even though you may receive your salary in one financial year, the salary-sacrificed contributions may be paid at a later date, and in a different financial year, potentially causing you excess contributions issues, and potentially extra super tax.
9. Your salary sacrifice agreement can only relate to future income
Any salary sacrifice arrangement that you agree to can only relate to future salary, not past earnings. You can salary sacrifice performance bonuses if the agreement regarding your salary sacrifice was entered into before you became entitled to your performance bonus.
Warning: Some employers use an external party to arrange salary sacrifice agreements and the external party charges a flat fee for every transaction. The costs can add up very quickly if your employer plans to make small super contributions on a regular basis.
10. Where do I go for more information on salary sacrificing?
The following information or advisory sources may help you:
- ATO website (www.ato.gov.au/super).
- Your super fund. Check out your super fund’s website for information, and the forms required for salary sacrificing. Many super funds now offer a limited advice service (intra-fund advice) on certain topics such as salary sacrificing and changing investment options.
- Your HR department/employer. If you work for a large employer it is likely they have salary sacrifice arrangements in place for other employees. If you work for a smaller employer, they may or may not have experience with salary sacrificing.
- Your accountant. If you plan to make substantial salary sacrifice contributions it is worthwhile getting tax advice on the strategy.
You can also check out other articles about salary sacrificing on the SuperGuide website.