What is Salary Sacrifice

Salary Sacrifice describes the strategy of entering into an agreement with your employer to pay part of your pretax salary directly into your SMSF.  Salary Sacrifice contributions are those contributions made by your Employer over and above their Superannuation Guarantee or award obligations.

Strategy Tax Benefits

The financial benefit in adopting a strategy of salary sacrificing is that the contributions made into your SMSF are not taxed in your personal name but in the SMSF at 15%.  So if your personal tax rate is more than 15% there is a tax advantage in salary sacrificing.  If you are on the top marginal tax rate of 46.50% you can save up to 31.50% on each dollar you salary sacrifice into super.  This can result in thousands of dollars in tax benefits each year.

A Guaranteed 60% after Tax Return with No Risk

Another way to think of salary sacrificing is that it can provide an effective guaranteed return on your money of 60% with no risk. This is because the tax rate you pay when you salary sacrifice is only 15% versus the top individual tax rate of 46.50%.  By way of a simple example assume you salary sacrifice $10,000 of your salary.  That salary would ordinarily be taxed at 46.50% meaning you would have paid $4,650 in tax leaving $5,350 to invest.  By salary sacrificing the same income into your SMSF, tax of only 15% will be payable by your SMSF leaving you with $8,500 to invest or an amazing 60% more.  The extra $3,150 represents extra savings you ordinarily would not have!  That's the easiest 60% tax free return you will ever make!

Your Tax Rate is Important

It is generally recommended that you earn above $37,000 (putting you in the 30% tax bracket) before contemplating a salary sacrificing strategy. Assuming this is the case, then the main consideration when deciding whether to salary sacrifice is the fact that the amount being sacrificed into super is preserved until you retire. This means that you need to salary sacrifice only as much income as you can afford to give up, that is not required to fund living expenses. Obviously the closer you are to retirement the more sense it make to salary sacrifice as you know you will be able to access the money sooner when you retire.

Accelerate Salary Sacrifice close to Retirement

Imagine you were able to salary sacrifice for more than one year or better still salary sacrifice an amount in excess of $10,000 per annum. The savings would exponentially multiply.  In fact a typical strategy adopted by clients is to accelerate their salary sacrifice strategy close to retirement (say 5 or even more years out from retirement).  They can do so with the comfort that they will be able to access the salary they sacrifice sooner as they are closer to retirement.

Watch your Contribution Limits

The following limits apply per Member for Concessional Contributions made into your SMSF.  The limits apply to the total of your Super Guarantee, Salary Sacrifice and Personal Concessional Contributions contributed under the 10% rule. 

Aged Over 50 at anytime during the Financial Year        $50,000
Aged Under 50 for entire Financial Year                           $25,000

There is a downside

A relatively unknown loophole in the Superannuation Guarantee Contribution (SGC) rules enables an employer (if they're nasty) to cut an individual's SGC entitlements when an employee reduces their taxable salary via a salary sacrificing arrangement.  This in effect cuts the employee's total salary package, unless the employee has a written contract stating otherwise. 

Example:

Barney earns $100,000 a year plus SGC (9%).   Barney can expect to receive $9,000 in SGC taking his total salary package to $109,000.  To the extent that Barney salary sacrifices $50,000, Barney's employer is then only liable to pay SGC on Barney's net salary after the salary sacrificed amount (ie on $50,000).  This causes a reduction in Barney's SGC entitlements of 9% of $50,000 or $4,500.  Barney may still be better off by following the salary sacrificed strategy in the above example however the SGC reduction is definitely an issue to note.  Typically most employers are nice and they will do the honorable thing and pay the SGC on the gross salary of $100,000 and not the net salary of $50,000.  But definitely ask your employer first.  You will at least find out how nice they are if nothing else!

Interactive Pension Analysis

To demonstrate the benefits of commencing a Salary Sacrifice Strategy using your own personal circumstances click here to participate in our Interactive Pension Analysis and see how much tax you can save.