Pension & Salary Sacrifice

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 47% you can save up to 32% 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 your salary sacrifice is only 15% versus the top individual tax rate of 47%.  By way of a simple example assume your salary sacrifice $10,000 of your salary.  That salary would ordinarily be taxed at 47% meaning you would have paid $4,700 in tax leaving $5,300 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 60% more.  The extra $3,200 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 $18,200 (putting you in the 21% 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 makes 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 where a tax deduction is claimed. 

Income Year Age Concessional Contributions Cap per member per annum
2019-20 All ages $25,000
2018-19 All ages $25,000
2017-18 All ages $25,000

TRIS Strategy in combination with a Salary Sacrifice Strategy

The effectiveness of a Salary Sacrifice Strategy is magnified when incorporated with a TRIS Strategy. This strategy basically involves you salary sacrifice as much of your income as you can afford (subject to limits) on one hand and on the other you receive a Pension income stream from your SMSF to help fund your living costs.  You can think of it as a "round robin" strategy where the money that is salary sacrificed is channeled back to you as a pension payment but in the process saving you thousands of tax dollars in tax.

TRIS Strategy allows you to maximize Salary Sacrifice Benefits

The major problem with a Salary Sacrifice Strategy is that it considerably reduces the income you have to live on.  With a TRIS Strategy this is somewhat mitigated as you can pay yourself a pension income from your SMSF softening the cashflow burden.  Importantly this maximizes the amount you can afford to salary sacrifice maximizing your tax savings leading up to retirement and giving you more in Super Benefits when you retire.

TRIS & Salary Sacrifice after age 60

After the age of 60, implementing a TRIS Strategy in combination with a Salary Sacrifice Strategy is truly a remarkable tax saving strategy because all pension payments are tax free after 60.  The tax saving benefits accrue on two levels.  The first is that you pay less tax on the salary you sacrifice.  The second is that there is no tax payable on the TRIS you draw from the SMSF. 

TRIS & Salary Sacrifice under 60

Whilst it is true that commencing a TRIS Strategy in combination with a Salary Sacrifice Strategy works best whilst you are working and are above 60 (when pension payments to you are tax free) it can still be a worthwhile financial exercise producing valuable tax savings if you are aged between Preservation Age and 59 as you pay less tax on the salary you sacrifice.  However offsetting this tax gains is the tax that you pay on the TRIS you draw from the SMSF (which we note is concessionally taxed and receives a 15% "Pension Rebate").  Overall the tax benefits can still be significant.  However this is not always the case.  It is possible because TRIS Pension payments are taxed that you can be worse off commencing a TRIS and salary sacrifice strategy when under 60!  The results vary from person to person.

TRIS & Salary Sacrifice - 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.  For example, say, Barney earns $100,000 a year plus SGC (9.5%).   Barney can expect to receive $9,500 in SGC taking his total salary package to $109,500.  To the extent that Barney salary sacrifices $15,000, Barney's employer is then only liable to pay SGC on Barney's net salary after the salary sacrificed amount (i.e. on $85,000).  This causes a reduction in Barney's SGC entitlements of 9.5% of $15,000 or $1,425.  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 $85,000.  But definitely ask your employer first.  You will at least find out how nice they are if nothing else!

Case Study

To demonstrate the benefits of commencing a TRIS and Salary Sacrifice Strategy, click here to view a Case Study.

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