Salary sacrificing simply means paying for something out of your pretax income rather than your after-tax income. And although you are still taxed on this money, it is at a rate likely to be less than your income tax rate.
Turbo charge your super
The most common type of salary sacrificing is into superannuation. In this case, your contribution to your super is taxed at 15 percent. For someone paying tax at the higher income tax rates this is a substantial saving, as well as a welcome encouragement to help you save for retirement.
For example, imagine that you are paying tax at the top rate of 46.5 percent (including the 1.5 percent Medicare levy). For every $100 of pretax salary you earn, after tax you only receive $53.50. But if you salary sacrifice $100 into your super you will receive $85 after tax (the super contribution is taxed at 15 percent). This is a very welcome $31.50 more for every $100 dollars.
And there’s a further tax break. The interest earned in the super fund is taxed at 15 percent, while any interest earned outside the super fund is taxed at your top marginal tax rate.
An example of the benefits
An example quoted in the Australian Financial Review using information provided by Mariner Financial graphically illustrates the benefits of salary sacrificing into super.
If a 40-year-old salary sacrifices $100 a month into super for the next 25 years, using a conservative rate of return (8.5 percent before management costs and tax) they would accumulate $527,000 by the age of 65. That would be a very handy nest egg indeed.
If you want to explore how salary sacrificing different amounts would affect your super, there is an easy to use but very sophisticated calculator available on the Australian Securities and Investment Commission’s consumer finance website, Fido:
http://www.fido.asic.gov.au/fido/fido.nsf/byheadline/Superannuation%20calculator?opendocument It allows you to see the long-term effects of fees, extra contributions, changing funds and taking time out of the workforce.
Super salary sacrificing cons
Overall, salary sacrificing offers substantial benefits and there are very few taxpayers who won’t benefit from it. There are some possible pitfalls though.
The biggest con of all is that some companies won’t allow you to salary sacrifice. Employers prevent up to 50 percent of wage earners and 20 percent of salaried workers from salary sacrificing, according to Mercer Human Resources Consulting.
It’s also important that you check your employer has actually been paying your salary sacrifice super contributions to your fund. They are obliged to do so every 28 days (as against every quarter for superannuation guarantee payments), so check your super fund statements thoroughly.
Apart from losing out on interest because your employer is late making payments, their tardiness also makes it more likely you will lose out should your employer be unfortunate enough to become insolvent.
The compulsory super contributions made by your employer (9 percent of your pay) may be reduced if you salary sacrifice into super. This varies with individual employment agreements.
Keep an eye on legislation and talk to your accountant. There are limits on how much you can salary sacrifice into your super, and these can change in the May budget each year.
Salary packaging
Salary packaging is a form of salary sacrificing, in that you are paying for items such as a car and laptop computer out of your pretax salary. However salary packaging is not as attractive as it used to be due to changes in tax thresholds, the introduction of the Goods and Services Tax (GST) and changes to the Fringe Benefits Tax (FBT).
Salary packaging reduces your income so that you end up paying a lower tax rate.
It is well-worth discussing FBT exemptions with your accountant to see what you can salary package. For example, airport lounge benefits and costs associated with rental properties are not subject to FBT.
Other expenses that don’t attract FBT – and that it may make sense to include as part of your salary package – are a personal organiser, living away from home expenses and, if you are living overseas, children’s education expenses. A mobile phone that is primarily used for business purposes is another item that does not attract FBT that is also often included in a salary package.
For most of these items, as a taxpayer you would not be able to claim a tax deduction, which is why it makes sense to include them in a salary package.
For those working in small businesses, it’s also worth remembering that a range of special concessions are available to smaller operators. Car parking, if provided on the premises, is exempt from FBT.
Drawbacks of salary sacrificing
In addition to the super salary sacrificing cons above, here are some other possible disadvantages of salary sacrificing:
• Salary sacrificing arrangements can only be put in place for future pay, they cannot be backdated;
• Too much salary sacrificing will ultimately reduce your disposable income;
• Lots of benefits only cut in at the top marginal tax rate;
• You have to take into account any changes announced in the budget each year, so your salary sacrificing arrangements should be reviewed at the end of every financial year and reconsidered at other times of the year; and
• Changes in the May 2007 budget that reduced tax rates mean that salary packaging expenses like superannuation and cars will not be as effective as in the past.