Sacrificing some of your salary into your superannuation is a smart tax-effective way to achieve financial freedom for retirement.
What is salary sacrificing?
Salary sacrificing is adding money to your super, from your pay before income-tax applies. This involves you foregoing some of your salary now, to make the additional contributions to your super fund.
As salary sacrifice contributions are a form of ‘before-tax’ or ‘concessional’ contributions, they’re taxed at 15% rather than your normal marginal income tax rate (can be up to 47%). Therefore, depending on your circumstances, this strategy could reduce the tax you pay on your salary, wages, or bonus by up to 32%.
Additionally, earnings are taxed at a maximum of 15%, rather than capital gains tax rates. This means due to paying less overall tax you have more overall wealth and more invested in a tax effective environment for the future.
How does it work?
You can only sacrifice income that relates to future employment and entitlements that have not been accrued. With salary and wages, the arrangement needs to be in place before you perform the work that entitles you to the salary or wages.
In order to set up your own salary sacrifice, firstly you must verify if your employer offers salary sacrificing. According to the MoneySmart website, most employees will offer their employees the ability to salary sacrifice into superannuation. Once you have determined this is allowed at your workplace, you will need to notify your employer in writing that you wish to establish. The next step, you will need to arrange a documented agreement, with help from your payroll department. The agreement should detail: the amount to be sacrificed into super, the frequency and length of the contributions and signed by you and your employer.
Important things to consider
There are rules around how much you can add to super and still receive a tax benefit.
- The before-tax (concessional) contribution cap for the 2020-21 financial year is $25,000. If you go over this limit, any excess contributions will be taxed at your marginal tax rate (which is generally higher than the 15% tax rate on before-tax contributions) and you may have to pay an excess concessional contributions charge.
- Be mindful that if you have more than one super fund, all before-tax contributions made to all your funds are added together and counted towards the collective cap.
- Remember to consider any bonuses and pay rises, as these may result in your employer making higher than expected before-tax contributions into your super account resulting in a breach of the contribution cap limit.
- You can’t access super until you meet certain conditions.
Concessional contributions include:
Your employer contributions (includes your employers mandatory Super contributions, any additional concessional contributions your employer makes, salary sacrifice payments made to your super fund and other amounts paid by your employer from your before-tax income to your super fund, such as administration fees and insurance premiums);
Notional taxed contributions if you are a member of a defined benefit fund;
Unfunded defined benefit contributions; and
Personal contributions you make and claim as a tax deduction
You can read more about concessional contributions on the ATO site.
From 1 July 2018, if certain eligibility criteria are met, you may be able to carry forward unused concessional cap amounts. This may enable you to make concessional contributions in excess of the annual cap in a future year.
Salary sacrificing case study
Chris aged 45, was recently promoted and has received a pay rise of $5,000 p.a, bringing his total salary to $100,000 pa. He’s paid off most of his mortgage and plans to retire in 20 years, so wants to use his pay rise to boost his retirement savings.
After speaking to a financial adviser, he decides to sacrifice the extra $5,000 into super each year. By using this strategy, he’ll save on tax and potentially invest an extra $975 each year, when compared to receiving the $5,000 as after-tax salary and investing outside super or spending.
Setting up salary sacrificing to save more for your retirement might seem like a no-brainer.
But it’s vital to consider your debt levels before adding to your super, and weigh up the following:
It’s not as tax effective for low-income earners
If you earn less than $45,000, there is minimal to no tax savings by implementing – it’s probably not worth having less in your pocket on payday for a small /no tax saving.
It may impact your current employment benefits
When you salary sacrifice, you change your salary arrangement. This means that benefits like holiday loading and overtime might be affected if they’re tied to your salary. To protect your benefits while salary sacrificing, you’ll need to discuss with your employer assess any impact.
You can’t claim deductions/tax offsets on sacrificed amount
You also can’t claim sacrificed amounts as fringe benefits tax.
Everyone is different, so if you’re thinking about setting up a salary sacrifice arrangement, consider your circumstances and whether it’s the right thing for you.
If you’re considering establishing salary super sacrifice, we recommend visiting the ATO salary sacrificing super page or speaking with one of our qualified financial advisers to learn more.
Need further help? Why not speak with an Oracle financial adviser who can set up a tailored personal retirement plan to meet your goals and objectives.
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