SMSF Technical Education & Strategies

 

Salary sacrifice with a transition to retirement pension strategy

As mentioned in the previous strategy page, salary sacrifice is an agreement between you and your employer where you give up part of your pre-tax salary in return for that amount being paid directly into your SMSF.

The primary reason for this strategy is that the agreed amount of salary is directly paid to a super fund and only taxed at a maximum of 15%, instead of your marginal tax rate (up to 46.5%) if that amount was taken as salary.

 

This is also a good way to maximise your superannuation contributions, especially if your close to retirement. But what happens if you want to maximise your super contributions, but you still need some extra income to live on ? Where will it come from ? This is where, if your over the age of 55 (preferably 60 as you'll see later), you can simultaneously start a Transition to Retirement pension (TARP) from your SMSF account to fill the void.

 

As mentioned on the Pension choices page, a TARP is a type of income stream that you can commence from your SMSF if you have reached preservation age (currently age 55) and are still working. As the name suggests, this type of pension was introduced to assist members who are in a transition phase to retirement, where you may still be doing some work (part time etc) but need a top up of income from your SMSF assets. Over the course of the year, you can have up to 10% of your SMSF account balance (as at July 1) paid out as an income stream, but you cannot access lump sum withdrawals until you satisfy a regular condition of release.

 

How does it work?

This strategy is fairly simple, and consists of the following:

1. Decide how much income you need to live on for the year.

 

2. Salary sacrifice part or all of your work income, thereby only paying a maximum of 15% tax on that amount instead of your average marginal tax rate. Remember this amount should not exceed the concessional contributions limit (currently $50,000 for over age 50) and need to satisfy all the conditions for salary sacrifice (see our salary sacrifice page).

 

3. Assuming you have reached your preservation age (currently age 55, but preferably age 60), commence a 'transition to retirement pension' from your SMSF, thereby limiting the tax on your income. If your under age 60, this income stream amount is added to your assessable income for the year, albeit with a tax deductible component based on how much of a tax free component you have, and a 15% tax rebate. If your age 60 or over, there is no tax to pay at all on these pensions.

 

The actual amounts that you salary sacrifice and take out as a pension from your SMSF will depend on how much income you actually need to live on. Generally you salary sacrifice as much as possible up to the concessional limit, and then take a TARP pension of an amount that tops up your remaining income to the level you need.

 

Other considerations

Some other points that need to be understood before entering into a salary sacrifice agreement:

- Reducing an employee’s salary through salary sacrifice may effectively reduce the base salary used to calculate the amount of Superannuation Guarantee Contributions that the employer needs to contribute. i.e. the 9% of salary that an employer contributes for the employee will be less because the 9% will be applied to a lower salary.

 

- The reduction in salary may also affect other employer entitlements that are based on a salary. This includes long service leave, annual leave payments.

 

- Note that if you are earning a relatively low amount and the average tax on your income is less that 15%, then its pointless to salary sacrifice.

 

- if your aged between 55 and 60, this strategy has limited tax advantages, and you may actually be worse off due to the lower SGC that your employer pays because of your lower salary. You have to crunch your numbers first to see if it actually works for you. It works best for age 60 & over due to the TARP being a tax free income then.

 

Example

Using our example on the previous page, Jim is now 60 years of age and is still employed as a mining engineer. His salary is $90,000 p.a. Jim wishes to maximise his concessional super contributions and so will salary sacrifice $40,000, and have it paid directly into his SMSF as an employer contribution. Jim renegotiates his contract at the beginning of the 2009/2010 financial year to receive salary of $50,000 plus $40,000 of employer superannuation contributions (in addition to his 9% compulsory employer contributions). This will keep Jim within the $50,000 limit on concessional contributions for those aged over 50. However, Jim needs to receive $70,000 in total income to live on, and so would like to commence a TARP income of $20,000 from his SMSF to top up his remaining income.

 

This is how it breaks down:

1. The $40,000 sacrificed over the course of the 2009/2010 financial year becomes assessable income of the SMSF and is taxed at a maximum of 15% = $6,000 instead of the $13,400 in tax Jim would have paid on this amount personally if it had been paid out to him, a saving of $7,400 tax.

2. The base salary that the compulsory employer contribution is based on is now lower at $50,000 instead of $90,000. Therefore, Jim’s compulsory employer contributions fall from $8,100 ($90,000 x 9%) to $4,500 ($50,000 x 9%), a loss of $3,600 in employer super contributions. However, with the tax savings in No.1 above, Jim still comes out in front overall to the tune of $3,800.

 

3. Jim commences a transition to retirement pension from his SMSF of $20,000 to replace that part of his salary that he sacrificed as a super contribution. His SMSF account balance is $300,000 as at July 1, so this pension of $20,000 is below the 10% max and above the minimum for his age. This income is tax free as he is over age 60.

 

Overall Result

Jim comes out about $3,800 in front, and has virtually maximised his superannuation concessional contribution for the year.

 

Note however that if Jim was under the age of 60, the result would be diminished as the TARP pension amount would be added to his assessable income and be subject to his marginal tax rates, albeit with a deductable amount and a 15% tax rebate.