SMSF Technical Education & Strategies

 

Salary sacrifice

Salary sacrifice is an agreement between an employee and an employer where the employee gives up part of their pre-tax salary in return for that amount being paid directly into their superannuation fund (including a SMSF).

The primary reason for this strategy is that by having an amount of salary directly paid to a super fund it is only taxed at a maximum of 15%, instead of the employees’ marginal tax rate (up to 46.5%) if that amount was taken as salary. So the trade off is that you pay less tax on that amount of money now in return for it going into super where you can’t access it until you have attained a condition of release (such as retirement). Note that these contributions are considered to be employer contributions.

 

What’s practically involved?

To be effective, Salary sacrifice arrangements require the following:

- Employee’s total remuneration needs to be re-negotiated. The employee needs to agree to a reduced wage/salary in return for superannuation contributions (or other benefits).

 

- The amount sacrificed, plus any other employer contribution (such as compulsory super contributions) must not exceed the concessional contributions limit. If it does, then the employer will be denied a deduction for the excess contribution, which would significantly disadvantage them.

- The employee’s renegotiated remuneration must refer to future entitlements, that is amounts not yet received by the employee. If it refers to present entitlements, it will not be tax effective, and those amounts will probably be assessed as income in the hands of the employee and taxed at their marginal tax rate.

 

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.

 

- If you are earning a relatively low amount and the average marginal tax rate on the income sacrificed is less that 15%, then its pointless to salary sacrifice. In fact your worse off, because you also receive less employer super contributions as stated above.

 

Example

Jim is 47 years of age and is employed as a mining engineer. His salary is $90,000 p.a. Jim wishes to salary sacrifice $10,000, 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 $80,000 plus $10,000 of employer superannuation contributions (in addition to his 9% compulsory employer contributions).

 

Results:

1. The $10,000 sacrificed over the course of the 2008/2009 financial year becomes assessable income of the SMSF and is taxed at a maximum of 15% ($1,500) instead of Jim’s marginal tax rate of 41.5% ($4,150), a saving of $2,650 tax.

2. The base salary that the compulsory employer contribution is based on is now lower at $80,000 instead of $90,000. Therefore, Jim’s compulsory employer contributions fall from $8,100 ($90,000 x 9%) to $7,200 ($80,000 x 9%), a loss of $900. However, with the tax savings above, Jim still comes out in front overall to the tune of $1,750.

 

3. The $10,000 that has gone into the SMSF is now able to be invested in the low tax environment (15% max) of superannuation. This means that the future earnings of that money will be taxed at a lower rate than if that money had been invested by Jim outside of super in his own name.

 

Summary

The concept of Salary sacrifice is quite simple, however there are a number of issues to consider:

- Ensuring that the salary sacrifice agreement is not retrospective.

- Ensuring that a formal agreement is established.

- Your SMSF must have a trust deed that allows the SMSF to accept salary sacrificed, employer contributions.

- The contributions must be appropriately taxed and allocated to the member’s account.

- Benefits must be preserved, unless a condition of release is met.

- The SMSF must have the appropriate documentation, including trustee minutes to satisfy any audit requirements, and ATO scrutiny.

- Ensure there is appropriate documentation between employer and employee to document prospective salary sacrifice agreement.

- Ensure there is appropriate documentation from employer sponsor to trustee verifying contribution obligations under the salary sacrifice agreement entered into between the employer and the employee.