Salary sacrificing

If you’re a high income earner, you probably know by now that earning additional income in your own name is the least tax effective method possible.

Not only are you going to work Monday, Tuesday and Wednesday morning just to pay the tax man, I’m sure you don’t feel like tipping in an additional 47% for every extra dollar you earn.

The problem is, if you’re a salary and wage earner, there’s only so much that can be done to minimise your personal income tax.

The ATO has always taken the stance that income you earn from personal exertion should be taxed in your name.

While there are options such as negative gearing, today we are going to focus on the benefits of salary sacrificing additional amounts into your superannuation fund.

Meet Craig.

Craig is a high income earner. He earns $185,000 a year plus super of 9.5% ($17,575).

Craig comes to me and complains that he pays too much tax. Poor Craig...

Craig wants to know what can be done to reduce his tax and puts me to work.

I run through the usual options. Negative gearing, keeping a logbook. Actually keeping receipts for work related expenses!

Craig’s eyes start to glaze over. He doesn’t want the hassle of buying an investment property or keeping a logbook.

I keep going through the list until the words ‘salary sacrificing’ manage to come out of my mouth.

Craig stops me.

He says his friends have been talking about this and they all want to know more.

Salary sacrificing is when you elect to receive an alternative benefit to your usual salary and wages. The most common method is to forego a proportion of your wages, and instead contribute that amount to your superannuation fund instead (i.e. you sacrifice part of your salary towards something other than wages).

In this case, instead of receiving $185,000 as salary and wages, Craig elects to receive $180,000, and have his employer contribute an additional $5,000 into his superfund automatically on his behalf.

From a tax minimisation and a wealth creation perspective, salary sacrificing is one of the best things you can do to get ahead. It ticks all the boxes for me:

• Automating your wealth because your employer is making the contributions on your behalf;
  

• You don’t receive the money so you can’t spend it (pay yourself first principle invoked);
  

• The money in your superfund is put to work, and should be earning a reasonable return on investment in a lower taxed environment; and
  

• The best part in this case, it creates a tax saving of up to 32% for high income earners. Not bad right.

The reason salary sacrificing additional amounts into super is so good is because it reduces the income in your own name, and the funds contributed to super will instead usually be taxed at 15%.

If Craig did nothing, the $5,000 would be taxed in his name at 47%, a tax bill of $2,350.

Alternatively, if Craig puts this amount into his superfund, his fund would only pay tax at 15%, a measly $750 in comparison.

For those playing at home, that’s a 32% return on your investment.

You’re welcome.

For the visual people in the room, here’s how it looks:

	Current	Proposed
Wages	$185,000	$185,000
Less: Salary sacrificed super	$0	$5,000
Taxable Income	$185,000	$180,000
Tax Payable	$60,047	$57,697
Additional super contributions	$0	$5,000
Tax payable in superfund	$0	$750
Total tax payable	$60,047	$58,447
Total tax saving		$1,600

It gets better from here.

Not only is there an immediate tax saving, the money is automatically invested on your behalf, and the earnings are taxed at only 15%, instead of 47% if Craig invested in his own name.

Over time this starts to look something like this:

	Tax Saving	Super Balance Increase
Over 10 years	$16,000	$53,000
Over 20 years	$32,000	$140,000
Over 30 years	$48,000	$282,000

So all Craig needs to do is divert $5,000 a year into super and he could be over $280,000 better off if he keeps it up until he is 65.

Not bad at all.

So if this is such a good idea, why aren’t more people doing it?

This is a multipart answer and the first part is perhaps people aren’t even aware of it.

The second part is, most people aren’t willing to sacrifice a part of their income, because they have already spent it before they receive it.

If this is the case, get back to basics and get your finances under control before you start diverting money elsewhere.

Most likely the real answer is that money that goes into super is locked away until you reach preservation age.

This essentially locks the money away until a distant point of time. Most people like being able to access their money now.

But the reality is while that money is locked away, it’s being invested on your behalf, and those earnings are being taxed at 15%, instead of 47% if Craig invested in his own name.

If you have the discipline to lock the money away, you receive the benefits of compounding for a very long time. And you receive those benefits in a lower taxed environment as well, making your wealth compound even faster.

Everyone’s circumstances are different though, and that’s why you should take the time to determine if salary sacrificing is right for you. Or if you are undecided and need clarity, discuss it with a suitable qualified financial planner.

If it’s so good, why doesn’t Craig sacrifice money that $5,000. Well he can, but he can only contribute up to $27,500 a year, and that includes the amount his employer contributes as well. The Australian Taxation Office are frequently tinkering with the amounts that can be contributed, so if you undertake this arrangement, be sure to keep an eye on the concessional contribution thresholds, you don’t want to get caught out.