April 2, 2007

	Sacrifice your way to wealth By Scott Francis

• How salary sacrificing to superannuation works.
• Why it is not unreasonable to consider salary sacrificing to superannuation the number-one wealth-creation strategy for people aged over 40 (and the only strategy over 60).
• Six additional salary sacrificing tips to keep in mind.
• How you would implement a salary-sacrifice strategy.

How does salary sacrificing work?

When we earn income, that income is taxed before it gets into our hands. For example, a person earning $55,000 loses 31.5¢ (tax and Medicare) of every dollar that they earn over $25,000.

A salary sacrifice strategy sees us take our income prior to it being taxed, and contribute it to superannuation. There is still 15% tax paid on the superannuation contribution, however this is significantly less than the 31.5% paid if the money is taken as income.

The following table illustrates this in action. In the situation where no salary sacrifice is in place income tax of $12,675 is paid on salary of $55,000. There is also the 9% employer contribution, which are taxed at 15% (contributions tax). Their combined after tax income and superannuation contributions total $46,533.

In the situation where $10,000 of income is salary-sacrificed to superannuation, only $45,000 is subject to normal income tax. The person pays $9525 of income tax on their $45,000 of after-salary sacrifice income. They are now making two superannuation contributions: the $10,000 salary sacrifice and the compulsory 9% employer contribution. Both are taxed at the 15% contributions tax rate. After all tax, this person is now receiving $48,183 of after-tax income and superannuation contributions.

nWhat a difference salary sacrificing makes
	No Salary Sacrifice	Salary Sacrifice
Gross Income	$55,000	$55,000
Salary Sacrifice to Super	—	$10,000
Taxable Income	$55,000	$45,000
Tax Payable	$12,675	$9,525
After Tax Income	$42,325	$35,475
9% Employer Super	$4,950	$4,950
Salary Sacrifice Contribution	—	$10,000
Contributions Tax	$743	$2,243
After Tax Super Contribution	$4,208	$12,708
Total Salary Benefit (Super and Income)	$46,533	$48,183

Why is it the best strategy for over-60s?

The analysis in the previous section, which shows the tax savings based on salary sacrifice superannuation contributions, is enough to show it is a powerful strategy. However, it is only the first of three points of "tax-effective leverage" that makes salary sacrificing powerful.

The second point is that the earnings in a superannuation fund are taxed at a maximum rate of 15%. This is a third the tax rate on investments held in the name of someone on a top marginal rate of 46.5%. Reducing the amount of tax being paid on earnings increases the compounding effect of investment earnings over time.

The third point is that under the superannuation changes that have now passed Parliament, people can use their superannuation to pay a tax-free income stream after the age of 60. This is a tax-effective way of funding retirement.

In summary, superannuation allows tax-effective contributions, tax-effective earnings and tax-effective withdrawals. That's why it is such a powerful wealth-creation strategy, particularly for people close to retirement.


Six salary sacrifice tips

1: You can use salary sacrifice to lower your income and receive the government co-contribution.

Salary sacrifice effectively reduces the income that is used to assess your ability to receive the government co-contribution, a scheme where the Government contributes an extra $1.50 to your super for every dollar of personal contributions that you put in, up to a limit. You need to earn less than $58,000 to start being eligible for some co-contribution benefits. In the case study above, the person who reduced their income from $55,000 to $45,000 through a $10,000 salary sacrifice contribution would now be eligible to make a contribution based on a $45,000 salary and receive a greater co contribution.

If you will be earning less than $58,000 after salary sacrificing some income to superannuation, you should learn more about the Government Co Contribution from the ATO website.


2: Reconsider undeducted contributions to superannuation, live off the money you were going to use as an undeducted contribution, and save tax by salary sacrificing your income to superannuation.

Any time a person receives a lump sum close to retirement, say from selling a property or an inheritance, there is an immediate temptation to contribute it to superannuation as a personal contribution. This is not a bad strategy, but a more powerful way to get that money into the superannuation environment may be to use the lump sum to fund your cost of living, then salary sacrifice almost all of your income to superannuation, saving you considerable tax.

A recent article of mine entitled Sacrificing offers big gains showed how this works for people with lump sums from the sale of property. It works equally for any lump sum.


3: The nasty secret: be aware of employers who reduce your 9% contributions when you reduce your salary by salary sacrificing

There are a few employers who base your 9% employer contributions on your after-salary sacrifice income. My experience is that these are a minority, however it is worth checking to understand what is happening with your salary sacrifice. It generally makes sense to go ahead with the salary sacrifice strategy anyway, but it is best to be fully informed.

4: Over 60, a transition to retirement income stream and salary sacrifice strategy is the only way to go.

Both Trish Power and myself have recently written articles on the power of using a "transition to retirement" income stream, which is tax-free after the age of 60, while salary sacrificing the majority of your income to superannuation. In doing this you are likely to face a maximum tax rate of only 15%!

If you are over the age of 60 and working, you really should investigate this combined strategy.

5: Don't be afraid to start early. Remember the $50,000 limit on tax-deductible superannuation contributions in a year, introduced with the superannuation changes, will slow the rate of salary sacrifice strategies, so be prepared to start earlier. (A $100,000 a year transition arrangement applies for people aged over 50.)

Many people make large superannuation contributions close to retirement, however this will eventually be scaled back based on the maximum $50,000 a year of superannuation contributions where a tax deduction is claimed (that is, 9% employer contributions and salary sacrifice contributions). This means that people will need to start thinking a little bit earlier about additional superannuation contributions.

Making an additional $1000 a year during your thirties and $2000 a year during your forties will see you with an extra $70,000 of superannuation at age 50, prior to making the final superannuation contributions leading up to retirement.

6: Remember you still pay 15% tax on a salary sacrifice contribution to superannuation, so make sure you keep at least $6000 of income (taxed at 0%) in your own name.

Before going crazy with a salary sacrifice strategy, keep in mind that these superannuation contributions are still taxed at 15%. Therefore, you should still earn at least $6000 of income in your own name, which is taxed at 0%. In reality, there is probably little value in salary sacrificing your income to below $25,000, which is where the 15% tax bracket ends.


How to proceed with salary sacrificing

It's all very well to discuss the theory of salary sacrificing, but how does someone go about setting it up in practice?

The first point of call is your payroll office or whoever handles these things in your organisation (the human resources office, or boss in a small business). They can let you know the company policy on additional superannuation contributions, and what paperwork they require you to fill out.

It is possible that they may require some further details about your superannuation account, such as an account number or B-pay number to use to make the contributions. These will be easily available from your superannuation fund's call centre.

Ensure that the contributions you are making are salary sacrificed contributions, from your pre-tax income.


So there your have it

So that's it: a good starting guide to how salary sacrifice works, why it's so powerful, six salary sacrifice secrets (with the alliteration thrown in at no extra cost) and the practical steps to implement such a strategy. It's a simple, powerful strategy and it really works.