Arranging salary sacrifice with an employer has been an effective way for employees to save for retirement. But not every employer allows it and flaws in legislation have caused problems with the implementation.
Since July 1, 2017, everyone eligible to contribute to super (those under the age of 65 or age 65-75 and who meet the work test) can make personal contributions and choose to claim a tax deduction. Previously, personal tax deductions could be claimed only by people who were fully or substantially self-employed, or not working.
Even though the proposed changes to improve how salary sacrifice works are before Parliament, the ability for employees to choose to make personal contributions and claim a tax deduction means a rethink on the use of salary sacrifice is required.
Should you use salary sacrifice or personal deductions?
Both options allow you to build retirement savings and save tax.
In both cases, instead of paying your marginal tax rate, only 15 per cent tax is deducted from the contributions by your super fund trustee. If your marginal tax rate is above 15 per cent you will have more of your money left to invest.
The end tax benefits are the same for both options. But in practice there is a difference in the timing of the tax benefit.
With salary sacrifice, your employer makes the contribution from before-tax salary. The super fund trustee usually deducts 15 per cent tax at the time of contribution, or within the same quarter.
Personal contributions are made from after-tax salary or other savings. At the end of the financial year you need to advise the super fund trustee that you intend to claim a tax deduction and receive acknowledgement back from the trustee. The trustee will take 15 per cent tax out of your account and you claim the deduction in your tax return.
With either option, if you have adjusted taxable income over $250,000 you will be required to pay an additional 15 percentage points when notified by the Tax Office. This increases the tax rate on contributions to 30 per cent.
Salary sacrifice can help to provide savings discipline, as your employer automatically deducts some of your pay to make the contributions for you. But there are downsides.
You can only sacrifice income not yet earned, which reduces flexibility and makes it hard to sacrifice bonuses. A written agreement needs to be in place before the salary is earned.
Salary sacrifice contributions are classified as employer contributions. Some employers use this loophole to reduce the amount they need to contribute under super guarantee (SG) rules. Legislation is currently before the Senate to remove this loophole but in the interim (or in case it is not passed) you should ensure your employer pays SG on your total employment package and does not use salary sacrifice to reduce their contributions.
By contrast, if you make personal contributions you can choose to make regular or irregular contributions based on your available cashflow.
At the end of the financial year you can review the amount contributed and your tax situation to determine how much, if any, to claim as a tax deduction. This gives you the benefit of hindsight to decide whether to claim a tax deduction or not and thereby gives you greater control and choice. Any contributions not claimed as a deductible amount will remain in your account as tax-free contributions.
The downside is that you may need to do more of the administration for making the contributions and claiming the deduction.
Regularly review arrangements
Let’s look at an example.
Craig is as an employee and wants to increase his super savings. He does not have a lot of surplus cashflow each month but hopes to receive a bonus later in the year, which he could contribute into super.
Craig’s employer allows salary sacrifice but he is concerned that reducing the cash component of his salary might reduce other employment benefits.
If Craig uses salary sacrifice he needs to plan how much to sacrifice at the start of the year. This might be hard to plan if he wants to fully use his concessional cap (without creating an excess) as he is unsure how much the bonus will be and how much SG his employer will need to pay. If he wants to sacrifice the bonus he needs to let his employer know how much to contribute before he knows how much he will receive.
As an alternative, Craig could make regular personal contributions or wait to decide how much to contribute after his bonus is paid. At the end of the year he can review his tax position to decide how much to claim as a tax deduction.
Both salary sacrifice and personal deductible contributions are subject to the concessional contributions cap. The cap allows each person to have only $25,000 of tax deductible contributions made each year.
The cap includes all employer contributions, salary sacrifice contributions and personal deductible contributions. If the cap is exceeded, you will revert back to paying your full marginal tax rate on the excess amount contributed plus interest penalties.
Whichever option you choose, it is important to review the arrangements at least annually to keep on track with your retirement plans and ensure you do not exceed the concessional contributions cap.
Louise Biti is director, Aged Care Steps. Disclaimer: The information in this article is general and does not take into account your particular circumstances. We recommend specific financial tax or legal advice be sought before any action is taken to apply the rules to your specific circumstances. Refer to the relevant Product Disclosure Statement before investing in any product.
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