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Self Managed Super Fund (SMSF) Article
Salary Sacrifice Contributions vs Government Co-Contribution
By Tony Negline.
This article may be out of date.
23rd March 2005
Over the last fourteen years superannuation salary sacrifice contributions have become very common because they are relatively easy to understand and implement and are also seen as tax-effective.
But just how tax effective are salary sacrifice contributions especially since the government introduced the co-contribution scheme?
Before we compare salary sacrifice and the co-contribution, we need to understand the different rules that apply to each.
First lets look at the co-contribution. To get the co-contribution you must make personal super contributions that are not claimed as a tax deduction. Your assessable income (that is income for tax purposes before tax deductions) plus reportable fringe benefits paid by your employer must be less than $58,000. At least 10% of your assessable income and reportable fringe benefits must come from an employer. You cannot be a temporary resident. You are aged less than 71 in the relevant year. And finally, to get the co-contribution paid you must first submit your tax return.
All government co-contributions go into a super fund as undeducted contributions which means they go in and come out tax free.
What about salary sacrifice? Salary sacrifice will only be possible if your employer allows you to structure your total remuneration according to your personal wishes. For example your salary package might be $50,000 and your employer allows you to take that benefit however you wish. You might choose to take $35,000 salary, $10,000 on a motor vehicle lease and $5,000 for a salary sacrifice super contribution.
Before you enter into a salary sacrifice arrangement, make sure you understand what your employer intends to do about the Super Guarantee. Some employers will assume that the $5,000 salary sacrifice contribution goes towards satisfying their SG obligations. Other employers think this is unfair so they look after their SG contributions obligations by making additional super contributions. It is very important that salary packaging arrangements are documented and apply to the future only and never to the past or present.
All salary sacrifice contributions are employer contributions and are therefore taxed in the super fund. But an employer will get a tax deduction for these super contributions.
What is the better strategy? As an initial comparison. let’s look at the example above. On the $5,000 salary sacrifice employer contribution, $750 tax (15%) would be paid by the super fund. That is the net contribution is $4,250. After the tax deduction, the contribution costs the employer $3,500.
However if we took that $5,000 as salary then $1,575 tax (31.5%) would have to be paid. This means we would have $3,425 left to make an undeducted contribution. In this example for co-contribution purposes income is about $50,000. The maximum co-contribution that can be paid for this income is $400. The total contribution $3,825 ($3,425 + $400). The cost to the employer is still $3,500.
Clearly salary sacrifice arrangements is much better under this scenario.
But this is not the end of the story because there are a number of ways salary sacrifice arrangements will be less attractive than the co-contribution.
The first of those scenarios involves a low income earning spouse. Suppose your spouse is employed part-time and earns $15,000 per annum. What is better now?
If an employed person has income for co-contribution purposes of under $28,000 and makes a personal contribution of at least $1,000 then they will get a $1,500 co-contribution from the government. So we would take the net salary of $3,425 and add $1,500 to this, making a total contribution of $4,925. The co-contribution is now in front.
The next scenario involves ways to reduce your overall tax bill because of rebates. For example, a couple with dependent children may be eligible for Family Tax Benefit which effectively reduces the amount of income tax they pay. (Most people elect to take the FTB as a Centrelink benefit but the net result is the same – it is still effectively a reduction in income tax.)
A couple with two children and total remuneration of $50,000 will be eligible for Family Tax Benefit at least $5,000. This effective reduction in tax may be sufficient enough to make the salary, income tax and co-contribution strategy more attractive. It is all a matter of knowing how the system works and then using the rules to maximise how much you can get out of it.
Another scenario involves people who are not eligible for the co-contribution. There are a number of reasons for this – the co-contribution is not payable if the person earns more than $58,000. For example, one spouse works and earns an above average salary while the other spouse runs the house and is not employed.
In these circumstances, salary sacrifice contributions will probably be the best strategy. This is especially the case if the employee earns less than when the super surcharge cuts in. During the current financial year, the super surcharge becomes payable when income for surcharge purposes (not the same as income for co-contribution purposes!) is $99,710. Once surcharge income exceeds $99,710 the rate of surcharge slowly increases to reach its maximum of 10% when surcharge income exceeds $121,074. Once a person is earning this level of income, the tax effectiveness of any super contributions becomes very doubtful.
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