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Self Managed Super Fund (SMSF) Article
After-tax super contributions can be better

By Tony Negline.

This article may be out of date.

4th November 2009

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Salary sacrifice contributions are best explained by looking at an example.  Geoff Wilson has just been told by his employer that he will be paid $100,000 during 2009/10.  To keep our example as simple as possible, we'll assume that Geoff is single and doesn't have any other income or claim any tax deductions.  Geoff's tax bill – ignoring Medicare levy – in 2009/10 will be approximately $25,450 which means he will have an after-tax salary of $74,550.

Suppose Geoff needs $52,000 a year ($1,000 per week) for living expenses and would like to put the salary he doesn't need into his super fund.

He has two choices.  Firstly he could take after-tax contribution on $22,550 ($74,550 - $52,000) of his after-tax salary and contribute it to super.  The super system calls these non-concessional contributions because they can't be claimed as a tax deduction and the super system does not tax these contributions.

The second alternative is to ask his employer to pay him a salary of $65,500.  The income tax on this amount is just over $13,500 so his after tax income is $52,000.  He decides to salary sacrifice the remaining $34,500 as an additional employer super contribution.  These are his salary sacrifice contributions.  Since July 2007, the taxation laws call all employer contributions Concessional Contributions even if an employer isn't allowed a tax deduction on them.

The first $25,000 of these contributions are taxed at 15% in the year that they are made and the balance will be taxed at 46.5%.  The net contribution will therefore be $26,332.  This is a $3,782 larger contribution than under the first option.

If Bill took these employer contributions out of the super system before he turned 60 then additional tax may be payable which would significantly erode and possibly eliminate the initial tax benefit of salary sacrificing.  If Geoff doesn't intend to take the contributions out until he is at least 60 then they would be paid out tax-free.

As can be seen higher income earners need to be very careful about Excess Concessional Contributions which are taxed at 46.5%.  This penalty tax applies to personal contributions claimed as a tax deduction and all employer contributions which are above $25,000.  Until July 2012 this threshold is $50,000 if a super investor is at least 50 during a financial year.

What is also not widely known is that Excess Concessional Contributions are included in an investor's Non-concessional Contributions (NCCs), which are most personal contributions not claimed as a tax deduction.  The maximum NCCs that can be made is $150,000 each financial year.  Amounts above this maximum are taxed at 46.5%.  Those under 65 can bring forward up to three years of NCCs (ie $450,000 without incurring tax penalties).

As an example, lets consider Geoff Wilson again.  Suppose during the 2010 tax year Geoff was under 50 and intends to make $450,000 in Non-concessional contributions together with total employer contributions of $70,000.  Under the tax rules there would appear to be no reason as to why the $45,000 excess employer contributions wouldn't face two lots of penalty tax because they cause the two contribution limits to be exceeded.  That is a tax rate of over 78%!

The final situation we will examine involves the lower paid.  Based on the 2009/10 individual income tax rates, the effective tax free threshold is $15,000 of taxable income for adult taxpayers eligible for the Low Income Tax Offset (LITO).

It is often thought that for low income earners the best strategy is to salary sacrifice down to $15,000 so that all income will be tax-free.

This approach fails to take into account the range of other Government concessions including the Senior Australians Tax Offset, Mature Age Worker's Tax Offset, Family Tax Benefit, the Government Co-contribution and the Child Care Benefit and Rebate.

For example suppose a person wants to use $10,000 of their salary for super contributions and can't decide between salary sacrificing or taking salary and making personal contributions with the net of tax income and also possibly receiving the Government Co-contribution.

Assuming the individual was only eligible for LITO and has no other income or tax deductions and also assuming that the Government Co-contribution is a negative income tax then the best strategy turns on an income of $39,230.

Back in 2007 the turning point was $38,780.  The new turning point is caused by changes in the income tax rates as well as the reduction in tax efficiency of salary sacrifice contributions.  From 1 July 2009 these contributions are defined as salary when working out the LITO.

Those with an income less $39,230 will pay less tax by taking salary and making after-tax non-concessional contributions instead of using the salary sacrifice system.

For example, someone earning $35,000 will pay a total of $2,354 in tax if they use the "salary method" and their total super contribution will be $9,146.  However if they use the "salary sacrifice method" they will pay $3,200 in tax and have a net contribution of $8,500.

Conversely someone earning $42,000 will find salary sacrifice better.  In this case the net of tax contribution is $8,500 and total tax paid is $4,530.  Using the "salary method", the net super contribution is $7,546 and the total tax is $5,084.  Interestingly the salary method produces more take-home income.

Salary sacrifice arrangements can only involve remuneration that is yet to be earned.  Also they should only be done in accordance with all relevant industrial relations laws and rules.

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