July 19, 2016
Many people might have heard the term salary sacrifice but not really understood what it is. Put simply, it is giving up some of your wage in return for higher super contributions from an employer.
There are two main benefits to salary sacrificing:
- It can come out of your gross wage before tax is deducted making it quite tax effective. If someone is paying a 34.5% marginal tax rate, it is preferable for funds to instead be paid to a super fund and taxed at 15%. This lower tax rate compensates for the fact you generally lose access to the funds sacrificed until retirement.
- It is an easier way to save because once set up, it happens automatically.
There is a limit to how much can be salary sacrificed. Currently, the limit is $30,000 per year for a person under 50 and $35,000 per year after age 50. This limit includes the amount already being contributed by an employer under the compulsory Superannuation Guarantee.
Susan is a 45 year old earning $80,000 per year. Susan already has nearly $8,000 per year contributed to her super by her employer as the compulsory superannuation guarantee contribution. Susan is under age 50 and therefore has a maximum of $30,000 per year which can be contributed to super on her behalf by the employer which means there is around $22,000 remaining that can be salary sacrificed from her gross wage.
Susan decides to sacrifice $10,400 per year. She gets paid weekly so requests her employer to deduct $200 each week from her gross wage and sacrifice this to her super. Normally the employer would have had to deduct $69 tax from this income (34.5%) so the amount paid to Susan’s bank account only reduces by $131 per week.
Whilst Susan’s wage will reduce by $131 per week, the super fund will receive the full $200 each week. Given Susan has not paid tax on this money, they will need to pay tax instead at a flat rate of 15%. On $200 per week, this equates to around $30 per week of tax and the amount left in Susan’s super fund is an extra $170 per week.
If Susan loses $131 per week but her super fund gains an extra $170 per week, then overall she is better off by $39 per week. Over a year, this represents a benefit from the tax difference of $2,028 per year.
Of course, the example so far assumes that Susan is extremely disciplined and saves the full $131 per week if she received it in cash. However, many people start with great intentions for saving but like New Years Resolutions, never seem quite able to make it happen. This brings us to the other benefit of salary sacrifice which is that it is saving part of her income automatically before she even sees it. If an extra $170 per week is being added to her super, after a year Susan could have an extra $8,840 in her super fund that she might not have been able to save if it was up to her putting it aside in her bank account.
If Susan kept the salary sacrifice up for 15 years until age 60 and it was earning an average of 7% pa within the super fund, then the $131 per week that she is out of pocket would have been exchanged for more than $222,000 extra in her super fund for when she retires.