Salary sacrificing's traps

PORTFOLIO POINT: Don’t go blindly into salary sacrificing just because you’ve heard you should. There are plenty of potential traps. Here’s how to avoid some of them.

Salary sacrificing should be a reasonably simple affair. You pass a signed note to your employer that you’d like to put some extra away into super. And off it goes.

But, sadly, it doesn’t necessarily work “just like that”. Salary sacrifice is actually quite complex and it’s very easy to get these arrangements wrong. And if you haven’t done the proper research, you might only have yourself to blame.

Poorly planned salary sacrifice arrangements can achieve nothing for you; some might benefit your employer more than you. Worse still, they could completely unravel, becoming an enormous and costly disaster.

The theory is straightforward: you agree to “sacrifice” some pre-tax salary to superannuation to build up your account balance. This makes perfect sense if the money being sacrificed would have otherwise have attracted a higher marginal rate than super’s 15% contributions tax.

Those earning more than $37,000 a year in Australia will be paying a marginal tax rate of 30%, plus the 1.5% Medicare Levy. Above $80,000 it’s 38.5% (including the levy), and over $180,000 it’s 46.5% with the levy.

The difference between your marginal tax rate and 15% is therefore the saving that you could make through salary sacrifice; you can reduce your overall tax burden and have more into super at the same time.

That is, if you’re earning $100,000, you could salary sacrifice $10,000 rather than take it as salary. As salary, you’d lose $3850 in tax, leaving you with $6150. Sending it off to super means you’d pay $1500 tax, leaving $8500 remaining in your super fund.

There’s a tax saving of $2350, and in many circumstances that sounds great.

First hurdle

The first hurdle is actually your employer. A salary sacrifice arrangement is actually an agreement between you and your employer. And it’s not compulsory for businesses to include salary sacrifice as part of their employment arrangements.

If they don’t offer salary sacrificing that’s and end of it, outside of you begging for a change of policy.

Ratbag employers

Then there’s the ratbag element: those employers who use salary sacrifice as a way of getting out of their own obligations. And there are many ways that they can do this through salary sacrificing.

For a start, the obligation on an employer to make super contributions on behalf of employees is that 9% of the employee’s salary goes into super. In our example above, for an employee earning $100,000, the employer needs to make sure that $9000 goes into super.

If the employee is salary sacrificing $10,000 into super, then the 9% is covered by the employee. Yes, that’s correct. In this case, it’s technically possible that the employee will no longer be getting the $9000 paid into super by his employer, because he decided to salary sacrifice a portion of his salary.

There is some hope the government will legislate to stop this happening, but it’s been a dream for quite some time.

Alternatively, the employer could say that the employee’s salary is now not $100,000, but $90,000. From the tax office’s perspective, it is only $90,000, in which case the employer might only pay 9% on $90,000 instead of 9% on $100,000.

There are other ways employers can also use salary sacrifice arrangements to decrease their liability to what I would describe as moral obligations.

Consider someone salary sacrificing their age-based maximum of $25,000 or $50,000, who is then retrenched. The employer could potentially make the payout of holiday pay, sick leave, long service leave, or redundancy entitlements based on the salary sacrifice-reduced wage.

Research your employer

If you’re considering a salary sacrifice arrangement with your employer, you need to do your research with the payroll department. The following questions are your starting point.

• Do they offer salary sacrifice?
• Will they pay it into your choice of fund (including your SMSF)?
• What will they use as your base salary for superannuation guarantee contributions, termination payments and other entitlements?
• Will they continue to pay the 9% SG contribution on your “full” salary, rather than what remains after salary sacrifice?

And don’t take a wink and a nod from your human resources department. Get it in writing and signed by someone in authority.

Beware of your limits

You also need to make sure that you don’t trip your age-based concessional contribution limits. Employers are under no obligation to tell you that the 9% SG they are putting away for you, added to whatever you’ve salary sacrificed, is going to put you over your $25,000, or $50,000, limit and leave you with a potentially bigger tax burden than you would have been in if you hadn’t decided to salary sacrifice.

Greater importance

Given that there is no sign of concessional contribution limits being lifted anytime soon, salary sacrifice is going to become more and more important to younger and younger Australians.

It will become – it certainly should become – far more common for people in their early 40s to be considering salary sacrificing something into super because they won’t be able to load up later in life.

Just be careful. You can’t trust your employer to do the right thing. Ask the hard questions. Or see a financial adviser who will ask the hard questions for you. Making a mistake when setting up your salary sacrificing arrangements is just far too costly.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as this, you are advised to consult your financial adviser.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.