TB 10 Salary sacrificing into superannuation Issued on 15 vember 2010. Summary Salary sacrificing part of an employee s wage or salary into superannuation can be a tax effective means to accumulate wealth for retirement. However several issues should be considered before recommending an employee enter into a salary sacrifice arrangement. A salary sacrifice calculator, designed to compare the tax benefits of entering a salary sacrifice arrangement versus taking paid salary, is available via the Technical Services website on Adviser Advantage. From 1 July 2009, salary sacrifice contributions to superannuation will count as income for the following measures: Co-contribution Deductible contributions Commonwealth Seniors Health Card Certain tax offsets Medicare Levy Surcharge Income support payments under age pension age Certain family assistance benefits Income tested fee for aged care Child support. te: the tax benefits of salary sacrificing will continue and will not be affected by these changes. Benefits of salary sacrifice Tax savings Under an effective salary sacrifice arrangement to superannuation, the employee s wage or salary is reduced which means the employee s assessable and taxable income for the relevant financial year is also reduced. Sacrificed salary or wages do not form part of assessable income, under an effective salary sacrifice arrangement. The primary benefit of such a salary sacrifice arrangement is the immediate tax savings (including Medicare Levy) generated by the sacrificed income. How to work out the tax benefits of salary sacrifice When determining how much wage or salary should be sacrificed into superannuation, consider what marginal tax rate would apply to each extra dollar that could be sacrificed and the tax implications of these benefits when entering (i.e. contributions tax) and exiting the superannuation system. It is important to compare the net benefit of each dollar sacrificed into superannuation after deducting contributions tax and the potential lump sum tax that may apply to each withdrawal. Additional taxes may apply when exiting superannuation Taxes on exiting superannuation could take the form of lump sum withdrawal taxes or taxes payable on payments from an income stream. These taxes may be applicable either in the short term or long term. Where taxes are payable in the long term, the compounded investment returns generated on any deferred tax liability should be taken into consideration. Example Sam, aged 57, earns a wage of $50,000 pa and has the ability to sacrifice 100% of his wage. Sam has no other income. He intends to retire in 12 months, at which time he will withdraw his benefits from superannuation. Sam already has taxable benefits in superannuation that would exceed his available low rate threshold. Wage Each dollar between $37,000 and $80,000 will be taxed at 31.5% if taken as a wage.
Salary sacrifice If sacrificed and later withdrawn from superannuation, Sam would incur contributions tax of 15% and then lump sum tax of 16.5% (as his current benefits already exceed the available low rate threshold). Conclusion Therefore, Sam would have a greater net benefit if he sacrificed this income and then later withdrew it from superannuation. Each dollar under $37,000 and is subject to tax at 16.5% (consider the tax free threshold, Low Income Tax Offset and Medicare Levy threshold). If cashed out of superannuation, Sam would incur contributions tax of 15% and then lump sum tax of 16.5%. All other things being equal, it would be more beneficial for Sam to take this as a wage. The following factors could significantly vary the outcome of Sam s analysis: Retirement after age 60 when lump sum withdrawals and pension payments from a taxed source are tax free. Current benefits that would not exceed his low rate threshold at retirement. Commencement of an income stream rather than taking a lump sum. Tax payable on investment returns generated from an alternative, non-superannuation investment. Tax savings are often generated by investing within superannuation (15% tax on earnings) and these tax savings are compounded over time. Salary sacrifice/transition to retirement strategy An effective strategy is to salary sacrifice all or part of an employee s wage or salary into superannuation and supplement this lost income by commencing a transition to retirement income stream. Transition to retirement allows a person that has reached preservation age to commence a non-commutable income stream without having retired permanently from the workforce. Calculations can should be performed to determine that the employee will actually be advantaged by implementing such a strategy. For more information, refer to the following resources which are available on the Technical Services website on Adviser Advantage: Technical Bulletin 12 Transition to retirement Super Ready Transition to retirement calculator. Ability to claim a tax deduction for personal superannuation contributions From 1 July 2009, salary sacrifice contributions* will count under the 10% rule. That is, when determining whether an employee can claim a tax deduction for personal superannuation contributions, the sum of the following count towards the 10% rule: Reportable employer super contributions Assessable income from employment, where the person is an employee for superannuation guarantee purposes Reportable fringe benefits. * where employee has the capacity to influence the size of the contribution This means the strategy to salary sacrifice to reduce assessable income from employment below 10% of total income, is not available after the 2008/09 financial year. Prior to 1 July 2009 Where a salary sacrifice arrangement reduces an employee s assessable income and reportable fringe benefits from employment below 10% of their total income (and reportable fringe benefits), the employee will become eligible to claim a tax deduction for their personal superannuation contributions. Salary sacrifice offers employees the ability to claim a deduction for personal superannuation contributions; which may assist in reducing tax payable on other income, such as capital gains. There is a universal concessional contributions cap. This cap applies to both employer and personal contributions for which a tax deduction has been claimed. Refer to the Concessional contribution cap section of this document. Tax offsets and other government benefits From 1 July 2009, salary sacrifice contributions* count as income for the following measures: Co-contribution Commonwealth Seniors Health Card Spouse contribution tax offset (for the receiving spouse) Senior Australians tax offset Pensioner tax offset Mature age worker tax offset Dependent spouse tax offset 2
Medicare levy surcharge Baby bonus Family Tax Benefit Parts A and B Income support payments under age pension age Income tested fee for aged care Child support. * where employee has the capacity to influence the size of the contribution Prior to 1 July 2009 The benefits listed above may be available due to the reduction in assessable and taxable income in the 2008/09 year and earlier years. Salary sacrifice contributions & FBT Generally, fringe benefits tax (FBT) applies where a benefit is provided to an employee (or an employee s associate) by their employer (or the employer s associate) in respect of the employment of the employee. However, a fringe benefit does not include a cash payment to a complying superannuation fund or RSA in respect of an employee. A non cash (in-specie) contribution made by an employer to a superannuation fund on behalf of an employee is also excluded from attracting fringe benefits tax. A superannuation contribution for the benefit of a spouse of an employee is not a contribution in respect of an employee and fringe benefits tax would apply. What is a salary sacrifice arrangement? A salary sacrifice arrangement is an arrangement where an employee agrees to forego part of their wage or salary, for benefits of similar value to be provided by the employer or the employer s associate. Generally, the employee incurs tax on a reduced wage or salary and the employer may be required to pay fringe benefits tax in respect of the alternative benefit provided. Effective salary sacrifice arrangements A salary sacrifice arrangement must be in place before the employee has actually earned the entitlement. This is known as an effective salary sacrifice arrangement. The sacrificed salary or wages do not form part of the employee s assessable income. Instead, the benefit, in this case the superannuation contribution is subject to tax at a maximum rate of 15% in the superannuation fund. Are there limits to the amount which can be salary sacrificed? If there are no limits specified in an industrial law, award, workplace agreement or employment contract, then there is no limit to the amount which can be salary sacrificed. Additional tax implications apply where the concessional contribution cap is exceeded (refer to Concessional contributions cap on page 4). Industrial law, awards or workplace agreements An industrial law, award or workplace agreement may specify a minimum amount of salary or wages that must be received by an employee. Where the level of non-cash benefits provided reduce salary or wages below the required minimum levels, the employee may still have entitlement (under industrial law) to the underpayment of wages or salary from their employer. As a result, an employer may limit the amount of salary or wages that can be salary sacrificed. Ineffective salary sacrifice arrangements Any agreement in respect of entitlements that have already been earned will be an ineffective salary sacrifice agreement. Under an ineffective salary sacrifice agreement, the sacrificed wage or salary will form part of the employee s assessable income and taxed accordingly. Any superannuation contributions made under an ineffective salary sacrifice arrangement will constitute non-concessional contributions of the employee. What entitlements may be salary sacrificed? Future earnings may be salary sacrificed. Future earnings are salary or wages which the employee has not earned the entitlement to. Other remuneration, such as leave payments and bonuses, may be salary sacrificed if the entitlement to be paid these amounts has not been earned. 3
Annual leave / sick leave / long service leave Leave payments during the ordinary course of employment If annual leave and long service leave is taken over the ordinary course of employment, an effective salary sacrifice agreement can be put in place. This is regardless of whether entitlement to the leave payments have accrued or not. Taking leave payments in the ordinary course of employment means the leave payments are received as salary and wages prior to termination of employment (rather than receiving the leave payments as a lump sum on termination). This may allow leave payments to be salary sacrificed where they otherwise would not (because a salary sacrifice agreement in respect of leave payments was not put in place prior to entitlement). Future leave entitlements An employee can enter a salary sacrifice agreement at any time, in relation to future leave entitlements. Generally a qualifying period has to be met before an employee becomes entitled to leave payments (especially long service leave). An employee can enter an effective salary sacrifice agreement in respect of leave payments where the employee has not completed sufficient service to be entitled to take the leave payment or receive a pro-rated entitlement upon termination of employment. Bonuses Performance bonuses Bonuses may be paid upon satisfaction of certain conditions. These bonuses may be salary sacrificed provided the salary sacrifice arrangement is entered into prior to the conditions being met. Discretionary bonuses A discretionary bonus (eg. a Christmas bonus) can be salary sacrificed provided the salary sacrifice arrangement is in place prior to the employer making the decision to pay the bonus. Issues to consider before salary sacrificing Concessional contribution cap The following concessional (or taxable ) contributions count towards an individual s concessional contributions cap: Salary sacrifice Superannuation Guarantee Any other employer contributions Personal tax deductible contributions To determine how much to salary sacrifice without exceeding the cap, the total of Superannuation Guarantee, personal tax deductible and any other employer contributions must be ascertained. Salary sacrifice contributions are employer contributions which count towards an individual s concessional contributions cap. Defined benefit funds When working out the amount of salary sacrifice contributions which can be made without exceeding the individual s concessional contributions cap, you will need to ascertain whether the individual s defined benefits fund is funded or unfunded. Funded defined benefits funds If a person is a member of a funded defined benefit fund then the 'notional taxed contribution' which is determined by an actuary is added to any other concessional contributions (eg. salary sacrifice or personal tax deductible contributions) made on behalf of the person. If the total amount exceeds the concessional contributions cap then tax will be payable on the excess at penalty rates. Grandfathering arrangements apply to individuals who have an interest in a defined benefit scheme on 12 May 2009. Where the notional taxed contributions exceed the concessional contributions cap, the notional taxed contributions are taken to be equal to the concessional contributions cap. The excess is disregarded for the 2009/10 and later financial years. If the defined benefit interest is transferred to a successor fund that retains equivalent rights for members, grandfathering also applies. Any rule changes to the fund could jeopardise the availability of these transitional provisions. You or the client needs to contact the defined benefit fund to find out the amount of the notional taxed contribution so you can ensure that any other concessional contributions do not exceed the contributions cap. 4
Unfunded defined benefit funds If a person is a member of an unfunded defined benefit fund (eg. Commonwealth Superannuation Scheme CSS and Public Superannuation Scheme PSS ), then the notional taxed contribution is generally nil. Clients can work out how much to salary sacrifice without exceeding their concessional cap without having to take into account any amount attributable to them via the unfunded defined benefit scheme. Age restrictions The ability for an employee to salary sacrifice part of their wage or salary into superannuation must coincide with the ability of a superannuation fund to accept the contributions. Mandated employer contributions can be received any time; however employer contributions generated by a salary sacrifice agreement do not constitute mandated employer contributions. Age Ability to salary sacrifice to superannuation Untaxed funds Less than 65 Anyone can salary sacrifice* Employer contributions made to an untaxed fund (ie constitutionally protected funds run by state governments or set up for members of the judiciary) are not counted towards the individual employee s concessional contribution cap. Clients with these funds can work out how much to salary sacrifice without having to take into account any employer contributions made to the untaxed fund. What are the caps? From 1 July 2009 the concessional contribution cap is $25,000 per individual. A transitional cap of $50,000 is in effect until the end of the 2011/12 financial year for individuals who are 50 years or older. If the individual turns 50 during a financial year, they will qualify for the $50,000 cap from that financial year up to and including the 2011/12 financial year. The caps apply in respect of total concessional superannuation contributions (i.e. only one limit applies per individual regardless of the individual having two or more non-related employers). The $25,000 cap is indexed each year, but only in $5,000 increments; the $50,000 transitional cap will not be indexed. For contributions made in the 2007/08 and 2008/09 financial years, the concessional contributions cap was $50,000. In addition, a transitional cap of $100,000 for individuals aged 50 and over applied to these financial years. Tax treatment of concessional contributions Generally, concessional contributions are included in the taxable income of the receiving superannuation fund and taxed at a maximum of 15%. Contributions which exceed the concessional contributions cap will effectively be taxed at the top marginal tax rate and will also count against the non-concessional contributions cap. 65 to less than 75 (that is, on or before 28 th day of month following that in which the employee turns age 75) Only available where employee is gainfully employed at least 40 hours in a consecutive 30 day period, in the financial year the contribution is made. * Subject to any limitations place by an employer, industrial law, awards or workplace agreements. Defined benefit schemes Where an employee is a member of a defined benefit scheme, investigations should be undertaken to determine whether salary sacrificing part of the employee s wage or salary to superannuation will affect their final benefit payable from the scheme. Where the defined benefit is based on the employee s wage or salary, a reduction of the defined benefit may occur. Contribution splitting When considering whether an employee should salary sacrifice part of their wage or salary into superannuation, the ability to split these contributions with their spouse should also be considered. te: Superannuation funds are not required to offer contribution splitting. Where contribution splitting is desired, an employee should ensure that the fund receiving these employer contributions offers contribution splitting to members. Refer to Technical Bulletin 09 Splitting of superannuation contributions between spouses for more information. Superannuation Guarantee entitlements Under Superannuation Guarantee (SG) legislation the employer is required to provide a minimum level of superannuation support based on the employee s earning base (i.e. ordinary time earnings). Salary sacrifice reduces an employee s wage or salary, therefore may reduce the employee s earning base 5
for SG purposes. There are three possible effects on the amount of SG paid by the employer: 1. SG remains unchanged The employer may be willing to provide superannuation support based on an earnings base ignoring the salary sacrifice arrangement in place. Alternatively, a legal or contractual obligation may require the employer to provide the same level of superannuation support. 2. SG decreases based on the reduced earnings base The employer may calculate their SG requirements on the reduced earnings base. 3. SG is reduced to nil Salary sacrifice contributions are employer contributions. An employer has satisfied their SG requirements where an employer contribution that is at least equal to the required superannuation support has been made to a complying superannuation fund, scheme or RSA within the required timeframe. Therefore, the salary sacrificed amount may have also satisfied the employer s SG requirements. Example Sam s SG earnings base is his ordinary time earnings. Sam s salary is $60,000 pa. Sam enters a salary sacrifice arrangement to forego $20,000 of his salary for additional employer superannuation contributions. Sam s salary is reduced to $40,000. Sam s employer could: 1. Contribute $20,000 in addition to the original superannuation support of $5,400 (9% of $60,000). 2. Contribute $20,000 in addition to reduced superannuation support of $3,600 (9% of $40,000). 3. Contribute $20,000 only (as this exceeds the minimum SG requirement of $3,600). Tips: It is important for employees to know on what basis the employer will pay their SG entitlements. Check the salary sacrifice agreement prior to commencing the salary sacrifice arrangement. Assessment by Centrelink and Department of Veteran s Affairs (DVA) Centrelink From 1 July 2009, salary sacrifice will count as income for income support payments and the low income health care card for persons under Age Pension age. Prior to 1 July 2009, where an employee has not attained Age Pension age, salary sacrificed wages or salary to superannuation was not assessed by Centrelink. Once an employee has attained Age Pension age, this salary sacrificed income will become assessable as income under the income test and any accumulated superannuation benefits will generally be treated as a financial investment. That is, included as an asset under the assets test and deemed under the income test. Any employer contributions required for SG, award or collective workplace agreement are not assessed as income, but will generally still be treated as a financial investment. DVA All employer superannuation contributions (including salary sacrifice and SG contributions) will always be assessed as income by DVA (irrespective of the employee s age). Accumulated superannuation benefits will become assessable once the DVA recipient has attained service pension age. Income replacement insurance Where an employee has an income replacement policy and is considering salary sacrificing into superannuation, the insurance provider should be contacted to determine whether any potential payment of benefits under the income replacement policy could be jeopardised by implementing the salary sacrifice arrangement. OneCare Income Secure Cover OneCare Income Secure Cover, without the priority income option, allows up to 75% of the employee s gross income to be insured. Gross income includes any SG payments and salary sacrificed benefits (not limited to superannuation). Therefore, a superannuation salary sacrifice arrangement will not reduce the potential benefits payable in the event of a claim. 6
Where the priority income option is elected, the potential benefits in the event of claim could actually be increased to 80% of gross income. Under priority income superannuation maintenance, some of these benefits in the event of claim must be directed into a superannuation fund. State or Territory New South Wales Will salary sacrifice into superannuation affect potential workers compensation payments? Example Tammy has a total remuneration package of $100,000. She takes a $50,000 cash benefit, receives SG of $4,500 and salary sacrifices $45,500 into superannuation. OneCare Income Secure Cover Amount paid directly to life insured Amount contribut ed to super Total received Priority Income Option $75,000 (75% x $100,000) Priority Income Option Super Maintenance only (20%) $60,000 (75% x $80,000) Priority Income Option Super Maintenance (10%) & Mortgage maintenance (10%) $70,000 (75% x $80,000 + $10,000) $0 $20,000 $10,000 $75,000 $80,000 $80,000 If Tammy elects the Priority Income Option she would increase her overall benefits. However, under the Superannuation Maintenance Option, some of Tammy s benefits must be contributed into superannuation for her benefit. WorkCover entitlements Our investigations (in December 2008) show that salary sacrifice into superannuation should not impact WorkCover entitlements in all Australian states with the exception of Western Australia (WA) and the rthern Territory (NT) - see table on the next page. Advisers should confirm this with their local WorkCover office prior to implementing an effective salary sacrifice agreement. Employees in WA and NT should be informed that WorkCover entitlements may be affected by the implementation of an effective salary sacrifice agreement. Victoria Queensland Western Australia South Australia rthern Territory Australian Capital Territory Tasmania Yes Yes Employer contributions and choice of fund An employer does not have to pay salary sacrificed superannuation contributions into the chosen fund of the employee. Choice of superannuation fund allows some employees to choose the complying superannuation fund/scheme or retirement savings account into which their employer must contribute their SG payments. Choice of fund does not extend to employer contributions in excess of the SG requirements. Employees of public benevolent institutions, private non-profit hospitals and public hospitals A public benevolent institution (that is not a hospital) can provide each of their employees with fringe benefits up to the grossed up value of $30,000 without incurring fringe benefits tax. A private non-profit hospital or public hospital can provide each of their employees with fringe benefits up to the grossed up value of $17,000 without incurring fringe benefits tax. Employees of public benevolent institutions, private non-profit hospitals and public hospitals should firstly consider salary sacrificing into benefits that have no inherent future tax liability (eg credit card payments and home loan repayments). After utilising these limits, salary sacrificing into superannuation may also be considered. Some public benevolent institutions, private nonprofit hospitals or public hospitals may deduct an amount from the employee s remuneration package that exceeds the actual value of the fringe benefit (not the grossed up value) despite the fact that they will not incur fringe benefits tax 7
for the provision of these benefits. This may negate some of the advantages gained by salary sacrificing into benefits that have no inherent future tax liability prior to salary sacrificing into superannuation. For further information contact the Australian Taxation Office, Business tax enquiries line on 13 28 66 or visit their website at www.ato.gov.au Salary sacrifice agreements A salary sacrifice agreement specifies the terms and conditions of the salary sacrifice arrangement that exists between the employee and their employer. As the name suggests, both the employee and the employer must agree to the terms and conditions outlined in the agreement. The following issues should be addressed in a salary sacrifice agreement. Child support From 1 July 2009, salary sacrifice contributions and other amounts are included as income for child support purposes. Prior to 1 July 2009 the basic formula used to determine the required payments for child support is based on taxable income and supplementary income (foreign income exempt from tax, plus any rental property losses, plus any reportable fringe benefits). Salary sacrificed benefits to superannuation is not included in the basic formula. However, where special circumstances exist resulting in an assessment that does not accurately reflect a parent s circumstances, the other parent can apply for a change of assessment. Reason 8 (out of 10) which allows for a change of assessment states the assessment is not fair because it does not take into account the income, earning capacity, property or financial resources of one or both parents. This provision would allow a parent receiving child support to apply for a change of assessment where the paying parent is salary sacrificing to superannuation. Similarly, an assessment will not automatically be changed where taxable income is reduced by implementing a salary sacrifice arrangement to superannuation. For further information contact the Child Support Agency on 13 12 72 or visit their website at www.csa.gov.au Frequency of salary sacrificed superannuation contributions Unlike SG contributions, superannuation legislation does not specify the contribution frequency required for salary sacrificed superannuation contributions. Any salary sacrifice agreement should include a paragraph outlining the minimum frequency that the salary sacrificed superannuation contributions should be made by the employer. te: It is possible for alternate legislative instruments to dictate the minimum frequency of when these payments must be made (eg. an industrial relations instrument). Calculation of Superannuation Guarantee entitlements As outlined in the Superannuation Guarantee entitlements section, salary sacrifice may reduce the amount of SG required to be provided by the employer on behalf of the employee. An employee may seek agreement from the employer to include a paragraph in the salary sacrifice agreement providing superannuation support on the pre salary sacrifice earnings base. Which superannuation fund/scheme or retirement savings account An employer is not obliged to pay salary sacrificed superannuation contributions into a fund chosen by the employee. An employee may seek agreement from the employer to include a paragraph specifying into which superannuation fund these additional employer contributions will be paid or a paragraph that provides the employee with the ability to choose any complying superannuation fund/scheme or retirement savings account into which the employer is required to pay these additional contributions. To protect the employer from any adverse consequences, the employer should limit this chosen fund to any fund that can be chosen by an employee in accordance with the choice of fund legislation. This Technical Bulletin has been produced by OnePath Technical Services and is intended for the use of financial advisers only. It is current as at the date of publication but may be subject to change. This publication has been prepared without taking into account a potential investor's objectives, financial situation or needs. Before making a recommendation based on this publication, consider its appropriateness based on the client s objectives, financial situation and needs. OnePath Technical Services is not a registered tax agent under the Tax Agent Services Act 2009. Your client should refer to a registered tax agent before relying on information in this publication that may impact their tax obligations, liabilities or entitlements. 8