Becoming an employer of choice with salary sacrifice

The introduction of ‘transition to retirement’ pensions in 2005 and the ‘Better Super’ amendments in 2007 have made salary sacrifice agreements particularly attractive to workers who are 60 or over and want to keep working.  Changes proposed by the Rudd Government in the recent Budget will mean that sacrificed salary will no longer be exempt from means testing for certain Government benefits, but there are still distinct tax advantages for employees sacrificing salary into superannuation. For an employer, offering salary sacrifice might provide an advantage when recruiting staff and, provided the arrangement is properly structured, there is really nothing to lose.

How it can work

Alexandra is 60 years old, owns her own home and has no significant expenses like school fees.  Alexandra only wants to work for another 5 years, so she decides to boost her superannuation before she retires (she only has $200,000 in her fund).  She earns $80,000 per annum (plus a $10,000 bonus), most of which goes into savings. 

At the start of the year, Alexandra agrees in writing with her employer that, in addition to the employer’s 9% Superannuation Guarantee contributions, her employer will pay $50,000 plus her $10,000 performance bonus (if she qualifies for it) into superannuation instead of paying salary.

At the end of the year, Alexandra qualifies for the bonus, so her employer contributes $60,000 to her fund, as well as making $8,100 in Superannuation Guarantee contributions. The contributions are taxed at 15% on entry into the fund.  If Alexandra had taken the $60,000 as salary, it would have been taxed at her marginal rate of 41.5%.  Because the salary she has sacrificed is not included in her assessable income, her taxable salary reduces to $30,000 and she drops down to the 16.5% tax bracket as a result.

But Alexandra finds $30,000 a year isn’t enough, so she supplements her salary with a ‘transition to retirement’ pension of $20,000 per annum. As Alexandra is 60, the pension is not included in her assessable income.

The table below shows that, although Alexandra gets around $20,000 less in her hand each year, she has boosted her annual super contributions by $51,000 (after tax) and pays over $10,000 less in tax each year.

Important issues

‘Transition to retirement’ pensions are account-based pensions available to workers that have reached their preservation age (which is 55 for anyone born before 1960). They can be commuted, rolled back into accumulation and a new ‘transition to retirement’ pension started, but they cannot be commuted and taken as a lump sum until a ‘nil’ cashing restriction applies (ie reaching age 65 or retirement).  There is a minimum annual payment amount like other account-based pensions (ie 4% if under age 65), but unlike other pensions, ‘transition to retirement’ pensions also have a maximum: 10% per annum of the person’s superannuation balance.  Managing this maximum payment amount is an important part of any salary sacrifice strategy involving a ‘transition to retirement’ pension, given a person under 65 ordinarily can’t take a lump sum benefit while they are working.

It is also crucial to get the salary sacrifice agreement right. To be effective, a salary sacrifice agreement must be for the employee’s future earnings and must state that the employer will pay a percentage of the employee’s salary into superannuation unless directed otherwise. If the agreement is set up correctly, the salary paid into superannuation will not be assessed as ‘salary or wages’ of the employee, and will be deductible to the employer and will count towards its Superannuation Guarantee obligations. 

Some salary sacrifice agreements come undone because they relate to salary to which the employee is already entitled, or the employee directs the employer to pay the salary into superannuation. For example, if an employee qualifies for a bonus based on sales targets at the end of the financial year and requests in writing that the bonus is paid into superannuation, this will not be an effective salary sacrifice agreement because the employee is already entitled to the bonus and because it is the employee that is directing where the salary is paid.

If a salary sacrifice arrangement is ineffective, the salary (including any bonus) paid into super will be treated as the employee’s assessable income and taxed at marginal rates and as a non-concessional contribution which may cause contribution cap problems.

Final comments

Salary sacrifice strategies have been great for building wealth in superannuation since ‘transition to retirement’ pensions were introduced, but the ‘nil’ rate of tax on pensions for people over 60 from 1 July 2007 makes them even more attractive. For employees that can afford to sacrifice disposable income in exchange for a boost to their superannuation savings, it’s a golden opportunity.  For employers, it might help attract and retain quality staff in a competitive market.

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