Did you know that as an Australian taxpayer, you could legally reduce your tax liability through a salary sacrifice or salary package agreement?
In this article, we’re going to take a look at the various tax implications associated with this option. And while the word ‘sacrifice’ might not necessarily sound like a positive implication, salary sacrificing can be.
So, it’s worth exploring your options – especially if you’re looking to set up a tax-effective way to manage your income.
That being said, whether you’re looking to reduce your taxable income or simply want to find out more about your options, keep reading.
What Is a Salary Sacrifice Agreement?
A salary sacrifice agreement is an arrangement between an employer and employee, where the employee agrees to forgo part of their salary in return for receiving benefits of a similar value. The most common type of salary sacrifice agreement in Australia is for superannuation contributions, where employees agree to have a portion of their salary paid into their superannuation fund instead of taking it as cash.
However, salary sacrifice agreements can also be used for a range of other benefits, such as childcare, housing, and transport. By sacrificing part of their salary, employees can pay for these benefits from their pre-tax salary.
This means you’ll get less money into your pocket every month, but your taxable income will have been reduced, and some of your expenses (or concessional superannuation contributions) are already paid.
Think of it as an instant tax deduction.
Suppose you earn a monthly income of $97,500 before tax and enter into an agreement with your employer to salary sacrifice $8,500 into your super fund. According to the Australian Taxation Office (ATO), if that is the case, you’ll only be liable to pay income tax on $89,000.
What Expenses Can Form Part of Your Sacrifice?
As part of the example above, we referred to a concessional super contribution as part of a particular salary sacrifice agreement. However, while super contributions are a popular way to minimise tax liability, employees aren’t limited to packaging just super.
In fact, there are several different salary sacrifice contributions that you can include as part of your agreement, including:
- novated car leases
- loan repayments
- childcare cost
- school fee
- portable electronic devices
- computer software
- protective uniforms for work, and
- tools of the trade.
Some of these items are known as fringe benefits, which means that employers will be liable to pay Fringe Benefits Tax (FBT) if they are included as part of your salary sacrifice agreement.
Luke is an IT specialist with an average annual salary of $85,000. He is unfamiliar with novated leases and salary packaging agreements, so he has entered into a normal lease agreement to purchase a Hyundai i30.
Currently, Luke is paying around $19,000 in taxes on top of the car leasing fees and running costs – which he is paying from his after-tax salary.
On the other hand, Emily, who earns roughly the same annual salary of $85,000 has gone a different route and entered into a novated car lease for a Ford Ranger. The total lease and running costs add up to around $8,200 each year.
Thanks to Emily’s salary sacrifice agreement, her annual salary is reduced to $76,800.
So, instead of paying around $19,000 in taxes, she is now only paying around $16,000. This means Emily is saving around $3,000 in taxes.
What Should You Consider Before Salary Packaging?
As with any tax-effective strategy, you need to decide if salary sacrificing makes sense in light of your personal circumstances. You should consider a few things before approaching your employer to establish a salary sacrifice agreement.
For example, if you’re looking to make salary sacrificed super contributions, you need to consider that these contributions are taxed at 15% in the fund. This means that if you’re earning in a lower income tax bracket and your marginal rate is less than 15%, there is no benefit to salary sacrifice.
However, if your marginal tax rate is more than 15%, it may be good to consider salary packaging as an option.
You also need to consider the concessional contribution cap rate for super funds. For example, if you make concessional contributions that add up to more than $27,500 for the year, the excess will be considered as part of your assessable income, and you may have to pay more tax. You may also be liable for the excess concessional contributions (ECC) charge.
And remember, if you’re contributing additional funds to your super, you’re doing this to create a retirement nest egg. This means that there are strict rules regarding how to access these funds. In most cases, you won’t be able to access your super funds until you reach retirement age (known as preservation age).
Lastly, suppose your employer uses a third-party company to facilitate the salary sacrifice (in other words, to pay the funds out on your behalf). In that case, you’ll likely have to pay an administration fee. While this is generally paid out of your pre-tax dollars, it’s worth crunching the numbers to establish if it will cost you more than it’ll benefit you.
As we mentioned before, if you’re considering any kind of tax-effective strategy, you need to do so in light of your financial situation. This article may provide you with a general overview of salary sacrificing, but you need to weigh up the pros and decide whether it makes sense for you, your family, and your financial objectives.
The best way to do this is to consider getting financial advice from your accountant or a financial adviser.
If you’re like most people, the phrase “salary sacrifice” likely creates images of giving up a portion of your income. However, salary sacrificing is a popular way to save for retirement. Under the Australian tax system, salary sacrificing allows you to redirect a portion of your pre-tax income into your superannuation fund.
This has the effect of lowering your taxable income and thus increasing your tax refund. Not only does this save you money in the long run, but it also allows you to grow your retirement savings more quickly.
Salary sacrificing is not specifically linked just to super contributions. For example, you may be allowed to deduct certain other expenses such as childcare costs, school fees and novated car leases.
Salary sacrificing could be a great way to reduce your taxable income and boost your super without making any major lifestyle changes. All you need to do is talk to an accountant and your employer before deciding to go this route.
There are a lot of benefits to consulting an accountant for tax planning, and at Box Advisory Services, we want to make sure you’re taking advantage of all of them. Our goal is to help you maximise your deductions and minimise your tax liability.