PORTFOLIO POINT: Have your cake and eat it too – combining salary sacrifice with a transition to retirement strategy.
“Hey Dad, there’s some bloke here at Eureka Report who reckons there’s a super strategy that allows you to both have more money in your hand each month AND still get more money in your super fund. What should we tell him?”
“Tell him he’s dreamin’.”
(With apologies to The Castle.)
Well, I’m not dreamin’. There is such a strategy. And while it’s probably called many things, I call it a “transition to retirement/salary sacrifice strategy” (or TTR/SalSac strategy).
It’s not magic. It’s not theft. More importantly, it’s not going to get you in trouble with the Tax Office.
It’s a completely legitimate superannuation strategy. And it means that – unless you’re already implementing it – if you’re over 55 and still working, then you’re probably donating extra revenue to the commissioner. Potentially thousands of dollars a year.
For the purpose of today’s article, let’s take a 55-year-old employee male. He earns $90,000 a year, with $300,000 in super ($50,000 of which is non-concessional). After tax (assuming no other deductions), our 55yo is taking home about $67,400. On top of that, he receives another $8100 into his super fund, which will be taxed at 15%, leaving $6885 to be invested inside super.
We’ll assume for the moment that our 55yo is not living beyond his means and that his net salary of $67,400 is enough for him (and his family).
So, what’s the basis of a TTR/SalSac strategy
The strategy essentially takes advantage of two low-tax rates that are available to everyone. They are:
- That concessional contributions into super, including salary sacrifice, are taxed at 15%, rather than a marginal tax rate of up to 46.5%.
- That income received from a super pension is taxed with a 15% rebate for those aged 55 to 60, and not taxed at all for those over 60.
Using these two tax laws, you first increase your salary sacrifice contributions to super, which lowers your income. Now, instead of paying 31.5% in marginal tax below $80k and 38.5% in marginal tax above $80k, the money is only taxed at 15% on its way into the fund.
Then, to make up for the lost income, you take a super pension. If you had have received the money from other sources, you would have been taxed at your marginal tax rates. But because this is coming from a super pension, you pay your marginal tax rate, but get a 15% tax rebate. So, in our example, our 55yo would pay either 16.5% (31.5% minus 15% rebate) for income earned under $80k or 23.5% for income earned over $80k.
Can you see where this is headed? There’s no losing. You will pay less tax because of the salary sacrifice and then replace the lost salary with tax advantaged income.
So, what does our 55yo do to maximise his position?
We’re working from the assumptions above and we want to keep him on the same after-tax income of $67,400.
(There are actual calculators in existence on the web that will maximise this strategy for you. I’m not going to run through every line of the calculations. But if what I’ve written today isn’t crystal clear, you should go to see a financial adviser in any case.)
First, we salary sacrifice.
In this example, he already has $8100 being put into super by his employer. Because he’s over 50, he has a concessional contributions cap for this financial year (and next) of $50,000. At most, he can salary sacrifice $41,900 into super.
It turns out that he will salary sacrifice about $38,166 to super, which is a straight reduction in his taxable salary of $90,000.
However, to supplement that income, we need to make sure that he’s still taking home $67,400, he will now take a pension from his super fund of $29,500. (He doesn’t need the whole $38,166 because of the rebate. He will pay less tax on the income in any case.)
He still now has an income in his hand of $67,400 a year. (If that was just a flurry of numbers and it didn’t make 100% sense, then try one of the calculators, or see an adviser).
What’s happening in the super fund?
So, on the outside, everything’s normal. The same after-tax income is landing in the account, even if it is a more complex arrangement.
But what about inside the super fund/s?
Previously, there was only $8100 going into his super fund, which was his SG contribution from his employer.
Now, there’s a total of $46,288 going into super in concessional contributions. On the other side of the ledger, a pension payment is being made of $29,500. So that is leaving the fund. (Actually, there are two funds now, but that’s a complication to leave for another day.)
The extra money that stays in your super is probably around $3000 a year. If you’re doing that for five years, it adds up.
Not bad. Does it get any better?
Oh yes. Being aged 55 to 60 is at the low-end of the benefits table. It actually gets much better.
Imagine how little a pension you would have to take from your super (therefore leaving more in) if you didn’t have to pay any tax, rather than “just” get a rebate? Well, if you’re over 60, that’s the case. You get pension income from your super fund completely tax free.
You don’t have to survive on just the same salary. If the $67,400 wasn’t enough, you can manipulate the figures to give yourself an extra amount of money – say $20-30 a week in the hand – and still end up with a higher superannuation balance.
Another important benefit is that when a super fund turns from accumulation to pension phase, the fund itself automatically becomes tax free on earnings.
Super funds in accumulation pay 15% tax on income and 10% tax on capital gains for assets held longer than a year. When it becomes a pension fund, it no longer pays tax on income or capital gains.
If a $300,000 accumulation super fund is earning $15,000 a year in income from investments, it would normally be paying $2250 in income tax. If it made, say, $15,000 of gains during the year, it would pay another $1500 in CGT. Total of $3750 of tax that wouldn’t be paid when in pension phase. You’ve just doubled the tax benefit being achieved by a 55yo.
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 those mentioned here, you are advised to consult your financial adviser.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.