A salary sacrifice pension strategy is also referred to as a transition to retirement strategy.
A salary sacrifice pension strategy is aimed at reducing tax.
This article explains how a salary sacrifice pension strategy works and includes an example.
The benefits of a salary sacrifice pension strategy are more prevalent for people aged over 60.
However, people under age 60 can benefit also.
You must have reached your superannuation preservation age to start a salary sacrifice pension strategy.
How Does the Salary Sacrifice Pension Strategy Work?
A transition to retirement or salary sacrifice pension strategy works by salary sacrificingtaxable income and replacing it with superannuation pension income.
Salary sacrifice contributions are made into super which reduces the amount of your wage that is taxed at your marginal tax rate.
As salary sacrifice contributions will be made into your super fund, you will now have less income to cover your lifestyle expenses.
Therefore, you use your super to start an income stream and use the super pension income to assist in covering living expenses.
The idea is that you save tax in the process.
Tax is saved because your wage, which is fully taxable, is replaced with tax-effective or tax-free income from super.
Additionally, you may be able to reduce tax on earnings within super.
Salary Sacrifice Pension Example
Let’s assume you are 61 years of age and have $300,000 in super.
You are still working in the same job you were in prior to reaching age 60.
Your salary is $70,000 p.a. in the current financial year.
You receive standard mandated employer superannuation guarantee (SG) contributions equal to 9.5% of your wage, or $6,650.
You have no carried forward catch-up concessional contributions.
The concessional super contribution cap is $25,000, meaning you are able to salary sacrifice up to $18,350 without exceeding the cap, after taking into account SGC.
If you salary sacrifice $18,350 into super, you will have a lower take-home wage.
How do you achieve the same income you would have achieved had you not made salary sacrifice super contributions?
You use your super balance of $300,000 to start a transition to retirement pension, provided you have reached your preservation age.
A transition to retirement pension allows you to receive an income of between 4% and 10% of your pension balance each year.
Based on a balance of $300,000, your minimum and maximum income thresholds would be $12,000 and $30,000, respectively.
Being over age 60, the pension income is received tax free.
The table below shows the salary sacrifice benefits based on the example above.
Cashflow 2018/19 No Salary Sacrifice Salary Sacrifice Pension
Salary $70 000 $70 000
less: salary sacrifice – $18 350
Taxable Salary $70 000 $51 650
Tax on Salary (incl. Medicare) $15 167 $8 611
Tax-Free Pension Income $0 $12 000
Net Income $54 833 $55 039
Tax on Income $15 167 $8 611
Tax on Salary Sacrifice $0 $2 752
Based on the strategy above, the salary sacrifice pension strategy provides a tax saving of $3,804 each year.
This tax saving is simply calculated as the difference in income tax and super contributions tax under each scenario.
As salary sacrifice contributions are concessional contributions, they incur contributions tax of 15% upon entering super.
So, contributions tax has to be taken into account also.
Salary Sacrifice Pension Under Age 60
A transition to retirement pension strategy, such as this, usually isn’t as beneficial for people under age 60.
And, being under 60, you need to have met your super preservation age to ensure you are eligible.
You can use this preservation age calculator to see if you have reached your preservation age.
The reason a salary sacrifice pension strategy isn’t as beneficial for people under age 60 is because all pension income isn’t received tax free.
A super account balance is made up of a tax-free and a taxable component.
Withdrawals from super, either as a lump sum or pension income stream, must be done proportionately from each component.
Over age 60, both of these components can be received tax free.
However, under age 60, only the tax-free component is tax free.
The taxable component is taxed at your marginal tax rate, just like a salary is.
The taxable component portion of pension income does come with a 15% tax offset, but this is to represent a refund of contributions tax.
Therefore, unless your super balance is made up predominately of tax-free components, there are usually insignificant or no benefits of a salary sacrifice pension strategy under 60.
Most people’s super balances are built-up from concessional contributions, which effectively count towards the taxable component.
Tax-free components are made up of non-concessional contributions made to an account.
Your superannuation provider will be able to notify you of the tax components that make up your balance.
Note: a superannuation balance may include a taxable (untaxed) component. If so this will be taxable for people of all ages.
Salary Sacrifice Pension Over Age 60
As shown in the working example above, a transition to retirement (TTR) strategy is most beneficial for people over age 60.
This is because super pension income is generally received tax free.
Therefore, to figure out the tax benefits of a salary sacrifice pension strategy, you only need to compare the contributions tax rate with your personal income tax rate.
If the contributions tax rate is lower, then you will usually save tax by implementing a salary sacrifice pension strategy.
Be sure to take into account the Division 293 contributions tax for high-income earners if you are earning over $250,000 per year.
There is another potential tax benefit if you have met a full superannuation condition of release or are aged over 65 and still working.
For example, if you had an employment arrangement come to an end after reaching age 60, but are continuing to work in another role, you will have met a full superannuation condition of release.
A full condition of release means that you have unrestricted access to the super you accumulated up until the point your employment arrangement came to an end.
This means you can start an ordinary account based pension, rather than a transition to retirement pension, as part of your salary sacrifice pension strategy.
The main benefits of an account based pension over a transition to retirement pension is that there is no maximum income threshold on annual income.
Also, all income and capital gains earnings within an account based pension are received tax free, compared to earnings tax of up to 15% in a TTR pension.
Therefore, using the example, let’s suppose your $300,000 balance earned investment income at a rate of 4% p.a.
In an accumulation account or transition to retirement pension, this $12,000 (4%) income would be taxed at 15%, which is $1,800.
This same $12,000 investment income within an account based pension would be received tax free.
This additional $1,800 tax saving would increase the tax savings associated with a salary sacrifice pension strategy.
SOURCE, All rights reserved to – Chris Strano, November 22, 2018, Salary Sacrifice Pension Example, http://www.superguy.com.au/salary-sacrifice-pension-example/
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