Understanding the full impact of a salary sacrifice strategy

Salary sacrifice into superannuation is a very tax effective strategy, but it is important clients also have a full understanding of the impact this could have on their other arrangements, says Fabian Bussoletti.

Over the years, salary sacrificing into superannuation has proven, and continues to be, one of the more popular and tax-effective planning strategies available.

However, to make the most of salary sacrifice arrangements, certain conditions must be met. Also, in certain circumstances, it may be possible that some employees entering into such arrangements will inadvertently reduce some of their other entitlements, so it’s important to tread carefully.

To ensure that the benefits of this strategy continue to be enjoyed, without suffering any unnecessary negative consequences, there are a number of important issues to consider.

As a starting point, it must be remembered that at its core, salary sacrificing involves an agreement between an employer and employee.

As such, offering salary sacrifice arrangements is at the discretion of the employer and there is generally no legal obligation for an employer to offer salary sacrifice to their employees.

Potential impacts of salary sacrificing

While the general tax and preservation treatment of salary sacrifice contributions are usually well understood, there are a number of other areas that are not always as prominently covered.

In particular, salary sacrifice contributions can have a potential negative impact on an employee’s superannuation guarantee entitlements and/or termination packages.

Superannuation guarantee (SG)

It is possible that a person entering into a salary sacrifice arrangement could inadvertently reduce or extinguish their current SG entitlements. This may occur for a number of reasons.

Firstly, an employer may choose to base their SG obligations for their employee on the employee’s reduced salary, net of salary sacrifice.

Further, salary sacrifice contributions are a type of employer contribution. As such, the employer may use these voluntary salary sacrifice contributions to reduce or eliminate their liability to make SG contributions on behalf of the employee.

Example

Joe earns a salary of $60,000pa and decides to salary sacrifice $10,000 into superannuation, leaving him with a taxable salary of $50,000.

In most situations, and at no detriment to the employer, the employer will continue to calculate Joe’s SG entitlement on the full $60,000. On that basis, the employer’s SG liability is $5,400 (60,000 x 9 per cent).

However, let’s assume that Joe’s employer opts to base Joe’s SG entitlement on the reduced salary of $50,000. Joe’s SG entitlement would now be $4,500.

Further, as the salary sacrifice contributions made by Joe’s employer actually count towards extinguishing his employer’s SG obligations in respect of Joe, and because the $10,000 salary sacrificed exceeds the required $5,400, technically the employer is not obligated to make any further payments.

As a result, in this case Joe’s total remuneration package has been reduced due to his decision to salary sacrifice into superannuation.

Termination packages

Another issue that needs to be considered is the potential impact that an employee’s salary sacrifice arrangement may have on their termination package (e.g. on retirement or retrenchment).

Example

Consider a pre-retiree with a salary of $100,000, who decides to salary sacrifice $50,000 into superannuation and as a result his taxable salary is now $50,000.

He has some unused annual leave and long service leave entitlements that will be paid to him as a lump sum on termination of his employment, in addition to an agreed termination payment amount broadly based on his years of service.

It is possible that employers in some jurisdictions could use his reduced $50,000 salary as the amount upon which these entitlements would be calculated.

Remittance of contributions

Another factor that needs to be considered is that there is currently no specific legislation governing the timing of an employer’s remittance of salary sacrifice contributions to an employee’s superannuation fund.

A solution

To ensure a greater level of certainty is achieved for clients, it is strongly advisable that a properly considered salary sacrifice agreement be put in writing and reviewed on a regular basis.

Ideally, such an agreement would include:

• the definition of salary used by the employer in working out the employee’s superannuation guarantee, termination payments, and other entitlements;
• whether or not salary sacrifice contributions will be used by the employer to extinguish an employee’s SG entitlements;
• the frequency that an employer will remit contributions to the employee’s superannuation fund.

Checklist for salary sacrifice

When planning to start a salary sacrifice arrangement, and to ensure the arrangement is as robust as possible, the following checklist might be a useful starting point:

1. Ensure that the employer involved will offer salary sacrifice.
2. Check any award or workplace agreement that may impose restrictions on how much may be sacrificed.
3. Ensure the arrangement is effective for tax purposes — remember any entitlements that have already been earned or accrued cannot be sacrificed.
4. Ensure that superannuation guarantee, annual and long service leave; termination payments and any other entitlements are not adversely impacted.
5. Keep a close watch on the relevant concessional contributions cap to avoid any nasty tax surprises — remember superannuation guarantee contributions are also counted towards this cap.
6. And finally, get the agreement in writing.

Fabian Bussoletti is a technical analyst at AMP.