The mere mention of the words “salary sacrifice” can instantly turn off many hard workers. After all, who would even fathom giving up any of their hard-earned money? The reality is, while the term may not be so flattering, salary sacrifice can have many tax benefits. It can also lead to exempt benefits and tax benefits, which are way better than they sound.
Here’s what you need to know when it comes to salary sacrifice and when it should be used, along with the advantages and considerations pertaining to it.
How Salary Sacrifice Works
In the simplest terms possible, salary sacrifice is an agreement between an employee and employer where the employee agrees to receive less before-tax income. In return for their sacrifice, the employer agrees to provide them with benefits of comparable value. Basically, you're using some pre-tax salary and using it to buy something you'd typically pay for with your after-tax income.
This whole process is sometimes called salary packaging or total remuneration packaging. But, we'll continue calling it "salary sacrifice" to keep things simple throughout this article.
The concept of salary sacrifice is best understood with some examples, so let's look at a good one. Say that you earn $100,000 before-tax every year. This year, you may agree to receive only $75,000 as your salary, in return for a $25,000 car. This car would be your benefit in exchange for reducing your salary. This would reduce your year's taxable income to $75,000, lowering your tax bill since you are essentially earning less. That sacrifice might even bump you into a lower tax bracket!
What benefits can be salary sacrificed?
The Australian Tax Office says there are no restrictions when it comes to the types of benefits you can sacrifice if they make up part of your remuneration. However, your employer's offerings will place some amount of restriction on how you can salary sacrifice to your advantage.
In general, a salary sacrifice arrangement will include a few different types of benefits, including superannuation, exempt benefits, and fringe benefits. The majority of employers allow their employees to salary sacrifice into super, but not all employers allow employees to salary sacrifice other benefits.
Here's a quick overview of the benefit types:
#1 Fringe Benefits
You'll find many examples of fringe benefits, including cars, property (real property, shares, and bonds), expense payments (school fees, child care costs, home phone costs, and loan repayments), along with less common benefits like free concert tickets or gym memberships. All of these examples are given by the ATO.
Generally, the employer is required to pay fringe benefits tax, or FBT, on these benefits unless they qualify for some sort of exemption. One example of an exempt employer would be a non-profit organization. Of course the employer passes this tax on to the employee and is accounted for in the salary sacrifice calculations. Basically meaning the employee bears the cash cost of the FBT (even though it is levied at the employer).
#2 Exempt Benefits
Many benefits are exempt from the tax that's imposed on fringe benefits, even if the employer would not typically be exempt from paying the fringe benefits tax. These exempt benefits are known as such, but they only apply to work-related uses.
For instance, you could get a laptop or phone and your employer would be exempt from fringe benefits tax so long as you're using the device for your work. Other examples include briefcase, tools, protective clothing, or computer software. In most situations, your employer won't have to pay fringe benefits tax on these items.
You can salary sacrifice into your super, which reduces your take-home pay and allows you to save more towards your nest egg. You're allowed to ask your employer to put any portion of your pre-tax salary into your super account on top of what the superannuation your employer is already paying under the Superannuation Guarantee. In general, your Superannuation Guarantee should be no less than 9.5% of your before-tax annual salary.
When you make a salary sacrifice into your super, these are classified as employer contributions rather than employee contributions. For you, that means these contributions are taxed as "concessional contributions" at a 15% rate. For most, this rate is lower than the marginal tax rate they'd pay if they make a normal employee contribution to their super.
Of course, there is a limit as to how much additional you can contribute to your super each year at that 15% rate. Overall, the combined total of salary sacrificed concessional contributions and employer contributions cannot exceed $25,000 in a given financial year. If you make a concessional contribution that exceeds this limit, the additional amount will be taxed at your marginal rate and count as an employee contribution.
So, if you earn between $37,000 and $90,000 the exceeding amount will be taxed at approximately 32.5%. The tax rate increases from there depending on your income and there is also an additional charge for exceeding the limit.
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Salary Sacrificing Your Mortgage
If you're curious about using the salary sacrifice approach to pay down your mortgage, the simple answer is that it's possible, although your options may vary depending on the industry and company you work for.
Typically, those in the not-for-profit, health, and charity industries will allow you to salary sacrifice for mortgage payments if they are exempt from Fringe Benefits Tax. If you work for an exempt employer they will tell you.
Most private businesses won’t be exempt from FBT and whilst it’s possible to salary sacrifice your mortgage, it won’t actually save you any tax – because the employer will deduct the Fringe Benefits Tax of 47% from your pay packet – so are no better off (and unless you’re earning over $180,000 you might end up paying more in FBT than you save in income tax).
Salary sacrificing your car
If you have a car that you don’t use for work, you may very well consider salary sacrificing it. In some cases you can save $1,833 per year – every year by doing this, but it all depends on your specific circumstances.
If you’re an employee you can do this with the use of a novated lease. This can get a bit tricky, but let's break it down as easily as possible.
Essentially, a novated lease is an agreement between you, your employer, and a lender. When you sign this agreement, your vehicle repayments will be made to the third-party lender by your employer. These will come out of your pre-tax salary and count as a fringe benefit, incurring the FBT.
Many people choose to do this, even though it takes some work to setup, just because of the huge tax break it provides. Your employer will be making the payments on your behalf using your pre-tax salary, meaning your taxable income will be greatly reduced and you'll end up with a smaller tax bill. You could also avoid paying GST since you haven't purchased the vehicle. Rather, with a novated lease, the employer is leasing it on your behalf.
Of course, if you lose or change jobs, the car will still be your responsibility and you’ll either need to get your new employer to take over or end the novated lease and pay for it personally.
If you’re a business owner rather than an employee you could look at using a chattel mortgage, rather than a novated lease and buy the car in the business name.
Should You Salary Sacrifice?
As you can see, salary sacrificing is actually a very positive thing that will work out to your advantage if you know how to do it right. Of course, it ultimately comes down to what your employer, will permit. If you're interested in pursuing this idea, reach out to your employer and your accountant for information on how you can use salary sacrificing to reduce your tax burden and, ultimately, prepare yourself for a brighter financial future.