Salary Sacrifice and Insurance
Salary Sacrifice is generally accepted as a great way to accumulate wealth … I’d bet many of you haven’t considered how a wealth creation strategy can provide you with wealth protection benefits at the same time. The remainder of this post explores this concept in more detail.
What is salary sacrifice?
Salary sacrifice is an arrangement between you and your employer, which involves giving up part of your pre-tax salary in exchange for an alternative benefit, such as superannuation contributions.
When you arrange to salary sacrifice to superannuation, your employer contributes to superannuation on your behalf, deducting the amount of the contribution from your gross (before tax) salary. In this way, your superannuation is funded by pre-tax dollars and you only pay personal income tax on the balance of your salary.
Advantages for Insurance
Salary sacrifice is a tax-effective way to increase your insurance cover within superannuation. Directing part of your salary into superannuation means that it will not be taxed at your marginal tax rate but at the concessional superannuation tax rate of 15%. This could provide more money to pay for insurance premiums allowing you to a more appropriate level of insurance cover for the same amount of money. Superannuation funds also receive a tax deduction for paying insurance premiums which can be used to offset the 15% contributions tax.
How does it work?
Insurance cover can be held outside or inside of superannuation. When holding the insurance outside of superannuation, the premiums are paid with after-tax money. When the insurance policy is held inside of superannuation, the premiums are paid with contributions less the 15% contributions tax. The superannuation is entitled to a tax deduction when paying insurance premiums which can offset the 15% tax, effectively allowing pre-tax contributions to be used.
Case study
Tony wants to take out life insurance cover and he has a choice of funding it outside or inside superannuation. Tony has $1,000 he wants to spend on insurance premiums. If he were to hold the insurance outside of superannuation, Tony would need to pay the premiums for his own net income (ie gross income less income tax). Tony is on the highest marginal tax rate of 45% plus 1.5% Medicare levy. The after tax value of Tony’s $1,000 is $535, this means that Tony would have only slightly more than half of his initial $1,000 to pay insurance premiums.
If Tony chose to hold the insurance inside his superannuation fund he could salary sacrifice the $1,000 to pay for the premium. The $1,000 contributed to the superannuation fund by Tony’s employer will be taxed at the concessional tax rate of 15%. However, where the tax deduction for paying the insurance premiums is used to offset the 15% tax, the whole $1,000 is available, meaning that the insurance premiums are being paid with pre-tax contributions. However this is done on a fund-by-fund basis and you should check whether your superannuation fund credits deductions received for insurance premiums paid back to the member’s account.
| Insurance outside of super | Insurance inside of super | |
| Salary | $1,000 | $1,000 |
| Less Tax | $465 | $150 |
| Add tax deduction | $0 | $150 |
| Net tax payable | $465 | $0 |
| Net amount available to pay premium |
$535 | $1,000 |
Outside of superannuation, Tony is using $1,000 of pre-tax money to pay a premium of $535. If Tony was paying the same premium via his superannuation fund, he would only need to salary sacrifice $535, he would save $465.
Alternatively, if Tony had the insurance inside his superannuation fund he could use the entire $1,000 to pay the insurance premium, effectively achieving almost double the cover for the same amount of pre-tax money.
Some issues to consider
A number of issues should be considered before entering into any salary sacrifice arrangement:
- A concessional contribution cap (which includes contributions from salary sacrifice arrangements) of $50,000 applies. This cap is indexed annually, increasing in $5,000 increments. For people aged 50 and over a transitional cap of $100,000 applies until 1 July 2012.
- Contributions that are made to superannuation through salary sacrifice made after 1 July 1999 are subject to the Government’s preservation rules. This means that any contributions made must generally be kept in the superannuation fund or rolled over to an approved fund until you retire at or after age 55. Contributing additional funds to superannuation is not a viable solution if you wish or have a need to withdraw the funds prior to retirement.
- Before arranging a salary sacrifice arrangement, you should check that this will not affect other entitlements that you have with your employer, such as workers compensation.
- Salary sacrificing may not be appropriate for those in low income tax brackets.
Effective salary sacrifice
Salary sacrifice is only effective if the following conditions have been satisfied:
- As an employee you must elect to enter into the salary sacrifice arrangements prior to the point in time at which any relevant employment services are performed, or prior to the commencement of services. In other words, salary sacrifice must not be retrospective. Salary sacrifice arrangements must be made in writing between you and your employer.
- Your cash salary must not be reduced below the minimum level specified in any relevant award or industrial agreement.
Contact your financial adviser
Salary sacrifice can serve remuneration planning and savings objectives. However, the rules are complex and it is important that you get appropriate advice before you enter into any arrangement.
For further clarification on any of the above information or for assistance with how this may be applicable to your personal situation, please contact Plan 2 Prosper.