When you hear the word “sacrifice,” it might sound like a negative thing. After all, who wants to give up something they’ve worked so hard for?
However, when it comes to salary sacrifice and taxes, the opposite is true. Sacrificing a portion of your salary can actually be an excellent way to gain an advantage on your tax bill.
But before you make any decisions, you need to understand the ins and outs of this strategy, including the potential benefits and drawbacks. So, in this blog post, we’ll explore what salary sacrifice is, how it works, and what you need to know about the tax implications.
What Does It Mean to Salary Sacrifice and Reduce Income Tax?
Salary sacrificing, also known as salary packaging, refers to an arrangement between an employer and an employee where the employee agrees to “give up” a portion of their pre-tax salary in exchange for certain benefits or contributions.
So, instead of delivering the full salary, the employer reduces the employee’s pay by the agreed-upon amount and redirects that portion to the chosen benefit or contribution.
What Benefits or Employer Contributions Can you Redirect Your Salary Towards?
The benefits or contributions you can redirect your salary towards through a salary sacrifice arrangement will depend on your employer’s policies and the Australian Taxation Office (ATO) rules.
Generally, the ATO states that there is no restriction on the benefits you can receive from a salary sacrifice arrangement as long as your employer agrees.
Some common benefits that you can obtain through a salary sacrifice agreement include the following:
- Superannuation contributions: This is one of the most popular forms of salary sacrifice, where you can direct a portion of your pre-tax salary towards your superannuation fund.
- Car expenses: This may include novated lease arrangements or the cost of running a company car.
- Health insurance: This may include pre-tax contributions towards your private health insurance premiums.
- Childcare expenses: You may be able to sacrifice part of your salary towards childcare fees
- Personal technology: Some employers offer salary sacrifice arrangements for purchasing laptops, mobile phones, or other technology items.
- Work-related expenses: This may include items such as work-related travel, training courses, or uniforms.
Why Would an Employer Not Offer The Option to Salary Package?
While salary packaging can benefit employees, there are a few reasons why an employer may choose not to offer this option.
One reason is the administrative burden that comes with managing salary packaging arrangements.
Another reason is the cost of providing certain benefits, particularly those that require your employer to pay Fringe Benefits Tax (FBT). FBT is a tax on the value of benefits an employer offers employees or their associates, and it is separate from income tax. Some benefits, such as car leases or private health insurance, may attract FBT and can be expensive for employers to provide.
There are, however, FBT-exempt benefits that your employer may offer, such as work-related purchases.
Additionally, smaller businesses may need more resources or expertise to manage salary sacrifice contributions effectively.
So, while salary packaging can be a useful tool for employees to reduce their tax liability and increase their take-home pay, it’s ultimately up to each employer to decide whether or not to offer this option.
Reducing Taxable Income: the Main Benefit of Having a Salary Sacrifice Arrangement
The main benefit of having a salary sacrifice arrangement is the potential to achieve tax savings. Generally, sacrificing a portion of your pre-tax salary towards a specific benefit or contribution can help reduce your taxable income.
For example, if you have a salary of $60,000 per year and you choose to sacrifice $5,000 of your salary towards your superannuation as an extra contribution, you reduce your taxable income to $55,000.
So, instead of paying $9,967 in income tax, you’re now only paying $8,342 (marginal tax rate is 32.5%) .
As a result, you have more take-home pay each year, and you’ve made an extra contribution to your superannuation account.
What Should You Consider Before Deciding on a Salary Package?
Before deciding on a salary packaging arrangement, there are several essential factors that you should consider:
- Tax implications: While salary packaging can offer tax savings, it’s crucial to understand other possible tax implications. For example, it may impact your eligibility for certain government benefits, such as the Medicare levy surcharge, tax offsets, and child support payments.
- Budget: You’ll need to consider how much you can realistically afford to sacrifice from your salary each pay period. You should create a budget to determine how much you can comfortably sacrifice without causing financial hardship.
- Long-term financial goals: Make sure to factor in your long-term financial goals and how salary packaging may impact these. For example, if you’re sacrificing a portion of your salary towards superannuation contributions, you should consider whether this aligns with your retirement goals.
- Administrative costs: Some organisations arrange a third party to manage salary packaged contributions, which will incur an additional fee that your employer may require you to pay. You’ll need to calculate how this administrative cost will impact your benefit at the end of the day.
- Excess concessional contributions: If you choose to make super contributions through salary sacrifice, you may exceed the concessional contributions cap. And according to ATO, this may result in you having to pay tax on the excess contribution.
So, before entering into a salary packaging arrangement, you should carefully consider how the potential drawbacks impact the benefits. Seeking advice from a financial advisor or tax professional can also ensure you fully understand the implications of any arrangements you may enter.
Key Takeaways
An effective salary sacrifice arrangement can be a valuable way to optimise your salary and take advantage of tax benefits, but you should approach it with caution and consideration. Understanding the eligibility, tax implications, budget, long-term financial goals and administrative costs associated with salary packaging arrangements are essential to make an informed decision.
If you consider all these factors, you can determine whether a salary packaging arrangement is right for you and how it can be tailored to meet your specific needs and goals.
Seeking advice from a financial advisor or tax professional can also provide further guidance on making the most of this opportunity.
KNS Accountants and Business Advisors can provide valuable assistance with salary packaging arrangements.
As experienced professionals in accounting and taxation, we can help you understand the effects of different benefits or contributions and determine which ones may be most advantageous. We can also assist in calculating the financial impact of salary packaging on your budget and long-term financial goals.
Contact us today to find out more.
