By Colin Lewis, Head of Technical Services, Fitzpatricks Private Wealth
If you’re an employee wishing to make tax-effective contributions to super, consider the most appropriate way to do this, especially in the current economic environment.
For most employees, superannuation savings come mainly via the 9.5 per cent compulsory Superannuation Guarantee (SG) contributions employers must pay. Although the SG rate is legislated to increase to 10 per cent from 1 July 2021, there is considerable lobbying going on within the Morrison Government in the wake of the COVID-19 crisis to delay this increase yet again.
If you earn more than $263,157 and receive SG contributions from two or more employers, you can ask an employer to stop paying SG—to avoid breaching the concessional contributions (CCs) cap—provided at least one of them continues to do so. However, only do this if you can negotiate more salary because paying tax on something is better than getting nothing at all!
Wage earners wishing to top up their super tax-effectively are able to make personal contributions and then claim a tax deduction at year’s end—just like people who are self-employed and retirees (eligible to contribute) have been able to do for years.
A few years ago, a tax deduction could only be claimed by people earning less than 10 per cent of their income from employment. Consequently, the only way an employee could make tax-effective contributions was by sacrificing part of their pre-tax income into super.
As the ‘10 per cent test’ no longer exists, all taxpayers eligible to contribute to super are able to make a personal deductible contribution so long as they have the income to do so and they give a written notice of intent (NOI) to claim a tax deduction to their super fund and have this notice acknowledged.
So, if you’re an employee, you can choose between making voluntary salary sacrifice contributions, provided your employer offers this, or making a personal deductible contribution(s), or a combination of both.
Regardless of how you contribute, in working out your voluntary CCs, you must take into account, amongst other amounts, your employer’s SG contributions, your employer’s notional taxed contributions if you’re a member of a defined benefit fund and your fund’s administration expenses and/or insurance premiums if paid by your employer, as all count towards the CCs cap.
Any space left under the $25,000 CCs cap is the amount you may contribute either by installments each pay period over the year under a salary sacrifice arrangement or as a personal deductible contribution(s) or a combination of both.
Any unused cap amounts from 2018–19 and 2019–20 may also be used if the total amount you had in the super system—your total superannuation balance—was less than $500,000 at 30 June 2020.
Make sure you do not reduce your income below $21,885—the ‘effective’ tax-free threshold—otherwise you’re losing 15 per cent of your money for nothing.
But what’s the best way to contribute as there are pros and cons of each?
Thankfully, if salary sacrificing, your contributions can no longer be used by your employer to meet its SG obligation—the practice of some employers in the past which had the effect of reducing an employee’s remuneration.
Salary sacrifice allows you to ‘set-and-forget’ for the year as contributions will automatically be made for you on a regular basis.
Making regular deposits into an investment at regular intervals over a period of time is a powerful way to invest and is known as ‘dollar cost averaging’. It gives you the opportunity to build exposure to growth assets in a disciplined way, can reduce the risk of investing during times of market volatility and helps avoid the pitfalls of attempting to ‘time’ entry into markets. By spreading contributions throughout the year, the odds are some will be made in favourable market conditions, even if others are not. Entering into a salary sacrifice arrangement with your employer is a means of implementing dollar cost averaging.
A disadvantage of this approach is that it is very rigid. To salary sacrifice into super, you must first enter into an ‘effective salary sacrifice arrangement’ with your employer, which requires planning as this arrangement must be in place before income is earned. So, an unexpected bonus cannot be tipped into super.
Also, you don’t know if and when your employer will actually put the money into your super fund, making it difficult to target the CCs cap.
Alternatively, claiming a tax deduction for a personal contribution(s) can be easier.
Instead of your employer contributing to super via a salary sacrifice arrangement, making your own contribution(s) gives you greater control, flexibility and certainty over the amount and timing of contribution(s) and dealing with the CCs cap around year end, but you need to be disciplined.
Reducing a capital gain on the sale of shares or property may be achieved within the cap at any point without having to incorporate it into an employer’s salary sacrifice arrangement. But the downside of making large deductible contributions is that you lose the benefits of dollar cost averaging that salary sacrificing offers.
If you wish to adopt dollar cost averaging, you’ll need to try and administer this yourself.
Making your own contributions means you’re not reliant on someone else doing it and you have peace of mind knowing that your money goes into your super fund. Many employers leave it for months between the money being deducted from wages and making the contribution. Unfortunately for some, the money never gets there!
Also, it avoids a nightmare should your employer go into administration/receivership, as money deducted from salary but not contributed may take years to recover. Given the economic downturn due to COVID-19, the likelihood of this occurring has increased. Accordingly, it may be safer in the current environment to make your own personal deductible contributions rather than have your contributions tied to your employer if you feel the company may be under threat.
If your employer goes into voluntary administration, any money deducted from a salary to go into super will be frozen and won’t be contributed until such time as things are worked out which may take some time.
If your employer goes into liquidation and you have unpaid entitlements, you can get help through the Fair Entitlements Guarantee, but SG contributions cannot be claimed. If you are owed super—among other entitlements—you may be entitled to some or all of what you are owed in priority to the company’s other creditors.
If you choose to make a personal deductible contribution(s) you must provide your super fund with a NOI to claim a tax deduction for the contribution—usually done around tax time. Be very careful not to touch the contribution, e.g. roll it over to another fund, withdraw it, or start an income stream, before first lodging your NOI.
Wage earners have different options in contributing to super, so choose the pathway that works best for you.