Superannuation tax advantage

If you earn salary or wages over $60,000 a year, you qualify for the over $60k tax advantage. Even if you earn less than $60,000, there could be a tax advantage for you as well.

It's a totally legal way to increase your retirement savings.

How is this possible?

Let's deal with the "over $60k" earners first. The tax rate on income above $60,000 is 39%.

The rate of withholding tax on employer contributions to a registered superannuation scheme depends on your marginal tax rate but can't be more than 33%.

The Government has kept this gap of six cents in the dollar (39% less 33%) as a legal tax advantage for people who were saving for their retirement.

An example of the tax advantage in action

The $60k tax advantage works like this:

Say you have a taxable income of $70,000.

If you choose to take all of your salary as take home pay, you will pay 39 cents of tax on every dollar you earn over $60,000 - that's $10,000 in gross income less $3,900 income tax, leaving $6,100 in your pocket.

To take advantage of the tax incentive, you arrange for your employer to reduce your salary by $10,000, and pay that same $10,000 directly into a registered super scheme. This is called a "salary sacrifice" of $10,000.

On the $10,000 of your salary sacrifice, your employer pays only 33 cents on the dollar in withholding tax - that's $3,300 tax, leaving $6,700 to be paid into your account in the registered superannuation scheme.

The over $60k tax advantage has just made you $600 in one year.

Maybe it doesn't sound like a huge amount - but multiply $600 by a few years, then calculate the effect compound interest has on your savings, and it quickly turns into serious money. At 2.5% net real interest over 20 years, in our example, the results will be: 

Saving $10,000 a year

• Using the tax advantage $171,150
• Not using the tax advantage $155,800

How do I take advantage of the incentive?

To exploit the over $60k tax advantage, you need the agreement and co-operation of your employer. Most employers are familiar with the salary sacrifice concept and should be able to arrange it for you very easily. You need to be aware that because you are changing the way in which your salary is paid, your employment contract is changing.

You arrange with your employer to reduce your salary and pay the equivalent amount (less withholding tax) into your account in a registered superannuation scheme. The scheme can be the company scheme, or one which you have arranged individually through a superannuation scheme provider.

What if I earn less than $60k?

A variant of the $60k advantage can also apply if the pay that you have left after the sacrifice is less than $38,000 (or even less than $9,500). That's because, between 1 April 2004 and 1 April 2007, the withholding tax that your employer pays can be based on the tax that applies to the last dollar of the pay that you actually receive.

After 1 April 2007, there are new rules that limit the maximum amount that you can turn into employer contributions to get the tax advantage. This table shows the withholding tax rate that applies to the total of taxable pay and employer contributions:

That doesn't change the calculations in the example given above – the 33% rate applies to all wage/salary income above $38,000 a year. But let's say your pay before the saving programme starts is $45,000 a year (just under the $45,600 threshold in the table) and you want to save $10,000 of that.

Your remaining taxable pay is now $35,000 and the marginal tax rate (the tax you pay on the last dollar of your income) is now 21% rather than the 33% that applies to your pay above $38,000 a year.

So, if you had received the $10,000 as pay, you would have paid $2,940 in tax leaving you with a net $7,060 after tax. Asking your employer to put the $10,000 straight into the superannuation scheme will leave you with net saving of $7,900 ($10,000 less tax of 21%). You will be $840 a year better off.

However, if your pay were $1,000 higher at $46,000 a year then there would be no point in salary sacrificing. Your marginal tax rate at that pay is still 33% and the withholding tax rate on the employer's contributions, no matter how much they are, will always be 33%. So salary sacrifice does not save you any tax if the total of your pay and employer contributions is between $45,600 and $60,000.

If you are a part-timer and earn, say, $11,000 a year, the same sort of thing can apply if you can swap up to $2,500 (as the withholding tax rate is only 15% rather than the 21% tax rate on your pay).

Sounds good. What's the catch?

There are a couple of things you should consider:

1. Withdrawal Tax

To take advantage of the incentive, you have to leave your money in your superannuation scheme until your retirement. If you take it out early, you may have to pay fund withdrawal tax of 5% - which can remove some of the advantage you gained from the incentive (but not all).

There are exceptions - for example, if you paid your money into a company scheme, and then you leave the company, the withdrawal tax may not apply. The rules on this are quite complicated.

2. Implications of a reduced salary

With the salary sacrifice, the portion of your total remuneration package classed as 'salary' is reduced. That can have an impact on salary-related benefits and obligations, such as ACC benefits, redundancy entitlement and student loan repayments. You and your employer need to work through those issues. Your employment contract will need to be amended.

For various reasons, a salary sacrifice arrangement will not suit all employees. Some employers may also choose not to provide this as an option. It does involve them in paperwork and extra costs.

Finding out more

If you want to investigate the superannuation tax advantage to save tax and boost your retirement savings, talk it through with your employer or a superannuation scheme provider. Most scheme providers will guide you and your employer through the right procedures and explain the detailed conditions that apply.