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What changed on 1 January 2020?

The removal of the 10% test from 1 July 2017 made personal deductible contributions more popular and widely available as a strategy to build super. As there are some drawbacks on salary sacrifice to super, some clients switched to personal deductible contributions as a way of building their super balance. One of the key drawbacks of salary sacrifice was that employers could reduce super guarantee (SG) payments

However, since 1 January 2020, salary sacrifice amounts are now included in an employee’s ordinary time earnings so employers must pay super guarantee on these amounts. Accordingly, it is worth revisiting the question – should your client use salary sacrifice or personal deductible contributions to build their super?

How will it work?

Legislation was passed in late 2019 to require employers to satisfy the following super guarantee rules for quarters commencing from 1 January 2020:

• Employer contributions made under a salary sacrifice arrangement are prevented from satisfying an employer’s super guarantee obligations – see example one
• Salary sacrifice contributions are added to ordinary time earnings (OTE), therefore, super guarantee obligations must be paid on pre-salary sacrifice income – see example two

The following examples illustrate how an employer could use the salary sacrifice amount to reduce their SG payments. SG is a quarterly requirement, but we have used fortnightly figures in the first example and annual figures in the second example for simplicity.

Example one

Before 1 January 2020, Sam who is age 52, had fortnightly earnings of $2,750. He established a salary sacrifice arrangement to forego $250 per fortnight (pf) of his salary for additional employer super contributions. Sam’s OTE reduced to $2,500 pf and his employer must have contributed at least $237.50 pf (9.5% of $2,500). Sam’s employer paid a $250 salary sacrifice contribution into his super fund and used this contribution to satisfy the $237.50 super guarantee obligation. Consequently, his employer’s SG obligation was satisfied. From 1 January 2020, Sam’s employer must pay the required amount of SG on pre-salary sacrifice income in addition to paying the salary sacrifice amount.

Example two

Let’s now consider Jade, who is age 47, in the current financial year (2019/20). Her salary is $60,000 per year and she salary sacrifices $10,000 per year into super. The table below outlines the employer’s actions before and after 1 January 2020.

Salary sacrifice – the case for

Salary sacrifice to super has been the cornerstone strategy to build a client’s retirement benefit in a tax-effective manner. The benefits of salary sacrificing, in contrast to personal deductible contributions include:

• Discipline – the automated nature of salary sacrificing into super may appeal to clients who would struggle to save the equivalent amount required to make a personal deductible contribution at the end of the financial year. Salary sacrifice may provide the discipline to build super over the long term.
• Dollar cost averaging – salary sacrifice allows clients to buy into the market at regular intervals and therefore reduce the risk of market timing. In contrast, large one-off personal deductible contributions made in May or June are more susceptible to market timing risk.
• No notice of intent – the client does not need to worry about submitting a notice of intent to their super fund when salary sacrificing, unlike personal deductible contributions.

Salary sacrifice – the case against

Before you recommend salary sacrifice, consider the following restrictions or possibilities.

Whether the employer does not provide salary sacrifice or the arrangement may be ineffective

Some advisers have recommended that a client salary sacrifice only to discover that the employer does not provide such an arrangement. This experience creates a lack of fulfilment for the client and means the advice needs to be re-evaluated. A personal deductible contribution strategy bypasses the employer and allows the adviser to manage the outcome with the client directly.

Where the employer can offer salary sacrifice, the arrangement must be in place before the employee has actually earned the entitlement. This is known as an ‘effective salary sacrifice’ arrangement. An agreement in respect of entitlements that have already been earned is an ineffective salary sacrifice arrangement. Under an ineffective salary sacrifice arrangement, the sacrificed wage or salary forms part of the employee’s assessable income and is taxed accordingly. Any super contributions made under an ineffective salary sacrifice arrangement constitute non-concessional contributions of the employee. Therefore, salary sacrificing creates a potential risk of ineffective arrangements and ineffective tax outcomes if not properly managed.

The prospect of excess concessional contributions

Managing the concessional contributions cap with salary sacrifice can be difficult for higher income clients. For example, unexpected salary increases, or a bonus can boost the amount of employer contributions and lead to excess concessional contributions. In contrast, a personal deductible contribution made towards the end of the financial year is much less likely to create an excess concessional contribution problem as existing SG amounts can be factored in when calculating the required amount of deductible contribution.

Another common problem with salary sacrifice arrangements can occur towards the end of the financial year if June payments are not made until July due to delays by either the employer or the super fund. The Australian Taxation Office (ATO) can use its discretion in special circumstances to reallocate the contribution to the appropriate financial year. However, the ATO has suggested in Practice Statement Law Administration PS LA 2008/1 that if the salary sacrifice arrangement has specific dates for the employer contributions to be made, the ATO is more likely to use its discretion to reallocate the contribution. In practice, not many agreements have specific dates for all contributions to made during the financial year. Therefore, ATO discretion to reallocate contributions cannot generally be relied upon when salary sacrificing.

Salary sacrifice contributions may go to a different fund

An employer does not have to pay salary sacrifice contributions into the chosen fund of the employee. Choice of super fund allows eligible employees to choose the super fund that receives their SG contributions, but not salary sacrifice contributions. Therefore, salary sacrifice contributions may be made to a fund chosen by the employer. An employee may seek agreement from the employer to include a section specifying the relevant super fund or a section that provides the employee with the ability to choose a super fund. In contrast, personal deductible contributions can be made to a super fund chosen by the individual member.

Uncertain frequency of salary sacrificed contributions

Unlike SG contributions, super legislation does not specify the contribution frequency required for salary sacrifice contributions. Some industrial relation instruments, for example, modern awards, may outline the minimum frequency of salary sacrifice amounts. Ideally, a salary sacrifice agreement should include a section outlining the minimum frequency that salary sacrifice contributions will be made by the employer.

In contrast, an individual member can choose when to make a personal deductible contribution. For example, the client may wish to make contributions evenly across the financial year or make a one-off contribution towards the end of the financial year.

Personal deductible contributions – the case for

Since 1 July 2017, all clients eligible to contribute to super can make personal deductible contributions, including employees, the self-employed and clients under age 65 who are retired. Since 1 July 2017, clients cannot make personal deductible contributions to untaxed and certain defined benefit super funds.

To make personal contributions to super, a client must be eligible to contribute. This generally means the client must be under age 65 or satisfy the work test (or work test exemption) between age 65 to 74. A contribution can be accepted within 28 days following the end of the month when they become age 75.

The personal contribution can be made regularly throughout the financial year, for example, if market timing is a concern, or alternatively they can be made towards the end of the financial year when the client has a clearer position of their taxable income. A possible approach to make the personal deductible contribution is to accumulate a certain amount in a mortgage offset account, or similar type of cash account, over the course of the financial year and then make a one-off contribution towards the end of the financial year. Otherwise, sufficient funds may not be available to make the personal deductible contribution.

End of financial year is a good time to assist clients in maximising their super balance through tax-effective strategies, for example, spouse contributions, co-contributions and contribution splitting. You can use personal deductible contributions as a potential strategy for all clients who are eligible to contribute to super.

Personal deductible contributions – the case against

One of the strict requirements to qualify for personal deductible contributions is that the notice of intent must be given to the super fund within legislated time frames. The notice must be given before the earlier of:

• when the client lodges their tax return, or
• 30 June of the next financial year.

In some cases, clients need to submit a notice of intent before these times. In particular, a client must submit a notice of intent and receive acknowledgement before:

• the client commences an income stream with either all or part of the contribution
• the client withdraws or rolls over benefits (which include the contribution)
• the client gives the trustee a splitting contributions application.