In Australia, employers must contribute 9.5% of an employee’s wage into the employee’s chosen superannuation fund. For example, someone earning a wage of $100,000 a year will see a $9,500 contributions made to his or her superannuation fund over 12 months.
Unlike the top dollars of that person’s income which are taxed at 39%, the above super contributions are “only” taxed at 15% (https://www.ato.gov.au/rates/individual-income- tax-rates/). It may therefore be attractive for that employee to ask his or her employer to pay some of that $100,000 into their superannuation fund instead. Doing so would be salary sacrificing!
If $10,000 was salary sacrificed, it would attract a tax bill of $1,500 instead of $3,900 if it was paid as a wage. That’s a simple and straightforward $2,400 tax saving and it gets better: future returns from that money being invested will also be taxed favorably, compounding the long-term benefits of salary sacrificing.
So what is the catch you rightly ask?
There are essentially two things to note about salary sacrificing:
a) Once the money has been contributed to superannuation, it is locked in there until preservation age which is currently 60 years old for most people (https://www.ato.gov.au/Individuals/Super/Accessing-your- super/)
b) There is a limit to how much any person can contribute to their superannuation in this fashion, which is currently $25,000 per year including the employer’s mandatory contribution (https://www.ato.gov.au/Rates/Key-superannuation- rates-and- thresholds/?anchor=Concessionalcontributionscap#Concessionalcontributionscap)
Salary sacrifice is very relevant to SMSF lending as it directly impacts the SMSF “income”, which in turn is a major factor in defining how big or small an SMSF loan the fund can secure.
As discussed in previous post, an SMSF loan servicing is relatively straight forward: contributions + future rental income + return on existing investments – ongoing costs – ongoing liabilities repayments – new SMSF loan repayments @ assessment rate. If one boosts the contributions figure in that equation through salary sacrifice, one consequently increases the amount that can be borrowed by its fund.
The devil is in the details though, as different lenders have very different ways to look at salary sacrifice. Some of them will only use it in their calculations if it has been occurring for at least 2 years. Some of them will be willing to use it if it has been happening for some shorter periods of time from a few months to twelve. Some of them will even be happy to use salary sacrifice which has not happened yet, for as long as we can demonstrate that the applicant has the ability to make it.
Unfortunately, servicing is only one side of the SMSF borrowing capacity coin. The above always has to be looked at in conjunction to the equity requirements of these lenders. While a bank may have the most favorable perspective about salary sacrifice and servicing in general for a specific applicant’s circumstances, it may not have the most generous loan to value ratio on offer, or it may have much more restrictive SMSF liquidity requirements.
Ultimately, for the same scenario, proceeding with a lender versus another will have a substantial impact on how much can be borrowed. How much can be borrowed will in turn defines which property can or can’t be purchased and that eventually will decide how profitable the whole endeavor is.
Salary sacrifice over the long term will boost both the servicing ability of an SMSF and it’s liquidity balance. It will invariably increase the funds ability to secure a higher overall limit of SMSF loans. It will assist the SMSF pay off a property faster or accumulate a deposit for the next property sooner. It will also reduce taxes payable for all but the lowest income earners.
If you are considering salary sacrificing, you should discuss your personal circumstances with your financial adviser or accountant. If you are looking at maximizing or increasing your SMSF borrowing capacity, give us a call on 1300 781 680 or email us [email protected]
* The information contained in this blog is general information only. No part of this blog is to be construed as a solicitation to buy or sell any security or financial product. The author, in preparing this blog, did not take into account the investment objectives, financial situation and particular needs of any particular person. Before acting on any information or advice in this document, you should consider the appropriateness of it (and any relevant product) having regard to your circumstances. You should also seek independent financial advice prior to acquiring a financial product.