We know salary sacrifice and super contributions are good for our long-term financial position but how much is too much? Is there an amount that we can salary sacrifice that makes us worse off?
Making concessional (tax deductible) super contributions can be an effective way of reducing personal income tax. However, they are only effective if the person has sufficient taxable income to be able to benefit from the tax impact of the concessional contribution.
As concessional contributions are generally subject to contributions tax of 15%, they are only tax effective to the point where taxable income is reduced to the effective tax-free threshold. When concessional contributions are made beyond this point, the person may actually pay more tax overall than if they made a non-concessional contribution.
The official tax free threshold for Australian residents is $18,200 per year. However, the effective tax free threshold can be higher.
In most cases the optimal amount to salary sacrifice (or make as a tax deductible contribution) is the lesser of:
- The difference between the individuals taxable income and their effective tax-free threshold
- The available concessional contributions cap
Calculating this effective tax-free threshold and therefore the optimal amount of salary sacrifice is complicated by:
- Marginal tax rates
- Low Income Tax Offset (LITO)
- Low and Middle Income Tax Offset (LMITO)
- Seniors and Pensioners Tax Offset (SAPTO)
- The Low Income Super Tax Offset (LISTO)
- Other offsets such as an Australian super income stream tax offset or a spouse super contribution tax offset
- Other factors such as whether the individual is a member of a couple or non-resident for tax purposes.
Calculating the Effective Tax-Free Threshold
Resident individuals who are not eligible for SAPTO may have an effective tax-free threshold of $23,226 for the 2020-21 financial year (after accounting for LITO and LMITO).
Details of how the effective tax free threshold is calculated are provided below:
- Taxable income $23,226
- Income tax $ 955
- LITO ($ 700)
- LIMITO ($ 255)
- Net Income (before Medicare Levy) $23,226
Although taxable income of $23,226 will result in no tax payable due to LITO and LMITO, based on the 2019-20 Medicare levy low income threshold of $22,801 (note: 2020-21 Medicare Levy thresholds are not yet available and are expected to be released towards the end of the financial year) there will be a small amount of Medicare levy payable of approximately $42. However, any further concessional contributions from this point will only reduce the Medicare levy by 10 cents in the dollar (until the point where Medicare levy ceases to apply). Given that concessional contributions are subject to 15% contributions tax (assuming LISTO doesn’t apply), the additional contributions tax incurred will be more than the Medicare levy saved.
Implications for Super Contributions
If concessional contributions made reduce a member’s taxable income below the effective tax-free threshold, they will not result in a personal tax saving for the member but may incur 15% contributions tax. The result is that more tax may be payable overall than if the member made a non-concessional contribution.
Resident Individuals (Eligible for SAPTO)
For individuals who are also eligible for SAPTO, the calculation of the effective tax-free threshold is more complicated. The reason is that SAPTO is based on ‘Rebate Income’ which amongst other things, includes amounts of salary sacrifice and personal deductible contributions.
This means that while making concessional contributions (within the concessional cap) will reduce taxable income, it will not reduce Rebate Income and therefore will not increase entitlement to SAPTO. This results in members with high levels of Rebate Income receiving lower levels of SAPTO which in turn results in a lower effective tax-free threshold.
Higher effective tax-free thresholds can apply where an individual is entitled to other non-refundable tax offsets (such as an Australian super income stream tax offset or a spouse super contribution tax offset).
Low Income Super Tax Offset
The Low Income Super Tax Offset (LISTO) essentially returns the 15% contributions tax paid on concessional contributions up to $3,333. LISTO is refunded to the super accounts of members with adjusted taxable income of $37,000 or less.
While LISTO effectively refunds contributions tax, making concessional contributions that are eligible for LISTO that cause taxable income to be below the effective tax-free threshold may still not be advantageous as it results in contributions forming part of the taxable (taxed) component, rather than the tax-free component which would be the case if they were made as non-concessional contributions.
EXAMPLE 1:
Paul is age 49 and not eligible for SAPTO as he is below Age Pension age.
He has taxable income of $45,000 in 2020/21 (before deciding to make a concessional contribution).
Paul’s available concessional contributions cap utilising the catch-up concessional contribution rules is $40,000.
When determining the amount to contribute as a personal deductible contribution, Paul should consider contributing the lesser of:
- Difference between his taxable income ($45,000) and effective tax-free threshold ($23,226) = $21,774.
- Available concessional contribution cap of $40,000
If Paul contributed up to his available concessional cap of $40,000, the additional $18,226 would not reduce his personal income tax liability (aside from saving $42 in Medicare levy based on 2019-20 Medicare levy low income threshold) and he would pay $2,733.90 contributions tax on this amount which would not be payable if contributed as a non-concessional contribution.
EXAMPLE 2:
Betty is age 67 and eligible for SAPTO.
She has taxable income of $45,000 in 2020/21 (before deciding to make a concessional contribution). Her Rebate Income is also $45,000 in 2020/21.
Betty meets the work test this financial year and is able to contribute even though she has reached age 67.
Betty’s available concessional contributions cap utilising the catch-up concessional contribution rules is $40,000.
When determining the amount to contribute as a personal deductible contribution, Betty should consider contributing the lesser of:
- Difference between her taxable income ($45,000) and effective tax-free threshold ($26,594) = $18,406.
- Available concessional contributions cap of $40,000
As Betty’s Rebate Income is still $45,000 after making the personal deductible contribution, the reduced SAPTO results in an effective tax-free threshold of $26,594.
If Betty contributed up to her available concessional cap of $40,000, the additional $21,594 would not reduce her personal income tax liability or Medicare levy and she would pay $3,239.10 contributions tax on this amount which would not be payable if contributed as a non-concessional contribution.
EXAMPLE 3:
John is age 67 and a member of a couple. He is eligible for SAPTO.
John’s taxable income is $35,000 in 2020/21 (before deciding to make a concessional contribution). His Rebate Income is also $35,000 in 2020/21.
John meets the work test this financial year and is able to contribute even though he has reached age 67.
John’s available concessional contributions cap is $25,000.
When determining the amount to contribute as a personal deductible contribution, John should consider contributing the lesser of:
- Difference between his taxable income ($35,000) and effective tax-free threshold ($27,693) = $7,307.
- Available concessional contributions cap of $25,000
Note that John’s effective tax-free threshold is $27,693. As John’s Rebate Income is still $35,000 after making the personal deductible contribution, the reduced SAPTO results in a lower effective tax-free threshold.
If John contributed up to his available concessional cap of $25,000, the additional $17,693 would not reduce his personal income tax liability or Medicare levy and he would pay $2,653.95 contributions tax on this amount which would not be payable if contributed as a non-concessional contribution.
DISCLAIMER:
This is intended to be general advice only. Goldsborough Financial Services has not taken into account the objectives, financial circumstances or investment needs of any particular person. For specific advice on your situation please contact your Goldsborough Financial Planner.
The above article has been written based on information published and provided by Colonial First State’s Technical Services Team – First Tech and is current as of April 2021.
