Sample Newsletter Issue

Please enjoy reading this sample issue of the "Own Your Financial Future" newsletter.

Please note that the figures in this sample newsletter are based on personal tax rates for the 2005/2006 financial year.

Is Salary Sacrifice Worth It?

Thanks to those readers who have submitted their questions. This fortnight I answer the first of the questions.

Pressed for time? Here is the summary

The Question

This is a great question as it has many aspects. Unfortunately that means that there is no single “right strategy” that will suit everyone. But it is a great situation to be in – extra money coming your way with multiple options of how to make it work for you. Consequently this discussion applies to anyone who has extra money coming their way, perhaps through a bonus or a capital gain.

Here are some of the variables that would impact on the right strategy for each person who finds themselves with a windfall gain:

• What is your marginal tax rate?
• Do you have non-tax deductible debt such as a mortgage?
• Do you foresee needing access to the money before you are 60?
• If you invested the after-tax bonus outside superannuation, how much risk would you be willing to take with the investment?

Why even consider salary sacrificing the bonus to superannuation?

So, for example if you have a bonus of $1,000 coming your way and you are on the average marginal tax rate of 31.5% the tax office will keep $315 of your bonus and you will get $685 to invest. (I’m assuming you’re not planning on spending your bonus.)

If you elect to sacrifice the bonus of $1,000 to superannuation the tax office will keep $150 and you will have $850 to invest through your superannuation fund. That’s an extra $165. Or you could say it is a guaranteed 24% return in the first year just by sacrificing it to superannuation.

The benefit to someone on the top marginal tax rate of 48.5% is even larger. They save $335 in tax. Or alternatively earn themselves the equivalent of a guaranteed 65% return in the first year.

The benefit of salary sacrifice is therefore that you have more invested for your future. And it gets better, because future earnings on that extra amount in superannuation are also only taxed at 15%. Whereas if you’d invested outside of superannuation investment earnings would be taxed at your marginal tax rate.

What’s the catch?

So if you can foresee the need to access that money before age 60 then salary sacrifice to superannuation may not be an appropriate strategy for you.

Don’t react too quickly

What are your other options?

I’m going to assume you are not intending on spending the bonus. So let’s consider the alternative that you invest the after-tax amount outside of superannuation. You have just made a strategic investment decision: to invest outside rather than inside superannuation. Whether that is a smart financial decision depends on if you can make up the lost tax in extra returns.

As demonstrated earlier your starting investment point is lower if you take the bonus as cash, because you’ve paid less tax. So you need to achieve a higher investment return outside of superannuation to make up that difference. How much higher do you think?

The following table summarised the additional investment return required outside of superannuation. For the return in superannuation I have assumed an average pre-tax return of 7.5%p.a. just for example purposes and not as a forecast. (Did you pick the not-so-subtle disclaimer?) For simplicity I have also assumed that all returns are received as income rather than capital gains.

Marginal Tax Rate	15% (Super)	31.5%	48.5%
Pre-tax Bonus	$1,000	$1,000	$1,000
Post-tax investment amount	$850	$685	$515
Average pre-tax investment return	7.5%p.a.	10.65%p.a.	16.56%p.a.
Amount after 25 years	$3,985	$3,985	$3,985

Your investments outside superannuation would have to be invested in much more risky assets just to get the extra 3.15%p.a. let alone the extra 9.06%p.a. return needed by the person on the top marginal tax rate.

If you choose not to salary sacrifice the bonus to superannuation you would therefore need to be comfortable to accept either:

• Much higher investment risk
• Lower retirement savings and therefore less lifestyle

For you, is the ability to access the money worth the cost?

Alternatively you could repay debt

In many cases repaying debts is wiser than investing surplus income, so long as you subsequently invest the interest you save.

But here the question is whether it is better than salary sacrificing the bonus to superannuation. The answer is to be found in crunching the numbers and making the comparison between salary sacrifice and debt repayment. This is similar in process to the investment example but with variables such as the loan term and the interest rate.

This has already become a long newsletter so I won’t provide another example, as hopefully you understand the decision making process and can apply it to your situation.

So, what’s the answer then Matt?

• Do you foresee needing access to the money before you are 60?
• Do you have non-tax deductible debt such as a mortgage?
• If you invested the after-tax bonus outside superannuation, how much risk would you be willing to take with the investment?

If you need help making the decision or crunching the numbers then I recommend that you seek advice from a financial planner. Calling me is always a great start! (Country WA and interstate readers can now call 1300 669 101 for the cost of a local call.)

Warm regards

Matt Hern

Return to the Newsletter Subscription page to claim your three free gifts.

Home | Terms of Use | Privacy Policy | Search This Site

Matt Hern trades as FINDRE
(Empowered Wealth Pty Ltd t/as)
ABN: 21 592 525 720

Phone: 08 9467 7320, Fax: 08 9463 7848
PO Box 80, Victoria Park, Perth, Western Australia 6979, Australia
Website: www.MattHern.com.au

Add to Favorites