Saturday, 10 May 2008

Using Salary Sacrifice and Super Contribution to Boost Net Worth

Right now I am in university (Melbourne University, if anyone is interested), which means I don't have enough time to work. As a result, I earn less than $20,000 per year. Looking at the individual income tax rates from the ATO, this means I am taxed at 15 per cent for every dollar above $6,000. I will only be charged more than 15 per cent if I earn more than $30,000 per year.

Suppose I finish university and work longer hours or get a high paying job. As a result I earn more than $30,000 and I will be taxed at 30 per cent for every dollar over $30,000. How will I fix this? Simply, I will salary sacrifice into my super fund. A Colonial First State article titled Boost Your Retirement Fund - Salary Sacrifice claims that salary sacrifice is especially good for those in the top tax bracket, i.e. those earning over $150,000 who have to pay 45 per cent on every dollar over $150,000. Taxation in Australia rises steeply as income rises. Personally I am not bothered by this, and when elections come around I always vote for the party that advocates the highest taxes. This is because, even if I earn a high salary, I can simply salary sacrifice and pay only 15 per cent income tax. The Colonial First State article claims that money going into super is taxed at only 15 per cent. This means that if you earn less than $30,000 per year, there is no point salary sacrificing into super, which is why I don't do it now.

That's not all. Once you salary sacrifice into super, you are eligible for the Government's Super co-contribution. This co-contribution is pretty much a government subsidy for saving. The maximum the Government will give you is $1,500 and this can only be achieved if you earn less than $28,980 per year. This means that you must salary sacrifice to the point where your taxable income is $28,980. Then you will not only get the maximum co-contribution ($1,500 per year) but you will minimize your income tax payments since the most you will pay is 15 per cent. Getting $1,500 from the Government may not sound like much for some, but I am 24 now and super will be paid out to me when I'm 65. Assuming my super fund grows on average 8 per cent per year, then $1,500 invested when I'm 24 becomes $35,193 by the time I'm 65. That seems like a lot!

There's another good reason why I should salary sacrifice to the point where I earn a taxable income of only $28,980. That reason is HECS. If I keep my taxable income low I won't have to repay my HECS debt. According to David Potts in Best to Wait Before HECS, I only have to pay back HECS (student loans) if I earn over $41,595 per year. Maybe people say that debt is bad and that I should repay this student debt as fast as possible. Not necessarily. Credit card debt is bad because credit cards usually charge maybe 15 per cent interest rates. However, HECS is a zero-interest loan from the Australian Government. Your HECS debt is only indexed to the CPI, which means that your debt does rise in nominal terms from not in real terms. In theory the best thing to do is to keep your money in an investment that beats inflation--shares or maybe property--and then pay back the debt just before you die. Potts says the following:
Because there's no interest accumulating, usually the longer you hold a HECS debt without having to pay any of it off, the better.

You might even hit the jackpot of never paying it off. This could be for any number of reasons ranging from the positive (an extended stay overseas or salary sacrificing into super) to the negative (you bomb out of uni and never make enough to reach the threshold).

I don't know whether it is necessary that you pay back this loan before you die. Perhaps you never have to pay this loan back if your income never goes above the compulsory repayment threshold. If that is the case then I can just let this debt accumulate till the day I die and in effect I will have received free university education. Even if it was free the education did cost me in terms of time wasted as well as cost of textbooks, petrol, and train tickets.

Update 15/5/2008:

The Australian Labor Party has announced massive tax cuts to help low income people. The Liberals call this "the politics of class envy" but I am happy since at the moment I am a low income person and even if I am a high-income person I will become a low-income person through salary sacrifice.

Thanks to these ALP tax cuts I will no longer be forced to live off $30,000 per year since the 30 per cent threshold will increase from July this year to $34,001, in July next year to $35,001, and in July 2010 to $37,001.

Some people claim that if I continue to salary sacrifice to minimize tax and to minimize HECS repayments, assuming that tax rates and HECS compulsory repayment thresholds are not adjusted for inflation, then I will have my real wage eroded in real terms over the long run. This not true because the $30,000 or so dollars of take-home pay I will get will mostly be invested in a mutual fund that I assume will rise greater than the rate of inflation.

Update 16/5/2008:

I have heard that reportable fringe benefits (i.e. amounts salary sacrificed) are included in HECS repayment threshold calculations. Therefore, this whole plan of salary sacrificing to avoid HECS may not work.

Another person, however, told me that salary sacrifice is not included in reportable fringe benefits. However, he claimed all this could change with the new Budget.

I'll probably need to talk to an expert. I hate it how tax rules are so arbitrary and complex.

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