The virtue of (salary) sacrifice

 

 

When you make a sacrifice, you're usually giving something up with the expectation of future gain.

 

Salary Sacrificing into your super is no different, you’re giving up ready access to your money in your take-home pay. But in return you’re boosting your retirement savings and saving on tax.

 

You can pay extra cash into your super from your pre-tax salary at the concessional 15% rate of tax (30% if you earn over $300,000 p.a.) —up to a limit (or cap) of $30,000 for 2016/17 (or $35,000 if you were 49 or over on 30 June 2016). That’s a considerable tax saving for most people on their usual marginal tax rate.

 

Get your regular payment in place

 

With a new financial year, it’s a great time to get your salary sacrifice arrangement in place – on top of the regular super guarantee payments made by your employer. This way you’ll be able to maximise your concessional contributions and minimise your tax burden over the course of the next financial year.
 

 

Boost super, save on tax

 

Let’s look at how salary sacrifice could work in practice.

 

Judith, aged 50, is a teacher earning $80,000 a year. She currently puts $385 per fortnight into her online savings account (approximately $10,010 a year) and wants to start building up her retirement savings.

She is considering whether to make:

• an after-tax contribution into superannuation of $10,010 a year, or
• an equivalent pre-tax (salary sacrifice) contributions

After-tax contributions v salary sacrifice for Judith (2015/16)

 

Judith’s income tax position:	After-tax contributions	Salary sacrifice contributions
Gross salary	$80,000	$80,000
Less salary sacrifice contributions	Nil	($15,238)
Reduced gross salary	$80,000	$64,672
Income tax, Medicare levy	($19,147)	($13,829)
Net salary	$60,853	$50,843
After-Tax contributions to super	($10,010)	Nil
Take-home pay after contributions	$50,843	$50,843
Net income tax saving		$5,318
Judith’s super contributions position:
Super Guarantee contributions (9.5%)	$7,600	$7,600
Salary sacrifice (pre-tax) contributions	Nil	$15,282
15% contributions tax	($1,140)	($3,439)
Total net concessional contributions	$6,460	$19,489
Plus non-concessional contributions to super	$10,010	Nil
Total net contributions for year	$16,470	$19,489
Additional net contributions into super		$3,019

 

In both scenarios, Judith’s take-home pay is the same. But by salary sacrificing into super, Judith can increase her super contributions for the year by $3,019, even after taking the 15% contributions tax into account.

 

Salary sacrifice checklist

 

Salary sacrifice isn’t without pitfalls. You’ll need to make sure you don’t unintentionally go over your contributions cap or reduce your other entitlements.

 

Here’s a handy checklist to make sure that you’ve ticked all the boxes.

1. Make sure that you can salary sacrifice

 

• Does your employer allow salary sacrifice?
• Are you under age 75?

 

2. Complete your employer’s standard salary sacrifice paperwork

 

You can’t salary sacrifice income already earned.

 

• Plan ahead to sacrifice bonus and leave payments.

3. Make sure your other entitlements aren’t affected

 

Check with your employer:

 

• how your super guarantee is calculated
• the definition of ‘salary’ used to work out your payments.

4. Monitor your concessional contributions cap

 

Check all concessional contributions for the financial year. These include: 

 

• compulsory contributions paid by your employer – such as the super guarantee 
• contributions from a previous role within that financial year 
• pre-tax contributions on top of your super guarantee
• administration fees and insurance premiums paid by your employer 
• contributions allowed as an income tax deduction – such as contributions you make if you are self-employed 
• notional taxed contributions if you are a member of a defined benefit fund

5. Get the agreement in writing

 

• Every employer is different. Make sure you know when your contributions are paid within the financial year so you don’t go over your concessional contributions cap.

6. Set up a notification

 

• Download the AMP app and set up an alert to notify you when your payments reach your account and when you are approaching your super cap.

So don’t delay. Make sure you get your salary sacrifice arrangements in place to make the most of this financial year. You’ll soon see the difference when you next look at your super balance.

 

Important information

 

© AMP Life Limited. This provides general information and hasn’t taken your circumstances into account. It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, AMP does not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any investment decision. Except where liability under any statute cannot be excluded, AMP does not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person.

 

 

 

Compound Interest. Step by step, how compound interest works.

 

Pop quiz, who said

 

"Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it. Compound interest is the most powerful force in the universe. Compound interest is the greatest mathematical discovery of all time."

 

The answer, Albert Einstein of course. Almost everyone has heard of Compound interest but few really understand how big of an impact it has on our everyday lives. Every loan we apply for, every mortgage, credit card, savings account, superannuation policy and investment including the family home is subject to compound interest. By understanding Compound Interest we can use it to reach our Financial goals.

 

What is compound interest?

The basic principal of compound interest is earning additional interest on interest. Once you earn your first interest payment, it is added to the principal. Let me explain in an example.

 

If you invested $100 and in the first year your investment return was 10% you would have earned $10 bringing your total investment to $110

 

$100 x 10% = $10

$100 + $10 = $110

If in the second year your investment return was again 10% you would have earned $11 bringing your total investment to $121

 

$110 x 10% = $11

$110 + $11 = $121

 

If in your third year your investment return was again 10% you would have earned $12.10 bringing your total investment to $133.10. 

 

$121 x 10% = $12.10

$121 + $12.10 = $133.10

 

So by receiving three years of compounding 10% returns your balance is not 30% higher but 33.1% higher.

 

There is a formula for calculating compound interest which you can easily use in Microsoft Excel. Alternatively there are many compounding interest calculators available online including the Money Smart website

 

 

"He who understands it, earns it."

Compound interest is the reason why Financial experts say to start early. By saving that little bit of money each week to put into the mortgage, pay off debt, contribute to super, save for that home deposit or that big holiday will make a big difference towards achieving your financial goals. In fact the earlier you start the bigger impact your small savings will make. Superannuation will likely be the longest investment you ever have and will therefore gain the most benefit from compounding interest.

 

It is human nature to spend what you earn and the idea of finding money you do not need can be daunting to most. The key is to make small gradual steps in the right direction. Every pay cycle set up an automatic transfer of what you think you can afford. Maybe its only $5 or $10 a week but it is $5 or $10 a week you weren't saving before. Try that for a couple of weeks and see if you even notice the money gone. Then try increasing your savings to $15 or $20 per week and see what sort of impact it makes you on your lifestyle. Many people struggle to accrue savings but by taking these small gradual steps you will end up building yourself a financial safety net that will reduce financial stress, build good financial habits and allow you to achieve more financially than you thought possible.

 

"He who doesn't, pays it."

Hands down compound interest is how banks make their money. Yes there is money in fees but not as much money as compound interest on debt.

 

Did you know most credit cards only require a minimum repayment of 2% or about $25 per month. So if you had a $6,000 credit card maxed out with a 20% interest rate, never made another purchase and only paid the minimum repayment of $120 per month you would pay an estimated $7,000 in interest. That is just insane.

If you decided to double your repayments to $240 per month, which is only $55.40 per week, you would only pay an estimated $1,827 in interest. What a difference! That is the power of compounding interest and starting early.

 

Conclusion

If you were to take away one thing let it be this, even the smallest contributions over time can make a big difference. Put aside a little bit of money every pay cycle to help pay off debt or build your savings. Saving is just as addictive as spending if you have a goal, even if that goal is to form good financial habits.

 

Please check out our website www.constancywealthmanagement.com.au

 

 

What you need to know

 

Constancy Wealth Management is an Authorised Representative and Credit Representative of AMP Financial Planning Pty Limited ABN 89 051 208 327 AFSL 232706 and Australian Credit Licence 232706. This information does not take your circumstances into account, so read the relevant disclosure documents and consider what’s right for you. If you acquire an AMP product or service, AMP companies and/or their representatives will receive fees and other benefits, which will be a dollar amount and/or a percentage of either the premium you pay or the value of your investments. Ask us for more details.

 

This post contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information