Salary Sacrifice - The Definitive New Zealand Guide
Our guide breaks down what a salary sacrifice is, how it works and whether you should consider taking a salary sacrifice. We also outline the top things you need to know about salary sacrifices before taking one, and answer frequently asked questions.
Updated 12 March 2022
Summary
We cover:
Disclaimer: Salary sacrifice is complicated and no situation is alike. Our guide is general in nature. If you wish to find out whether salary sacrifice is suitable for your situation, we suggest contacting a tax accountant or financial advisor. The IRD can't advise on individual situations and will likely suggest you contact a tax accountant.
Summary
- In a nutshell, salary sacrifice involves an employee swapping part of their cash pay to receive remuneration in another form that's more suitable to their needs. This could be higher employer contributions to KiwiSaver, a private superannuation scheme or daycare/childcare benefits.
- Salary sacrifice is relatively uncommon in New Zealand employment law, but it can cause much confusion for the select few who decide to pursue salary sacrifice. There are ACC, tax and payroll considerations to manage which can make it complicated.
- It's not typical to see salary sacrifice mentioned in many employment contracts or discussed at a job interview. Still, it can apply to a few unique situations, specifically regarding KiwiSaver or when an employee chooses to substitute income for alternative compensation such as childcare payments.
- Our guide breaks down what a salary sacrifice is, how it works and whether you should consider taking a salary sacrifice. We also outline the top things you need to know about salary sacrifices before taking one, and answer frequently asked questions.
We cover:
- What is a Salary Sacrifice, and How Does it Work?
- How Does a Salary Sacrifice Impact the Tax I Pay?
- Top Things to Consider When Taking a Salary Sacrifice
- Practical Example – University of Auckland Salary Sacrifice Scheme
- Pros and Cons of Salary Sacrifices (Applying the University of Auckland as an Example)
- Frequently Asked Questions
Disclaimer: Salary sacrifice is complicated and no situation is alike. Our guide is general in nature. If you wish to find out whether salary sacrifice is suitable for your situation, we suggest contacting a tax accountant or financial advisor. The IRD can't advise on individual situations and will likely suggest you contact a tax accountant.
MoneyHub Founder Christopher Walsh shares his view on salary sacrifice:
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"Salary sacrificing, also known as 'salary packaging', can save you tax costs to anyone who decides to restructure how they're paid their salary. However, while it seems a fast way to lower tax costs, many New Zealanders don't organise it for several reasons. The most common is that their employer doesn't offer it.
Salary sacrificing, if done effectively, reduces the tax you pay and increases your disposable income. However, there are limits to how much salary you can sacrifice - check with your employer about what you can do. If you are going to do it, the best time to set up a salary sacrifice is as soon as you start your job. But how effective it is will depend on how much you earn and how much you can afford to sacrifice. With living costs at record highs, there is added risk in sacrificing too much. Whatever you decide to do, a tax accountant is a helpful point of call to make sure you structure your sacrifice tax efficiently. I would strongly urge you to make sure you understand how your salary sacrifice would work, what it will cost and a get a clear 'before and after' of what you're going to save in tax". |
MoneyHub Founder
Christopher Walsh |
What is a Salary Sacrifice, and How Does it Work?
Salary sacrifice occurs when an employee voluntarily gives up a portion of their salary to receive compensation in another form. This is a common strategy for increasing their retirement savings or getting non-income benefits such as access to childcare.
For example, if you're a full-time employee that wants to invest more into your KiwiSaver, salary sacrifice allows you to substitute a portion of your salary to increase the amount you contribute each month to retirement.
New Zealand employers don't typically encourage salary sacrifice for their new employees. This arguably adds an additional layer of complexity to calculating tax costs and will typically only apply to a very small minority of the workforce. However, there are significant benefits to taking up a salary sacrifice, including better planning for retirement or having more savings to draw down in the future. Some people choosing salary sacrifice agreements also find it allows them to be more disciplined when budgeting and managing their finances.
For example, if you're a full-time employee that wants to invest more into your KiwiSaver, salary sacrifice allows you to substitute a portion of your salary to increase the amount you contribute each month to retirement.
New Zealand employers don't typically encourage salary sacrifice for their new employees. This arguably adds an additional layer of complexity to calculating tax costs and will typically only apply to a very small minority of the workforce. However, there are significant benefits to taking up a salary sacrifice, including better planning for retirement or having more savings to draw down in the future. Some people choosing salary sacrifice agreements also find it allows them to be more disciplined when budgeting and managing their finances.
How is a salary sacrifice organised?
A salary sacrifice provision will be included in an employment agreement if the employee and the employer agree. A remuneration policy is usually established to provide employees with more flexible and affordable remuneration agreements that suit their individual needs. Through a salary sacrifice scheme, the net remuneration an employee gets may increase, depending on the income levels of the individual. But from an employer's perspective, the value of the gross remuneration typically remains the same.
Know This: Salary sacrifice is predominantly provided to serve the employee. Each person is at a different stage of their life, and salary sacrifice provides the opportunity for employees to set up their remuneration in their best interests.
In addition, it enables employers to support and cater to their employees in the best way for them, ideally leading to happier team members and less staff turnover, as well as higher productivity. From an employee perspective, this can mean prioritising building long term wealth for retirement or allowing for alternative means of earning and saving.
Know This: Salary sacrifice is predominantly provided to serve the employee. Each person is at a different stage of their life, and salary sacrifice provides the opportunity for employees to set up their remuneration in their best interests.
In addition, it enables employers to support and cater to their employees in the best way for them, ideally leading to happier team members and less staff turnover, as well as higher productivity. From an employee perspective, this can mean prioritising building long term wealth for retirement or allowing for alternative means of earning and saving.
How Does a Salary Sacrifice Impact the Tax I Pay?
Under a salary sacrifice agreement, employees will initially earn less PAYE taxable pay (resulting in lower taxes) but shift the tax burden onto the KiwiSaver portion of earnings. Base salary is taxed under the PAYE model, whereas KiwiSaver is taxed through the ESCT (Employee Superannuation Contribution Tax) model.
In general, the cost to the employer of employing the employee will remain the same. However, there are certain situations where an employee may benefit from a salary sacrifice depending on their income level. This is because the PAYE tax rates are slightly different at certain income thresholds than the ESCT tax rates.
In general, the cost to the employer of employing the employee will remain the same. However, there are certain situations where an employee may benefit from a salary sacrifice depending on their income level. This is because the PAYE tax rates are slightly different at certain income thresholds than the ESCT tax rates.
Exhibit 1: ESCT Tax Rates as of April 1 2021
Source: Business.govt.nz
Employee's income for year ended 31 March (including gross employer cash contributions) |
ESCT from 1 April |
$0 to $16,800 |
10.5% |
$16,801 to $57,600 |
17.5% |
$57,601 to $84,000 |
30% |
$84,001+ |
33% |
Exhibit 2: PAYE Tax Rates as of April 1 2021
Source: PAYE Income Tax calculator.
Tax rate |
Taxable income bracket |
Tax owed |
10.5% |
$0 to $14,000 |
10.50% of taxable income, |
17.50% |
$14,001 to $48,000 |
$1,470 plus 17.50% of the amount over $14,000 |
30.00% |
$48,001 to $70,000 |
$7,420 plus 30.00% of the amount over $48,000 |
33.00% |
$70,001 to $180,000 |
$14,020 plus 33.00% of the amount over $70,000 |
39.00% |
$180,000+ |
$50,320 plus 39.00% of the amount over $180,000 |
Understanding ESCT vs PAYE
As seen from the tables above, the tax rates differ depending on if your income falls under ESCT or PAYE. The most notable difference is the differing thresholds at $70,000, $84,000 and $180,000. ESCT is capped at 33% at the upper limits versus 39% for PAYE. Depending on your income levels, you may pay more or less tax depending on how you split your income to pay through PAYE or ESCT.
PAYE is calculated through the gross (before taxes are taken out) income you generate. Typically, the employer will estimate the reasonable tax rate you are likely to pay based on your total compensation and tax you at that rate each week or month you get paid (hence the PAYE name – Pay As You Earn). Then, an employer will deduct the tax you are likely to pay at the end of the year before they pay it into your bank account.
ESCT is the system used to tax your income before entering your KiwiSaver account. This system applies specifically to employer contributions, not your own contributions. This is because your employer will typically calculate and deduct this amount on your behalf.
PAYE is calculated through the gross (before taxes are taken out) income you generate. Typically, the employer will estimate the reasonable tax rate you are likely to pay based on your total compensation and tax you at that rate each week or month you get paid (hence the PAYE name – Pay As You Earn). Then, an employer will deduct the tax you are likely to pay at the end of the year before they pay it into your bank account.
ESCT is the system used to tax your income before entering your KiwiSaver account. This system applies specifically to employer contributions, not your own contributions. This is because your employer will typically calculate and deduct this amount on your behalf.
Top Things to Consider When Taking a Salary Sacrifice
1. Total Tax Liability
The most obvious consideration is how salary sacrifice will influence your total compensation net of taxes. The top tax bracket for ESCT is 33%, compared to the top tax bracket for PAYE at 39%. These discrepancies mean there can be situations where you are paying more or less tax on a salary sacrifice versus a standard remuneration package.
2. Accessibility
When considering a salary sacrifice to increase your retirement savings contributions, it's important to recognise the inherent pros and cons associated with doing so. Putting more effort into your long-term financial success and building wealth in the right way is a sensible way to look after your future. However, it's also important to remember KiwiSaver broadly cannot be accessed until retirement age (65+) or unless you satisfy a few criteria relating to purchasing property, moving overseas, significant financial hardship or health reasons.
Further, KiwiSaver funds are typically managed funds with split portions of bonds, stocks and cash. Unlike foreign superannuation schemes that allow you to select and manage the individual holdings in the portfolio, KiwiSaver is more rigid in the types of things you can invest in. This can influence the amount of control you have (and the associated risk/reward trade-off).
3. Everyday Expenses
Reducing your take-home pay in exchange for higher KiwiSaver has significant implications for budgeting and expenses. The main consideration is whether you have a short-term need for a larger income to cover the ever increasing living costs. Everyone will have different factors to consider. Still, the bottom line is that taking a salary sacrifice will restrict the things you can do with the salary sacrificed portion of your money.
The most obvious consideration is how salary sacrifice will influence your total compensation net of taxes. The top tax bracket for ESCT is 33%, compared to the top tax bracket for PAYE at 39%. These discrepancies mean there can be situations where you are paying more or less tax on a salary sacrifice versus a standard remuneration package.
2. Accessibility
When considering a salary sacrifice to increase your retirement savings contributions, it's important to recognise the inherent pros and cons associated with doing so. Putting more effort into your long-term financial success and building wealth in the right way is a sensible way to look after your future. However, it's also important to remember KiwiSaver broadly cannot be accessed until retirement age (65+) or unless you satisfy a few criteria relating to purchasing property, moving overseas, significant financial hardship or health reasons.
Further, KiwiSaver funds are typically managed funds with split portions of bonds, stocks and cash. Unlike foreign superannuation schemes that allow you to select and manage the individual holdings in the portfolio, KiwiSaver is more rigid in the types of things you can invest in. This can influence the amount of control you have (and the associated risk/reward trade-off).
3. Everyday Expenses
Reducing your take-home pay in exchange for higher KiwiSaver has significant implications for budgeting and expenses. The main consideration is whether you have a short-term need for a larger income to cover the ever increasing living costs. Everyone will have different factors to consider. Still, the bottom line is that taking a salary sacrifice will restrict the things you can do with the salary sacrificed portion of your money.
Practical Example – University of Auckland Salary Sacrifice Scheme
As an example of an employer undertaking salary sacrifice, the University of Auckland has set up a salary sacrifice scheme for university employees with children in their Early Childhood Education. More details of the scheme can be found here.
Summary:
Exhibit 3: Example Salary Without a Salary Sacrifice agreement
Summary:
- Under the university salary sacrifice scheme, a portion of the university staff's income can be sacrificed in exchange for the benefit of early childhood education (ECE) at the University's early childhood education support centre.
- The scheme outlines that qualified staff can voluntarily reduce their base salary by a specified amount in advance for the ECE services, which is equivalent to the employee's pay reduction.
- A working example to show the calculations is shown below. In this example, the University of Auckland has used tax rates from 2010 and assumed the PAYE tax code is set to "M".
Exhibit 3: Example Salary Without a Salary Sacrifice agreement
Base Salary (Before Tax) |
$50,000 |
Less PAYE Deducted |
$10,514 |
Net Pay |
$39,486 |
Less ECE fees |
$5,000 |
Net Pay After ECE Fees |
$34,486 |
Source: University of Auckland (downloads a PDF)
Assuming Early Childhood Education fees of $5,000 per year, these are paid to the University after PAYE has been deducted. Therefore, under the standard salary agreement, the net pay after childcare costs is $34,486.
Exhibit 4: Example Salary with a Salary Sacrifice Agreement
Assuming Early Childhood Education fees of $5,000 per year, these are paid to the University after PAYE has been deducted. Therefore, under the standard salary agreement, the net pay after childcare costs is $34,486.
Exhibit 4: Example Salary with a Salary Sacrifice Agreement
Base Salary (Before Tax and SSA) |
$50,000 |
Less Salary Sacrifice for ECE fees |
$5,000 |
Base Salary (Before Tax) |
$45,000 |
Less PAYE deducted |
$9,156 |
Net Pay |
$35,844 |
Source: University of Auckland (downloads a PDF)
Under a salary sacrifice agreement, an employee may voluntarily reduce their base salary before ECE fees to pay childhood costs first (before paying PAYE). Therefore, under exhibit 4, the total income you would classify for PAYE is $45,000 (versus $50,000 in exhibit 3).
How does each situation compare?
Under a salary sacrifice agreement, an employee may voluntarily reduce their base salary before ECE fees to pay childhood costs first (before paying PAYE). Therefore, under exhibit 4, the total income you would classify for PAYE is $45,000 (versus $50,000 in exhibit 3).
How does each situation compare?
- Comparing the net (take-home) pay from both examples, choosing a salary sacrifice agreement would result in a net pay of $35,844.
- Compared to the $34,486 example without the salary sacrifice agreement, adopting the salary sacrifice agreement results in more net pay after factoring in childcare costs.
- In the above example, the employee can get $1,358 more as disposable income for short-term expenses than not taking up a salary sacrifice agreement.
- The example above shows how using salary sacrifice can benefit some employees who want to adjust their salary to take advantage of other benefits or potentially increase take-home pay.
- However, it is important to note that this does not always mean you will pay less tax. The ESCT tax rate is not discussed in the above example, and you may still be paying the same amount of tax.
- If you're interested in exploring options, we suggest talking to a tax accountant or financial advisor about your specific situation for further details.
Pros and Cons of Salary Sacrifices (Applying the University of Auckland as an Example)
Pros:
Cons:
The University of Auckland states several implications associated with taking a salary sacrifice. Not all may apply to you, but generally, these include the following:
- The main benefit of the salary sacrifice above is that you are only paying PAYE tax on the reduced base salary by reducing the gross salary. The result is the net pay (money you take home) increases.
- In the above example, the salary sacrifice arrangement increased the take-home pay of the staff member whilst keeping the child enrolled in the early childhood education scheme.
Cons:
The University of Auckland states several implications associated with taking a salary sacrifice. Not all may apply to you, but generally, these include the following:
- Eligibility to claim childcare rebates from the IRD
- Differing calculation of ACC entitlements
- Impact on student loan deductions
- Impact on working for families' credits
- Impact on other specific tax credits
- Impact on income protection insurance
- Impact on mortgage or credit applications
Frequently Asked Questions
How common is a salary sacrifice?
Salary sacrifice is not as common as you would think, and not something you would typically expect to see in your contract when signing an employment agreement. New Zealanders who undertake a salary sacrifice are normally in unique situations, such as wanting to increase more retirement as they near retirement age or those who do not have any significant cost outlay in the short-term and would prefer to increase other benefits instead of salary.
Our View: Most people working in New Zealand today will likely be on a standard base salary and minimum 3% KiwiSaver employer contribution match. Therefore, salary sacrifice is not normally discussed in the typical hiring process.
Our View: Most people working in New Zealand today will likely be on a standard base salary and minimum 3% KiwiSaver employer contribution match. Therefore, salary sacrifice is not normally discussed in the typical hiring process.
Will salary sacrifice result in me getting less base salary?
For background on how KiwiSaver works, check our beginner's guide here. While not commonly known, any portion of your salary that you are putting into your KiwiSaver is technically a "salary sacrifice". Mechanically, you are sacrificing a portion of your salary that would otherwise end up in your hand to put elsewhere.
It's important to know how your employer treats the matching KiwiSaver contribution. This is because KiwiSaver is intended to make employers actively contribute and pay towards their employees' retirement. This also means that every employee enrolled in KiwiSaver will also pay an additional cost by allocating at least 3% of their standard salary to KiwiSaver.
However, some employers may include a "Salary Sacrifice" provision that details reducing the employee's pay by the amount that the employer is paying. So, for example, your pay is reduced by 3% to offset the 3% that your employer is paying you. In such a situation you're a effectively paying 6% into Kiwisaver.
The employer effectively passes on the cost of matching KiwiSaver to the employee. Be sure to check the employment contract provisions, as this is not the case for every employer. Most employers will pay 3% on top of your stated base salary, whilst salary sacrifice provisions typically have to be negotiated and agreed upon between the employer and the employee. Be sure to read your employment agreement in detail before you sign your employment agreement.
It's important to know how your employer treats the matching KiwiSaver contribution. This is because KiwiSaver is intended to make employers actively contribute and pay towards their employees' retirement. This also means that every employee enrolled in KiwiSaver will also pay an additional cost by allocating at least 3% of their standard salary to KiwiSaver.
However, some employers may include a "Salary Sacrifice" provision that details reducing the employee's pay by the amount that the employer is paying. So, for example, your pay is reduced by 3% to offset the 3% that your employer is paying you. In such a situation you're a effectively paying 6% into Kiwisaver.
The employer effectively passes on the cost of matching KiwiSaver to the employee. Be sure to check the employment contract provisions, as this is not the case for every employer. Most employers will pay 3% on top of your stated base salary, whilst salary sacrifice provisions typically have to be negotiated and agreed upon between the employer and the employee. Be sure to read your employment agreement in detail before you sign your employment agreement.
Will salary sacrifice result in me losing benefits like annual leave?
In most circumstances, no. Benefits like annual leave are typically calculated on a total remuneration package, meaning you will get the same amount of "holiday pay" regardless of whether you're on a salary sacrifice scheme. However, we suggest consulting your tax accountant for these details and in light of other potential implications of salary sacrifice, such as ACC levies or tax credits.
Can salary sacrifice apply in retrospect? For example, can I change the salary I have received in the past?
No. Salary Sacrifice schemes only apply to pay periods in the future. Therefore, it can't apply to previous income tax periods (for income that has already been earned).
What are the salary and tax implications if I'm on a salary sacrifice arrangement and receive a salary increase?
Typically, any salary increase will apply to your salary before the salary sacrifice scheme. In other words, your salary increase will be fully passed through and will not change the flat amount you are currently sacrificing in your salary. However, it will largely depend on the agreement you have with your employer and whether the salary sacrifice is a flat amount or a percentage of the base salary.
If I take annual leave, will that impact my salary sacrifice scheme? What about if I take unpaid leave?
No, taking paid leave (such as annual leave) will not impact your salary sacrifice scheme. However, you will continue to sacrifice your salary when you are on paid leave.
Regarding unpaid leave, this will typically influence your total remuneration for the year and impact your salary sacrifice agreement. In other words, you will earn less income than you stated in the salary sacrifice agreement, meaning you are likely to fall short on the salary sacrifice or contribution to KiwiSaver.
Regarding unpaid leave, this will typically influence your total remuneration for the year and impact your salary sacrifice agreement. In other words, you will earn less income than you stated in the salary sacrifice agreement, meaning you are likely to fall short on the salary sacrifice or contribution to KiwiSaver.
What are the typical terms and provisions included in a salary sacrifice agreement?
There isn't a universal template for salary sacrifice agreements in New Zealand. However, some common parameters include the set period for salary sacrifice to take over, the minimum duration, the salary sacrifice rate or the costs to take one up. For example, some employers will set a minimum of one year (generally because if it's any shorter, the costs and time spent arranging it aren't worth it for either employee or employer).
Some employers may charge additional costs to include or set up a salary sacrifice agreement. This can include additional accountant and tax manager costs and administrative fees.
Some employers may charge additional costs to include or set up a salary sacrifice agreement. This can include additional accountant and tax manager costs and administrative fees.
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