Marginal tax rate or average tax rate?

I had a meeting with a prospect client a week or so ago and we discussed at what point they should look at making tax deductible contributions.

I said above taxable earnings of $37,000 you are on the 34.5% marginal tax rate so contributing to super has significant tax advantages at that point he said, "but our average tax rate doesn't get to 15% until earnings of $45,000 so wouldn't we contribute until we're above that point." or something to that effect.

I thought that was an interesting point he brings up and others may have a misconception on this when making these sorts of decisions. When we have our marginal tax rates, our average tax rate is always going to be different than our marginal tax rate (unless you earn less than $18,200 then it's just 0%) whereas superannuation and a company has flat tax rates (15% and 30%).

Well, obviously (to me anyway) looking at the average tax rate is wrong. For those earnings between $37,000 and $45,000, you are paying 34.5% tax where you could be paying just 15% tax you can see in the example below:

Tax on earnings up to $37,000 = $3,867
Tax on earnings $37,000 - $45,000 = $2,880 (note this is more than 34.5% of $8,000 and that is because of the impact of the low income tax offset - which I'll discuss below)

Total tax $6,747 = 15% of $45,000.

On the other hand, you could choose to direct funds to superannuation:

Tax on earnings up to $37,000 = $3,867
Tax on earnings $37,000 - $45,000 when directed to superannuation = $1,200.

Total tax $5,067 = 11.26% of $45,000

So unless the rules stated "Once you contribute to superannuation, all your income will be taxed at the superannuation tax rate", then you should work off your marginal tax rates.

Just a note on the marginal tax rates, whilst we apparently just have 5, we actually have a lot more because of the impact of the low income tax offset and medicare levy, both of which aren't applied uniformly. So, really, the following is the actual marginal tax rates when that is factored in:

$0 -           $20,542 ... 0%
$20,543 -  $21655 .... 19%
$21656 -   $27068 .... 29%
$27069 -   $37000 .... 21%

$37001 -   $66667 .... 36%
$66668 -   $87000 .... 34.5%
$87001 -   $180000 .. 39%
> $180,001 .............. .47%


So, looking at those numbers, if you are earning $27,000, you might not normally think to salary sacrifice to super because you're only on the 19% marginal tax rate. But the additional boost of reducing medicare levy and increasing low income tax offset, a few thousand $ to superannuation in that band is quite attractive. 

Glenn Hilber is a Certified Financial Planner with over 10 years experience and the owner of Precision Wealth Management.

This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.