Super idea… not!

Like many employees of big companies, lats year I took up the offer of buying shares in the employee share plan. Bear in mind, though, these are not Australian shares, they are for a large foreign company and are listed on a large foreign stock exchange. So DOING anything with the shares is difficult at best, but they are also locked away for 5 years anyhow. To add insult to injury, the price dropped 20% just after the allocation day.

Then the other day I got talking to my accountant. He pointed out, quite rightly, that this is madness.

The shares in the employee plan are paid for, by me, from my after-tax salary.

I could salary sacrifice a superannuation contribution from my pre-tax earnings and the benefit would be far greater.

For the sake of illustration:

- Lets assume I’m on the 40% marginal tax rate

- Lets assume I purchase $5000 in shares.

That $5000 comes from my after tax salary, so I had to earn $5000 / 0.6 = $8333.

And any earnings from those shares are also taxed at my marginal rate of 40%.

Now assume instead that I make a salary sacrifice into my super fund. The contribution tax is 15%.

So to get the same DOLLAR VALUE INVESTED, I need to salary sacrifice $5000 / 0.85 = $5882 (this puts $5000 after contributions tax into my super account).

And seeing as I did a salary sacrifice, my pre-tax income dropped by that $5882, meaning I don’t pay tax on any of that money. So my tax bill will reduce by 40% of $5882, or $2352.

Another way to look at it: I could instead contribute $8333 from my pre-tax earnings (the drop in my take-home would then be the same as buying the shares in the employee share plan). I’d lose 15% of that amount in contributions tax (leaving me with $7083 added to the fund). So my INVESTED VALUE is over $2000 MORE. Considering we started with the proposition of making a $5000 investment, the benefit of a pre-tax contribution to super is giving me $2000 more to invest!!

The effect of a salary sacrifice into super is dramatic: you pay less tax, the amount of money you can set aside for your dotage is significantly higher. For the rich folk on the higher tax rates, the effects are even more pronounced.

Looks like the employee share plan kind of sucks, really.

2 Comments

I got burned in a Rational Software employee share plan.. once when I joined and got a stack of “options” at a great price valid for a few years.. huge share price crash soon after I joined made them worthless and again in the employee share scheme..

Its all about the “warm and fuzzies” that it gives employees who are less smarter than you.. it helps them feel good.. its usually crap though and not a real good idea.. if the company performs badly you could lose your job AND your shares could become worthless/depreciated at the same time.

Dunc.

Comment by Duncan Margetts | April 30th, 2008 10:41 am | Permalink

Yep, since the 2007 Budget super is the rort to be in. In fact it’s now so generous that I reckon some government is gonna have to tighten it up sooner or later. It will become quite unaffordable and grossly unfair to the poor mugs not able to use the lurk (who will therefore have to pay more tax).

Comment by derrida derider | May 1st, 2008 10:28 pm | Permalink

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