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Investing basics: Winners and losers in franking credit debate

Emma Rapaport  |  08 Mar 2019Text size  Decrease  Increase  |  
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Whether it becomes law or not, Labor's franking credits policy has certainly had a polarising effect, which is set to intensify in the countdown to the May 2019 federal election.

Last month, we wrote an article explaining what franking credits are, so you can confidently wade into the debate should you choose.

In this article, we'll look at who is affected by the proposal.

Self-funded retirees

Individuals funding their retirement via an SMSF who receive no pension entitlements and pay little or no tax stand to bear most of the burden of Labor's dividend tax policy.

Historically, SMSF fund earnings have been exempt from tax if they are being received as a pension, assuming they have a member balance up to $1.6 million.

Trustees could benefit from franking credits in the form of a cash refund from the ATO when their franking credits exceeded their tax obligations.

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Under Labor's proposed change, retirees will not receive a cash refund for excess franking credits.

Individual Investors.

Retail investors are a large segment within the total mix of investors receiving fully franked dividends from blue-chip stocks Telstra, AMP, IAG and the big four banks, according to the Australian Shareholders Association.

Like SMSFs, individual investors who pay little or no income tax currently benefit from cash refunds for franking credits. Depending on their circumstances, many of these investors will no longer receive these refunds.

PBO modelling shows that 1.13 million individual taxpayers claimed excess franking credits in 2014-15, meaning that 92 per cent of taxpayers do not receive excess creits through their personal income tax return. 

Good, bad and unintended consequences

There are also fears that the policy could lead investors to shift their money away from Australian companies.

Fidelity's Kate Howitt believes the removal of franking credits could also lead to rising levels of corporate debt, which ratchets up their risk if interest rates increase.

More money for schools, hospitals

The Parliamentary Budget Office says cash refunds for excess imputation credits are costing the budget $4.9 billion a year, based on 2014-15 tax data. The proposal is expected to generate $59 billion in government savings over 10 years.

Shadow Treasurer Chris Bowen says this money could be better spent on services, schools, education and paying down debt.

Note: The PBO notes the modelling does not consider several changes to superannuation and company policy implemented since 2014.

'Smaller balances will suffer'

Jonathan Philpot, partner at HLB Mann Judd Wealth Management, says under Labor's plan, those with lower balances stand to lose more.

For instance, he compares someone with an $800,000 pension to a $4 million balance. In both cases, he assumes a 40 per cent investment in Australian shares, and a dividend yield of 4 per cent with fully franked shares.

The $800,000 balance stands to lose $5,485 (0.625 of earnings) while the $4 million balance loses $9,428 (0.225 on earnings).

Modelling by SMSF Association policy adviser Franco Morelli shows the impact on different balances under Labor’s proposal and the current franking system.

Under Labor's proposal:

20190307 invbas table

*40% allocation to Australian shares Source: SMSF Association 

SMSF Association head of technical Peter Hogan acknowledges that the complaints of seemingly wealthy retirees sitting on a retirement pot of $800,000 can sound bizarre, particularly to Australians struggling to save for a home or put food on the table.

However, he says this fails to consider the reality of how retirees understand and operate their share portfolios.

"Many of my former clients treat their shares as lifestyle assets – capital which generates the income which they live off," he said. "Their mentality is you save, build up a portfolio and live off the dividend income. You don't sell the thing that is generating income."

The median franking credit rebate for SMSFs is $5,100, according to the Alliance for a Fairer Retirement System.

Hogan says it was common for retirees to pass away with million-dollar share portfolios.

Who is exempt?

Labor's policy proposed caused an initial backlash. This forced them to exempt pensioners and SMSFs with at least one member who is either a pensioner or allowance recipient at 28 March 2018.

We should clarify, a previous article on Morningstar.com.au stated that SMSFs that receive cash rebates would be exempt.

More accurately, SMSFs where at least one recipient of an Australian Government pension or allowance would be exempt, as stated in the amended article.

An allowance may include anyone receiving a carer payment, parenting payment, Newstart or sickness allowance.

Some SMSF's who hold assets just above the threshold for the Age Pension asset have said they will purposely reduce their assets to become eligible.

However, under Labor's current proposed exemptions, a member of the SMSF must have been receiving the pension or an allowance as at 28 March 2018 to qualify.


is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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