How proposed changes to franking credits could impact your retirement savings

In an election year, there is always speculation about proposed policy changes and what they will mean for us. This year, the big issue for many Australians, particularly retirees and those nearing retirement, is the proposed changes to taxation treatment for some investment assets, particularly changes to franking credits.

The direct impact on you will, of course, depend on where and how your assets are invested, but it’s also worth considering the potential implications for the wider market, and how these could affect your retirement savings.

What are the proposed changes?

The Australian Labor Party (ALP) has made a number of proposals that will affect the taxation treatment of a range of investment assets, including changes to negative gearing, capital gains tax, and the refund of excess imputation credits, also known as ‘franking credits’.  If elected into government, the ALP proposes to remove the refund of excess imputation credits, effective 1 July 2019.

While the changes to negative gearing and capital gains tax will impact some, the changes to franking credits have the potential to affect many Australians, particularly retirees and those nearing retirement, so it’s certainly worth taking a closer look.

What are franking credits?

 First introduced in 1987, the imputation or franking credit system is designed to prevent company profits being tax twice; once as company income and again by the entity (or person) receiving the dividend income.

For example, if a company makes $100 profit and is taxed at 30%, they would be left with $70 to distribute in dividends. The $70 cash dividend would have a $30 franking credit attached, as this is the amount the company has paid in tax. The person who receives the dividend is then able to offset any tax payable with the franking credit. If the person has less tax payable than the value of imputation credits received, they can claim a cash refund for the excess from the ATO.

Under the proposed ALP policy, dividend recipients could still claim tax offsets, but not use franking credits to turn their tax to negative, so they will no longer be able to claim cash refunds.

What does this mean for retirees?

 Franking credits have shaped the investment portfolios of Australians for over 30 years, so removing them will have a direct impact on individual investors and likely a wider impact on the market, as investors make adjustments to their portfolios to accommodate the changes.

Researchers at the Australian National University studied the impact of franking credits on retirement savings, finding that under the current system, franking credits support increased consumption in retirement of 5-6%.

The direct impact of these proposed changes will most strongly be felt by:

• retirees in pension phase with a Self Managed Super Fund (SMSF); and
• pensioners and retirees with direct shareholdings, not through their super fund.

Under the current system, these groups can use franking credits to offset their tax.  Because their tax liabilities are usually quite low, this means many can reduce their tax to negative, and claim a cash refund. Under the proposed system, which does not allow offsets to turn tax negative, these groups are likely to have insufficient tax liabilities to claim franking credits, effectively rendering them redundant.

Even if you personally don’t fall into one of these groups, if implemented, the changes have the potential to be felt across the market, as investors move to change their portfolios. However, it’s important to remember that even without franking credits, many investments will continue to have attractive yields, such as the four major Australian banks, which trade on dividend yields of 6 – 8 % before franking.

What can you do about it?

Firstly, it is important to remember that Labor’s policies are currently only proposals, with no certainty they will be implemented. We don’t recommend people take action until we have more certainty about the exact legislation. However, you should certainly be planning ahead and considering strategies that may be available to you.

For example, many retail and industry superannuation funds will continue to be able to pass on a franking credit refund so you may need to consider whether your SMSF is still the best option for you. There may also be the potential for you to move assets between structures; for example, transferring personally-held shares into superannuation.

You might also start considering potential asset allocation changes. Stocks paying high franked dividends such as banks, telecommunications, and large miners could become less attractive and less highly rated, while sources of non-franked income may become more attractive – e.g., interest income, rental income, trust distributions, encouraging increased asset allocation exposures to property, infrastructure, and fixed interest.

What should you do today?

If you oppose the changes, there are ways to lobby against them, and while there is certainly value in expressing your opinions, the best advice I can give you is to get financial advice as soon as possible.

Getting expert advice to understand the potential impact on your retirement savings ahead of any change in government, will put you in the best possible place to make measured decisions if the policy is implemented.  If you do nothing, you may be in a position where you need to make snap, reactive decisions about your finances, which rarely prove profitable in the long term.

To understand how these changes will impact you, taking into account your financial goals and circumstances, talk to an Apt Adviser today.

General Advice warning

The information provided in this blog does not constitute financial product advice. The information is of a general nature only and does not take into account your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice. Apt Wealth Partners (AFSL 436121 ABN 49 159 583 847) recommends that you obtain professional advice before making any decision in relation to your particular requirements or circumstances.