As someone who spent 25 years building our SMSF to provide for us in retirement I am in the last stages of unwinding and transferring our assets out
Below is an analysis (not mine from an SMSF group I use to belong to) of the consequences of what our fiscally inept politicians on both sides have served up.
Dividend Imputation and Franking Credits
All governments see large blocks of money and exploit them at the cost of individuals. Large companies just rearrange their affairs to avoid governments.
Dividend imputation Franking Credits
•Old times. A company would make a profit. After the profit was taxed then the company would keep a % and the rest paid to shareholders by a dividend. The dividend would be taxed again at the shareholders personal tax rate. The same money was taxed twice.
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•Keating introduced if a companies profit was taxed, the shareholder should not have to pay tax on the same money and introduced a technical way of offsetting the shareholders tax liability. The system was dividend imputation which produces franking credits.
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•Shareholders found if they had a large % of fully franked shares they could eliminate any tax they may have to pay in either their personal or super fund. Some shareholders brought so many shares that they not only wiped out their tax liability but left EG $20,000 of excess taxed offsets with the ATO.
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•Howard in 2000 said the ATO would refund the excess tax offsets to the individual tax payer. A $1.5 mill SMSF, all in bank shares, meant that the ATO sent a $30,000 each year.
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•EG a fund earning $75,000 in dividends , gets $30,000 of excess franking credits from the ATO for a total return of $105,000. PS. 12 countries initially followed the Australian model, all shut it down as it cost their tax revenue to much.
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•The ALP is proposing not to refund excess franking credits for a very specific group of people. Those effected are SMSF and personal tax payers with a high % of their investments in fully franked shares. The full imputation system will be keep for all others.
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•ALP says it will not affect industrial and retail super funds. Agreed, most of the funds paying pensions keep the excess franking credits to pay the tax liabilities of those in the fund who are in accumulation. Translation; Industry & Retail fund pensioners are being ripped off.
Voter Impacts
•After pressure the ALP has stated it will refund excess franking credits to Centrelink pensioners or part pensioners as it will have little impact on the budget. If the pensioner is also in a SMSF prior to 28 March 2018 then the entire fund will have excess franking credits refunded.
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•The Batman by election results virtually guarantees that if the ALP wins the next federal election the policy of the removal of refunds of excess franking credits will be implemented from 1/7/19.
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•In Batman, ALP polling of excess franking credits removal was done on over 60 year olds for 5 days prior to the bye election and it was not a significant vote swing factor.
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•This will also probably embolden ALP to bring in negative gearing and CGT discount changes that will again impact asset rich again. ALP has also stated they want any superannuation payments above $75,000 to be taxed. Remember these are not law yet and probably will be modified by negotiation if the ALP win.
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•Translation: A populace policy that has little visual impact for the majority of voters who do not understand/care about the imputation system. Unless there is a significant improvement in general financial literacy amongst the populace and/or a big improvement in debating skills by any opposing members of parliament some of this will be law if the ALP wins the next election.
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•As Ross Garnut said “Most people above 60 vote with the coalition. The ALP and coalition know voters above 60 are unlikely to change their vote. So all sides of politics exploit superannuation with little electoral impact.”
Real issues
•Lets look at the impacts of non payment of excess franking credits.
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•Most SMSF funds in pension mode with a high proportion of fully franked shares will lose about 15 to 30% of their income.
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•Those with hybrid investments (eg CBA Pearls etc) that contain franking as part of their annual returns please read your terms and conditions. Your income and value of the hybrid may drop significantly under the ALP proposal.
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•But there is another potential impact. SMSF’s own 13% of the ASX. The majority of it in banks, BHP, RIO, supermarkets and Telstra. If excess franking credits are not refunded, many shareholders will rearrange their portfolio’s to either get shares with higher dividends or more growth. The value of these shares may fall in value.
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•Pimco, one of the worlds largest funds sold Australia banks and property bonds after the ALP announcement. Pimco does not benefit from franking credits but understands the potential share value loss from the announcement.
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•Each person/SMSF trustee will have to model the potential impact of the removal of excess franking credits. Why? There are some very weird outcomes for those who have a large % of franking credits in their SMSF or personal investment portfolio. EG.
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–A SMSF may be better selling low dividend fully franked shares and buy higher dividend REITS with fewer franking credits and capitol returns.
–For some it may be better to close an SMSF and have all their investments in their personal name.
–The richer the SMSF is the less impact the proposed changes appear to have.
–If you close your SMSF and transfer to an industrial fund or Challenger type annuity you may get better returns with less hassle.
Modelling of ALP proposal
•A single person SMSF all in bank shares loss of franking credits:
–A $1 mill SMSF will lose $21,000/year or 30% of income.
–A $10 mill SMSF will lose $210,000 – $63,000 (offset accumulation account tax) therefore a 21% loss of income.
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•A SMSF that is shut down and funds moved to personal account.
–A $1.5 mill SMSF moved to personal account will have the same income in either mode.
–A $2.0 mill SMSF moved to personal account will result in a $3000/year GAIN in income.
–Reason why. The excess franking credits not paid in the SMSF are used in your personal account to offset your tax liabilities. BUT this assumes you will not make any capitol gains in your SMSF.
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•A SMSF is transferred to an industrial fund. Australian Super claim a return of 9 to 12% over the last 7 years for balanced retirement funds. Challenger claim a 7% return for their annuities. In both cases there are fees but the returns are above 6% and you don’t have to pay for a SMSF and they just send a cheque each month. The ALP changes will not significantly effect these funds.
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•Finally, there are some issues you will need to think about prior to 1/7/19 (under the assumption of an ALP election win and the introduction of removal of excess franking, changes to CGT and negative gearing).
–If you have a high % of fully franked shares will you need to rearrange your portfolio to optimise its income and taxation.
–If you have EG shares or rental properties with large capitol gains consider selling them early to optimise the current Capitol gains discount which may only apply up to 30/6/19
–Grandfathering may not apply. When the government introduced the $1.6 mill Transfer balance cap it did not apply grandfathering of existing superannuation funds
–Don’t wait until an election early next year as the share and housing market will be unpredictable.
