Labor’s proposed franking credit policy explained

The 18 May 2019 Federal Election looms and the Labor Party is looking like the potential winning party at this stage. Many of us have now heard about Labor’s plan to axe cash refunds (i.e. refundable franking credits) for wealthy investors. Moreover Labor has announced assertively progressive tax measures, such as changes to negative gearing and capital gains tax, and taxing distributions from family trusts at 30%. 

Their plan to end cash refunds for excess imputation credits for individuals and superannuation funds is reportedly likely to save the tax payer $11.4bn over four years. Franking credits will still be claimable as a deduction to reduce tax paid on income, and aged pension recipients (as well as charities) are exempt from the policy.

So if this plan gets through what happens to my retirement income?

Self-funded retirees would have to boost their savings by up to 9% to make up for Labor’s proposal to end cash rebates for excess imputation credits, according to new modelling from the Australian National University. Labor has downplayed the significance of this report, noting that it does not model its changes exempting pensioners, and that it acknowledges that high-income earners would be hit hardest by the policy.

So what should you do about your portfolio?

Wealth management specialists are divided: some say it may push investors into riskier asset classes in a bid to retain the same after-tax income levels while others say it’s too early to alter your portfolio.

For superannuation holders with a balance of $200,000 to $1 million, Labor’s policy could have a negative impact on income, and potentially alter the bias towards Australian shares in super.

The SMSF Association says the proposal will cut about $5000 of income — or $90 a week — from the median SMSF in retirement phase earning about $50,000 a year in pension income, with a 40 per cent allocation to Australian shares;

The research paper by three economists found that dividend imputation helped retirees boost their consumption by between 5% and 6% and created a “significant bias” in favour of Australian shares in retirees’ portfolios. Removal of full access to imputation credits in retirement could unwind the benefits mentioned above and would undoubtedly solicit significant political backlash from retirees.

The paper also notes the substantial home bias generated by imputation credits in retirement. This proposed policy will actually help to de-risk Australia’s retirement savings pool and encourage people to seek out a more diversified portfolio.

Case Study – Couple, both aged 70, homeowners (no mortgage) with $850,000 in superannuation *

They are not entitled to receive any age pension as their assets exceed the age pension means test limit, meaning they are self-funded retirees.

The following simplified asset allocation shows the role refundable franking credits play in their retirement income and the negative effect on their income under Labor’s plans:

Under Labor’s proposal, this would cost them more than $144 a week or a fall in annual income of 17.14 per cent.

The income they get from being self-funded under the Labor proposed policy of $36,250 is only about $1200 above the full age pension of $35,048, which can be accessed by a home-owning couple with less than $380,500 in assets.

The post-tax return on their assets with refundable franking credits is 5.14 per cent. Without refundable franking credit it falls to 4.26 per cent.

As it stands, this couple do not qualify for the age pension as they exceed the $830,000 threshold. If they want to maintain their income level and use their SMSF capital they would fall below the $830,000 part pension assets test threshold and start accessing the age pension within a few years, putting pressure on future government-funded pensions.

*Source: https://www.morningstar.com.au/smsf/article/impact-and-opportunity-bracing-for-labors-fra/171207

What should we do now?

Every situation is unique, it pays to get some financial advice. For a no-obligation initial meeting you can contact (02) 8277 4216, or info@agilitywealth.com.au to make an appointment.

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