The debate over the Labor Party’s proposed changes to the tax treatment of franking credits picked up a gear last week, with accusations of manipulation of a parliamentary committee and a scuffle at a public meeting in Sydney.
Through all of this, Labor Shadow Treasurer Chris Bowen has remained resolute. Apparently confident of its chances at the upcoming election, Labor is not offering any compromises.
And this means investors relying on excess franking credit rebates as a significant source of income need to consider their options.
In December, self-managed superannuation fund administrator SuperConcepts published the results of a survey of more than 600 of its SMSF trustee clients. It found that the majority would change their investment strategies in response to a change in the tax treatment of franking credits.
A significant proportion said they would put more of their holdings into international shares. Others said they would invest more in term deposits, fixed income and property.
Getting out of the SMSF sector altogether was a serious consideration, with 14.5 per cent of respondents saying they are thinking of shutting their SMSF if the tax policy changes.
Strategy options outlined by commentators include expanding the membership of an SMSF to include children. The Government’s policy is to increase the maximum number of SMSF members from four to six, although the change has not been legislated yet. One adviser has suggested that the franking credits that would otherwise be lost could be used to cover tax liabilities of members in accumulation.
A number of advisers have recommended a shift in SMSF portfolios to include non-equity assets paying income. The franking credits that would otherwise be wasted could be used to reduce tax payable on income from those assets.
Other advisers are recommending that investors change their portfolios so they get more of their return from capital gains. Investors should focus on the overall return they want and be prepared to take gains by selling assets to meet income needs.
Some argue that a shift in focus from high-yielding stocks that have poor growth prospects and weak share price performance, to stocks with strong growth potential could be a good result for retirees. They would have to be prepared to change their mindset and sell shares from time to time to meet income needs.
Another option is to wind up their SMSFs, as the SuperConcepts survey identified, and transfer into an APRA regulated fund, where the franking credits would retain their full value (tax is applied at the fund level and large funds would continue to use franking credits to offset other taxable income).
There is no doubt that for many retirees (although just how many is a hotly debated question), the policy change will have a big impact. A team at the Australian National University’s College of Business and Economics modelled the implications of access to imputation credits, concluding that the Labor Party’s proposed changes to the imputation system would have a “significant impact for many retirees” and not just the wealthy that Labor says it is targeting.
According to the ANU modelling, excess imputation credits support increased consumption of around 5 to 6 per cent in retirement.
A member of the ANU team, Geoff Warren, says another way of looking at Labor’s proposal is that it would be equivalent to reducing the average superannuation fund balance at retirement by 8 or 9 per cent.
Speaking at the Alliance for a Fairer Retirement System Summit in Sydney last October, Warren says: “Imputation credits are an income supplement and that aids the adequacy of the retirement system. By buying Australian shares that are fully franked people end up with a real kicker to their investment return.”
Labor says the change would have most impact on a small number of individuals and SMSF members earning high income. It says 90 per cent of all cash refunds to super funds accrued to SMSFs in 2014/15 and that 50 per cent of the total benefits go to the wealthiest 10 per cent of SMSF balances.
Labor’s policy includes a ‘pensioner guarantee’, so that Age Pension and allowance recipients will be protected from the abolition of cash refunds for excess credits. Self-managed super funds with at least one pensioner or allowance recipient before March 28, 2018, will also be exempt from the change.
The Parliamentary Budget Office has estimated that 840,000 individual Australian taxpayers would be affected by Labor’s proposal, 210,000 SMSFs and 2300 APRA-regulated super funds.
The PBO figures show that 70 per cent of SMSFs with balances of $2.4 million or more claimed excess credits in 2014/15, but it also showed that a wide range of SMSFs, including many with low balances, also claimed excess franking credits. Around 70 per cent of individual taxpayers claiming excess franking credits in 2014/15 had taxable income of less than $35,000.
According to actuary Rice Warner, ATO data shows that SMSFs with large balances (above $2 million) hold about 52 per cent of all SMSF assets and they have about 30 per cent of their assets in Australian shares.
From Labor’s point of view, these people are getting too much of a benefits from the superannuation and dividend imputation systems.
However, Rice Warner points out that SMSFs with small balances also have between 25 per cent and 30 per cent of their assets in Australian shares and also get the benefit of franking credit rebates to supplement their more modest incomes.
“While most of the reduction in aggregate franking credit rebates may come from those with larger balances, there will still be SMSFs with smaller asset balances in the pension phase that could be impacted.” Rice Warner says.
The ANU study analysed the net cost to government of providing access to imputation tax credits to retirees. The results showed an estimated total net cost per individual over the course of retirement of about $30,000 for retirees who retire with. $100,000 balance and around $80,000 for those retiring with a $500,000 balance.
Warren says: “While this may seem relatively expensive, it also offers social benefits. First, it either raises potential consumption during retirement at a given balance, or reduces the amount needed to be placed into superannuation during the working phase, thus increasing potential consumption prior to retirement.
“We note that the largest benefit in dollar terms accrues to retirees with the largest initial balances, raising some questions around equity.”