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Franking Changes, LICs and Investment Strategy

Feb 23, 2019


As a guy who advocates for dividend focused investing, I’ve had a lot of questions about the possible changes to franking credits.

And how this affects the strategy of investing in Aussie shares for income, as well as what this means for listed investment companies (LICs) and those looking to live off dividends more generally.

I’ve given some thoughts on this before in the comments section when asked by readers.  But the topic really deserves its own article.

Before we dive in, let’s acknowledge I’m just a random 30 year old blogger with no finance qualifications.  Not only that, but the franking changes are a long way off becoming legislated!

So as always, this isn’t advice and everyone needs to decide what’s best for their own situation.

 

How franking credits affect different investors

Whether the changes affect you or not, is really dependant on your personal tax rate.

Let’s use a common fully franked dividend yield of 4%.  Shareholders receive this 4% dividend in cash.  The franking credit is simply a tax credit with your name on it.  When the value of franking is included, the gross yield becomes 5.7%.

Investors are currently taxed in the following way:

Investor A.  5.7% gross yield, less 45% tax = 3.1% net yield after tax.  (4% cash dividend, less extra tax owing)

Investor B.  5.7% gross yield, less 37% tax = 3.6% net yield after tax.  (4% cash dividend, less extra tax owing)

Investor C.  5.7% gross yield, less 30% tax = 4% net yield after tax.  (4% cash dividend, no tax payable or refund owing)

Investor D.  5.7% gross yield, less 15% tax = 4.8% net yield after tax.  (4% cash dividend, plus 0.8% franking refund)

Investor E.  5.7% gross yield, less 0% tax = 5.7% net yield after tax.  (4% cash dividend, plus 1.7% franking refund)

Basically, the difference between your personal tax rate and the company tax rate either means you’re owed a refund, or you have to pay some out of pocket tax on your dividends.

 

And here’s how it looks under Labor’s proposed changes…

For Investors A, B, and C, it’s steady as she goes.

Because their tax rate is 30% or higher, they aren’t entitled to a refund so their numbers don’t change.  The franking credits are still able to be used to reduce the tax owing on those dividends, just like before.

So these investors are still looking at a net yield of between 3.1% and 4%.

But for Investor D and E, they lose their franking refunds.  So they’ll continue to receive 4% cash dividends, but no longer have the excess franking credits refunded to them.

Clearly this sucks for people on low tax brackets.  But it has no effect on those paying 30% tax or above.  The lower your tax rate, the more you lose.

Obviously, that’s a negative for those of modest means using Aussie dividends as their chosen source of retirement income.

 

What will happen to share prices?

My guess is, shares in high yielding Aussie companies would most likely drop in value, as retirees become dismayed at their loss of income and look for yield elsewhere.

But I expect any falls to be limited, unless accompanied by economic issues.  Reason being, the Aussie sharemarket is not expensive at the moment.  In any case, the long term fundamentals are sound.

The price-to-earnings ratio (PE) of the market is around 15 or 16, around the long term average.  And the ASX 200 is currently yielding about 4.4%, slightly higher than historical averages.

Remember, this is during a time of record low interest rates.  So Aussie shares are actually good value right now.

 

How does this affect LICs?

Well, given LICs pay fully franked dividends, it’s a negative.  Remember, in terms of cashflow, this only affects those on the lower tax brackets.

But given the shareholder base is largely everyday investors and retirees who rely on franking refunds, the buy-and-hold style LICs may also fall out of favour.

Others likely to fall in popularity (possibly more-so) are the higher yielding trading style LICs, such as those managed by Wilson Asset Management, for example.  Given the higher yield, the franking refund lost is larger.

Essentially, for the older LICs we cover here, it makes them slightly less efficient than before, for low tax paying shareholders.

 

Let me explain…

A diversified vehicle like Milton invests in a large portfolio of Aussie companies and trusts.  And most of those holdings pay fully franked dividends, which are passed onto Milton.

Now, Milton pays no tax on this income because its own tax rate (30%) is the same as the value of those franking credits (30%).  So far so good.

But Milton also invests in companies and trusts which don’t pay fully franked dividends, like companies with mostly overseas earnings, utilities, infrastructure assets and property trusts.

Milton has to pay tax on income from these investments.  This tax generates franking credits, which it passes on to shareholders with its dividend.

Under Labor’s grand idea, this franking will not be refundable to no/low taxpayers.  Although it only affects a small portion of the portfolio, it’s still a frustrating outcome.

How much is it?

Well, for the half-year just ended, Milton earned $71.4m in income and paid just $2.4m in tax.  So that’s an overall tax rate of 3.4%.

As you can see, it’s not a lot.  But this smidgen of company tax turns a 4.4% yield, into a 4.25% yield for the end shareholder.

Hardly catastrophic, but not ideal either.

Index funds like VAS (Vanguard Australian Shares) operate as a trust structure and don’t pay tax.  So any income and capital gains realised are passed straight through to be taxed in the hands of the shareholders.

This structure would be more efficient for low taxpayers under the proposal.  More on this later.

Now, LICs may alter the amount of unfranked shares they invest in because of this.  We’ll have to wait and see.  But essentially, the cash dividend yield is probably more important metric to focus on going forward for retirees, rather than gross yield including franking.

As I said, these vehicles may fall out of favour and begin trading at regular discounts to NTA.  This could mean lower prices and a higher yield which would compensate buyers and even itself out to some extent.

Of course, no outcome is certain.  But the market may well build this inefficiency into the share price.

 

Will LICs change to a trust structure?

An idea floating around is that LICs will simply switch to a trust structure (Listed Investment Trust or ‘LIT’), so shareholders don’t lose out.

But it’s not quite that simple.  Because there are essentially two types of LICs out there…

One is the old fashioned buy-and-hold LICs like Argo and others, which have been running for north of 60 years and invest for the long term.  This means they often have large capital gains built up in the portfolio and are unlikely to liquidate and pay tax to change structure.

And the other is the trading style LICs (like WAM and others) which are more active, higher turnover and generally pay lots of tax on their gains and distribute most of these profits as large dividends.  This means there is very little long term capital gains in the portfolio and switching to a trust structure would be rather easy.

Also, shareholders could then have the trading profits distributed in full every year and simply pay tax at their personal tax rate (more efficient for retirees).

While this sounds like a good workaround, the issue for the trading style LICs is, trading profits vary markedly each year, meaning so too will the dividends.

Currently, the company structure allows trading style LICs (and any LIC or company for that matter) to decide a sustainable level of dividends to pay each year, and reinvest the remaining profits, giving them some cushion for next years’ dividend, and so on.

 

The verdict

So while the old LICs could change to a trust structure, I see it as extremely unlikely.  But I could definitely be wrong, so we’ll have to wait and see.

But they know shareholders (mostly retirees) love the consistency of dividends each year and the company structure is what allows this to occur.

One buy-and-hold style LIC which could more easily change to a trust is BKI.  At less than 20 years old, BKI is a younger LIC and doesn’t have the large capital gains in the portfolio that the others do.

But I still think it’s unlikely.  Whatever decision the LICs make, I believe it’ll be carefully considered and in the best interests of shareholders.

AFIC and BKI have recently decided to pay shareholders a special dividend in advance of possible changes, which get some extra franking credits in the hands of shareholders.

I won’t complain about that!  One reader recently said it best, “I’ve never had a special rent payment from any of my tenants before.”  Haha, what a great line.

If any of the old LICs do change structure, does that make them less attractive?

In my view, yes… somewhat.  For one thing, the trust structure would mean no more smoothing dividends.

But keep in mind, regardless of structure, they are very conscious of providing a growing income stream to shareholders.  So investing in good companies which are expected to provide growing dividends would still be the primary focus.

Now I know that isn’t really quantifiable.  But personally, that’s very important and definitely counts for something, when we’re comparing these vehicles to an index fund, for example.

 

LICs and Indexing

There’s no question, this proposal effectively penalises the company structure.

So as detailed above, LICs become slightly less efficient for retirees than an index fund like VAS, for example.

But it’s also very possible that LICs fall out of favour somewhat and trade at a discount to NTA following any changes.  Perhaps sizeable discounts.

In any case, the dividend yield of the old LICs and VAS is likely to remain similar.  And if we assume LICs continue to operate in the company structure, the dividends will remain more reliable than those from an index fund.

As for the growth outlook, it’s likely similar for both given the diversified portfolios (but tilted in favour of the index, given it won’t miss any big winners).

Thinking this through, let’s say the share prices of the older LICs do fall.  This will mean the ‘value’ of your shares has reduced.  How do you feel about that?

Keep in mind, this also means you’ll be able to continue buying these investments for a lower price and a higher yield than you otherwise could.  How do you feel about it now?

Of course, I’m only speculating here (like everyone else!), but I do think it’s likely to even itself out.

Now, if you’re listening to any hysterical characters in chat forums, you’re likely to think this future scenario could be the end of the world as we know it.  Or at least, the end of the world for dividend investors!

 

Investing for income – is it ruined?

I’ve seen it said that retiring on dividends now doesn’t work as a strategy, and anyone looking to use the income approach or the 4% rule in Australia, is in for a nasty shock.  Is that true?

In a word, no!

But let’s look at this in more detail.  I’ll show you why it’s not as bad as some would have you believe.

Say an Aussie couple reaches Financial Independence by saving hard and investing in shares, building a portfolio worth $1 million.

Their portfolio has a dividend yield of 4% fully franked, or 5.7% grossed up.

Currently, this means $40,000 of cash dividends, along with $17,000 of franking credits.  Gross income is $57,000 in total.

Split between two people this is $28,500 each – $20,000 cash dividends, plus $8,500 of franking credits.

Tax owing on $28,500 is around $2,000 (calculator here).  So there are $6,500 of franking credits remaining.  These would currently come as a tax refund, taking the after-tax income to $26,500 for each spouse.

This means the total after-tax income for our couple is $53,000.  Or an after-tax yield of 5.3%.

Under Labor’s proposal, the franking refunds drop off.  So they’ll simply receive the $40,000 cash dividends, and the franking credits will go mostly unused.

So our couple’s income is now just $40,000 in cash dividends.  There is no tax to pay because the franking credits count as tax already paid.

Of course, this is a decent cut to income versus the current scenario.  But is this couple ruined if they’re relying on 4% dividends?

Nope.  4% of their portfolio is $40,000.

Also, if they’re a sensible, level-headed couple, they would have a number of backup plans in place anyway!

 

The new numbers

Essentially, the figures for living off fully franked dividends would change.  The cash dividends paid is all the income you’d see.

But it’s not all bad.

Cash dividends will still be tax-free up to around $95,000 per person.  Here’s why…

Say a person earns $95,000 of fully franked dividends.  This will come with roughly $40,000 of franking credits attached.

This gives a gross taxable income of $135,000.  But the tax owing on this income is around $40,000, equal to the franking credit.  So there’s no out of pocket tax to pay and the franking has been fully utilised.

In case you’re wondering how that works, this is when your income hits an effective tax rate of 30% (some earnings in the lower brackets and some in higher brackets).

Bottom line: our investors will still earn a dividend yield of 4% after-tax.

So a couple can earn up to $190,000 of fully franked dividends and have no out of pocket tax to pay.

This means a portfolio worth $4.75 million, split between a couple, can earn this very hefty income and still clear 4% after-tax.  There’s a reason why I say dividend investing in this country is surprisingly tax efficient!

Now this is all great, but it also means those with less wealth still miss out on franking refunds.

So essentially, all of us looking to live on a reasonable sized portfolio would have to accept a 4% or so yield from Aussie shares to fund our Financial Independence.

No longer will the yield be boosted to 5-6%.

Is this as good as before?  No.

Is the dividend approach ruined?  No.

Is it still better than the alternatives?  In my view, yes.

 

Aussie investing – still worth it?

Firstly, if Labor’s proposal is a deal-breaker for you, then you were investing in Aussie shares for the wrong reasons.  You don’t base an investment strategy on one piece of tax policy.

Some people have pointed out that if these changes come through, it might be better to focus investing internationally.

Maybe that’s the right choice for many people, and you can most certainly do that.  But it’s not for me.  At least not yet.

Like I’ve said previously, I’ll look at investing in international shares once our Aussie income stream is fully built.

But right now, given we’re investing for an income stream to live on, it doesn’t make sense for us.  Here’s why…

Investing in an international index fund like VGS (Vanguard International), we can generate an income stream with a yield of 2% to 2.5%.  That’s before tax.  And normal tax brackets apply.

Investing in an Australian index fund like VAS (Vanguard Australia), we can generate an income stream with a yield of 4% to 4.5% yield.  That’s after tax.  And high levels of franking credits will mean no tax payable until our income is well into the six-figures.

So the starting yield from international shares is about half.  And it’s less tax efficient.  Plus, the currency movements mean those dividends will fluctuate a lot from year to year.  That’s compared to Australian shares which pay dividends based in Aussie dollars.

Now of course, you can argue that international shares are more about growth.  I understand that.  And that’s why as income investors who don’t wish to sell off shares to create cashflow, Aussie shares make more sense for us.

Banking on higher growth and selling off shares is just not something I’m comfortable with.  But you do what’s best for you!

 

Investment Strategy

It’s easy to get caught up in comparisons and numbers.  So let’s bring it back to basics for a minute.

Our approach is to invest in a diversified portfolio of Australian shares for a strong level of tax-effective dividend income, which grows over time.

As our economy and population expands and company profits grow, corporate Australia will pay larger dividends to shareholders through the years.

Aussie companies have been paying dividends of around 4-5% per annum for the last 100 years – way before franking credits even existed, let alone franking refunds.

So I don’t see why either of these things would stop now.

And I don’t know about you, but 4% after-tax yield for a reliable, hassle-free, diversified income stream is good enough for me.

Add some growth in line with the economy (3-4%), and you’ve got a pretty attractive long term return.  Not to mention an income stream that is most likely to beat inflation and keep us well fed in our early retirement!

 

Why LICs will be fine

Following on from the above, a number of the old LICs have been around since the 30s, 40s and 50s.

Again, this is well before the imputation system was even thought of, let alone franking refunds!

For example, Milton has been providing growing dividends to shareholders since 1958, which have increased comfortably faster than inflation.  Argo and AFIC have been prospering even longer than that.

Through changes in tax policy.  Changes in government.  And changes in the economy.

And I believe they’ll continue prospering for a long time to come.

Why?  Because they get the basics right.

They’re conservatively managed.  They focus on keeping costs low.  And they invest in a diverse group of profitable businesses for the long term.  Most of all, their focus is on the fundamentals – the earnings and dividend streams.

These factors are just as important as ever.  Perhaps even more so today, in a world of hyper-trading, growth chasing and the get rich quick mentality.

 

How to deal with the possible franking changes

As I see it, there are 4 ways you can approach this…

–1.  Stop investing until there is more certainty.  Or as the market-timers call it, “wait until the storm passes.”  Unfortunately, there are never certainties in investing.  Only probabilities.

After this ‘storm’ goes away, there’ll be another one.  Then another one!

I get this makes people nervous, but the fact is we have to keep investing anyway.  By breaking our investment habit, we’re essentially saying that news and short-term political issues are more worthy of our focus than our long term plans.  Rubbish!

If that’s enough to frighten us off, then how on earth will we ever invest when we have a recession one day?!

–2.  LIC investors can decide to buy index funds like VAS, until after the changes come through, to see what affect it has on LICs.

Then make a decision which option looks more attractive going forward.  This is a more reasonable thing to do than the above!

–3.  Continue along with your chosen investment strategy and ignore it all.  Now, this may seem reckless to some, but it’s a very valid choice.  There’ll always be changes coming out of left field.

If you’re happy with your strategy and still expect to comfortably reach your goals, that’s all that matters.

–4.  Look for ways to tweak your strategy, to optimise use of franking credits and low tax rates.  See next section.

Notice that freaking out and jumping ship isn’t an option?  That’s because we don’t do that around here, as it makes zero sense.

After all, the dividend approach is still valid.  Investing in Australia still makes sense.  And the income stream is still very attractive.

 

Adjusting the portfolio

For those in the accumulation phase, there will likely be no noticeable difference in your investment returns.

So this section is more for the soon-to-be retirees or those already financially independent.  But it’s still worth thinking about what you’d do in the same scenario.

There’s an infinite number of ways you could rejig your portfolio – many depend on your own situation.

This isn’t an exhaustive list.  But here’s a few options I see for Aussie income investors on low tax rates, if they do see their after-tax cashflow reduced by Labor’s changes.

 

— 1.  Buy Aussie index funds instead. This will ensure that zero tax is paid by the fund (as discussed above with LICs).  Dividends will be more lumpy through the cycle, so a larger cash buffer will be required.

 

— 2.  Buy REITs (real estate investment trusts). These also pass through almost all cash earnings and so very little tax is paid by the trust.  For zero/low taxpayers like us, the high yields can be attractive.  Generally not well suited to high taxpayers.

Be very careful, as not all REITs are good.  Many trade at low yields currently, and many others have poor dividend histories.

We do own a few REITs today, including AQR, AVN and CMA (not advice).  I may do a post about REITs in the future, if readers are keen (let me know).

There’s also ETFs like this one (thanks to ‘Nodrog’ for finding it).  The fund aims to hold a group of higher yielding and diverse ‘Real Assets’ (think REITs, utilities and infrastructure assets).  All holdings are ‘trusts’, so income is passed through to the shareholder.  The fee seems high, but it looks okay at first glance.

 

— 3.  Peer-to-peer lending.  Again a high yielding option which could suit those on low tax rates.  We’ve been using RateSetter as a small part of our portfolio for a few years now.  I like it for a few reasons…

High yield monthly interest payments.  Different time-frames to choose from.  A healthy provision fund in place, helping no lender to lose a cent since beginning in 2010.  It’s possible to start with very small amounts, the platform is easy to use and has good transparency of data.

If you’re interested, read my full overview of peer-to-peer lending and RateSetter (there’s also a $100 signup bonus for Strong Money readers!).

 

Things to remember

If choosing some of the higher yield options above, keep them as a smaller part of your portfolio.

And remember, tweaking your portfolio at all is 100% optional.

Also, be careful when looking to juice your income/yield in the short term.  It can leave you worse off in the long run.  Or, as they say, there’s no free lunch!

While it’s fine (I think) to give consideration to higher yielding options, we absolutely need growth to keep our income rising with inflation.  So chasing yield and ignoring growth is a bad idea.

A little bit of extra yield is okay.  But don’t get greedy, or you’ll be left with a high risk portfolio which has poor or no growth over time.

 

What am I doing?

After all this chatter about what it means and what you can do about it, what are we actually doing?

Well, not much to be honest!

I’m continuing to buy shares every month.  Yes, even in LICs.  But generally, I’m less willing to buy when prices are above NTA.  So in that case, I sometimes look to buy the index instead (VAS).

I do find Aussie index funds more attractive than a couple of years ago, for a few reasons which I’ll get to in another post.

But our share portfolio is still mostly LICs, and gladly so.  On top of this, we hold a few REITs and have some funds in RateSetter.

And in case you think I’m being reactive, both were a part of our portfolio before Labor’s grand plan came to light.

So nothing has really changed!

But I’ll be interested to see if LICs take a hit should this policy come through, as it might offer some attractive buying opportunities.

Maybe it’s already starting to be priced in, as Milton and BKI are both currently trading at a discount to NTA of around 5%.

 

Summary

It might seem like I don’t care about what happens.  But that’s not really true.  In fact, we’re a good example of those who’ll be hit the hardest.

I just believe we’ll always find a way to make it work.  Because if there’s one thing we can be sure of, it’s that unexpected things will happen.

Policies will change.  Governments will change.  Markets will change.  And you can bet the economy will change.

In my backup plans series, I laboured the point of building resilience and being adaptable.  And the possible franking changes are a perfect example of why that’s so important.

Those who get overly emotional about this stuff are bound to make poor decisions and lose sight of the big picture.  Yes it’s important, so naturally we care.  But it’s more important to make sensible long term choices that align with our goals.

 

Final Thoughts

Bottom line:  Suck it up.  Don’t panic.  We’ll survive.

You might’ve noticed something throughout this blog.  We’re not just building financial strength here.  We’re building personal strength as well.

Because that’s just as important in reaching our goals and living a great life.

We need to focus on our own actions and what we can control.  What does this mean exactly?

Keep your living costs in check.  Save as much as you can.  And stick to a regular investment plan, no matter what.

As always, stay focused on constantly increasing your ownership in a large group of Australian businesses to hold for the long term, and measure your results by the ever growing income stream!

Do you plan to change anything about your investment strategy if the franking changes come through?  Let me know in the comments.

83 Comments

83 Replies to “Franking Changes, LICs and Investment Strategy”

  1. Great article Dave. I like how you are taking a very level headed approach to this uncertainty. I personally am going to invest in more ETFs for the time being until I see where the market settles once government changes and legislation are finalised. I have mainly built up BKI so was also happy with the special divvy;)

    Really good advice though, keep it up!

    1. Thanks mate – you mean thanks for the ‘not advice’ right? Haha!

      Well there’s no point getting worried about these things! That sounds like a good plan to me FifoFireman 🙂

  2. This is definitely something I have been weighing up and I’m sure will promote some great discussion here. I have definitely changed my approach whist waiting to see how it all pans out. I agree it is important to keep investing to keep up that momentum. I had always aimed for a mixed AUS/international portfolio (unsure of weighting but maybe 50/50) anyway because I believe in diversification and at a high marginal tax rate I am greatly affected by taxation of dividends in my accumulation/working phase.

    So, my current approach has been leaning to more international and more ETFs. I think international investing lends itself to ETFs anyways to keep costs low while investing in markets we don’t know as much about.

    I think that one thing that gets missed is that there is similarly a growing income stream from international investing too. If you go with rough numbers INT – 6% growth/2% dividend verse AUS 4% growth/4% dividend – your international portfolio will spit out increasing dividends in dollar terms even if actual yield remains at 2%. I know you need to look at yield from current prices but at the end of the day it’s what lands in your account and what you live on. I think some amount of unfranked dividends to mop up excess franking credits from your fully franked AUS shares seems to be a nice balanced outcome. It remains tax efficient. Also a mixed method of sell down of international with pure dividends from AUS shares will also mop up excess credits.

    I agree with your view that if you are changing plan entirely due to taxation then your plan was wrong to start with. I don’t think the world is ending here. Just needs a bit more thought and tweaking perhaps which is much easier to do earlier on.

    1. Thanks for your thoughts SJ. Good points there!

      Yes of course you can still get growing income from global shares – it’ll just be all over the shop because of currency that’s all. But all else being equal you’d expect stronger dividend growth from the lower yielding global shares.

      The sell down method can definitely work well in combination with the tax advantaged Aussie dividends as you say – just depends on whether the investor is comfortable with that or not.

  3. Hi Dave,

    Great read thanks.

    Nothing too much for accumulators to worry about. Should Labor succeed in abolishing franking credit refunds affected assets will be repriced accordingly. So business as usual. It will also be interesting to see if Foreign investors who have never benefitted from franking credits swoop on lower priced ASX equities thus providing a floor under price.

    Bit harder for lower income retirees investing outside a zero tax environment such as in Super Pension mode to adjust the portfolio if desired. Rest asssured there will be a multitude of new high yield, no / low franked product come to market also likely including low fee index product. If the retiree wants to rejig the portfolio away from too much “franked” dividends then the resultant capital gains can be partly / fully offset by any excess franking credits that would be wasted under Labor’s proposal. Only potential problem is that many others might be thinking same so be watchful of valuations. Bubbles and subsequent busts in “niche” markets can be much more severe than the overall market as AReit investors found out during the GFC where the Areit index ETF fell near 90% and a decade later is still way below it’s pre-GFC peak.

    For those concerned about the impact on LICs until more is known as Dave suggested there is the option of an index ETF such as VAS. Similar yield to the older LICs but franking is around 75% from memory. Just be prepared for distributions to be more erratic. If you have a sensible cash buffer then not a great concern.

    Of course this is all speculation at this stage. If / when any change to franking credit refunds gets legislated there will be no shortage of strategies to make the best of the circumstance.

    On a positive note I’m sure many here are familiar with Peter Thornhill. Reflect on Peter’s Dividend Chart in the following linked article and note that this DOES NOT include franking credits:

    https://www.motivatedmoney.com.au/replay-my-say-no-57/

    With or without franking credits in my view dividend investing remains an incredibly powerful approach.

    Cheers
    Nodrog

    1. “It will also be interesting to see if Foreign investors who have never benefitted from franking credits swoop on lower priced ASX equities thus providing a floor under price.”

      You’ve just described me!

    2. Thanks Nodrog! Great comment and interesting points.

      I never considered the effect foreign investors could have in supporting prices. And as you say, the alternatives and ‘niche’ products that will be created may cause other complications.

      When in doubt, best to keep it simple I think! Something most of us take a while to realise unfortunately – I’ve only realised this lately, having built a large property portfolio with lots of debt and then a messy share portfolio with lots of companies, which is now being unwound. Haha, oh well 🙂

      Good summary – people can tinker around the edges but the growing income approach is still as valid as ever.

  4. “My guess is, shares in high yielding Aussie companies would most likely drop in value, as retirees become dismayed at their loss of income and look for yield elsewhere.”

    You really think this cohort can move share prices as opposed to the institutions????

    1. Well, yes and no. I believe I read somewhere that we have an unusually high amount of retail shareholders in our big banks and telstra for example – people that have held since the IPO’s (because they were very local companies people understood) and who’ve continued to buy more. But either way, I think my main point is, if this ‘bad news’ comes to pass, these companies will be re-rated by the market (by everyone).

  5. Hi Dave – great post. I would definitely be interested in reading a REIT analysis. I hold a few myself — namely BWP, HPI and VAP (an ETF). Thanks

    1. Cheers mate. I try to make it simple, but sometimes there’s lots of variables which makes it hard!

  6. Interesting post, thanks. I haven’t seen some of the hyperbole in chat rooms you mentioned. A lot of people in Reddit seem just to be trying to understand potential impacts, and this article is helpful for that.

    Be very interested to see the breakdown of your portfolio at some point, as sometimes it’s a bit hard to follow where the relativities all sit between your property, LICs, VAS and others. If you’e lucky you might end up with a portfolio as messy as mine!

    I’m mainly curious about your comment about the Legg Mason affiliate run fund (RINC) ‘looking okay at first glance’. The fee is very high indeed, at 0.85%. For that high fee, an investor over the past year – approximately how long the fund has run – received dividends of 4.36% (as at 23 February).

    An investor in the passive VAS ETF would have received dividends of 5.95% over the same period, while paying a fee of just 0.15% – nearly six time lower. They also wouldn’t have assumed the long-term performance risk of an active manager.

    The Legg Mason fund has done well in capital gains – perhaps a one-off effect through people switching into it in preference to LICs in advance of any changes, but when 70% of a income-focused ETF return comes through capital gains, and its dividends record lags in the index, it does make one wonder what exactly is being purchased

    1. Hi FI Explorer,

      I initially drew Dave’s attention to the legg mason Fund merely to show how low / no franked “real” assets such as utilities, infrastructure and listed property could be combined in a product to create a portfolio minimally impacted by the proposed franking credit policy.

      For the reasons you gave the Legg Mason Fund is not desirable. But there have been rumours Vanguard is considering suitable product in case of change. It may or may not be along these lines but I think a low fee, low turnover “real” asset ETF / Fund would be attractive to some.

      Of course there are ETFs currently available that fall under the real asset category such as IFRA (hedged global infrastructure), VBLD (unhedged global infrastructure), DJRE (unhedged global REITs) and local listed property index ETFs (VAP / SLF). All have their pro and cons.

      But should franking credit refunds get abolished I expect to see some interesting product released.

      I personally tend to like to keep our investing strategy and portfolio simple. However each investor’s circumstance is unique so being aware of the possibilities could prove helpful.

      Cheers

      1. Thanks, I see yes, I agree, that makes a lot of sense Nodrog. My worry is we see a rise in questionable second mortgage and mezzanine funds that end up taking advantage of a lot of people.

    2. Thanks Explorer

      Haha you seem quite fascinated in the portfolio for some reason! I gave a breakdown, there’s not much more to it than that, apart from specific holdings you won’t be a fan of lol 😉

      My shares are around 75% old LICs/VAS (which is currently 13%), with the remainder being other LICs and a few REITs. Hope that is of interest. I won’t be sharing the detail you do, and I’m still hesitant because I don’t want people to think they should do what I do – because making it specific might prompt people to act and I don’t really want that. I want people to make their own choices.

      As for RINC – I only looked at the fund very quickly, I’m not endorsing it or anything. The fee is high, no question there!

      I’d say the dividends are lagging and still catching up because of investor inflows, as the fund is only 1 year old – similar to what I hear is happening with A200?

      The forecast net yield based for the fund right now is just under 6%. Just to be clear, I was comparing it to a situation of no franking refunds with VAS giving a net yield of 4 – 4.5%.

      So clearly there’s a difference there, and I could see it being popular with some folk who are looking for extra yield in this future scenario we’re discussing.

      I’d say the recent capital gains is more due to the interest rate outlook. Those type of holdings – REITS, utilities etc tend to do well when the rate outlook is stable or low, and get dumped when interest rates look to be increasing. But I’m only guessing of course.

      Hope that makes more sense.

      1. Ah, apologies. I may have missed the breakdown – which post was it in?

        Interesting point on the interest rate outlook. The RBA had indicated a tightening bias over much of the period, which was built into market expectations up to a key RBA Chair speech about a week ago. This should have actually provided a headwind to a group of interest rate sensitive investments, not underpinned a capital appreciation of around 11%. In my view, given this, inflows as you say, or active bets taken by the manager are more likely causes of that. For a fee of 0.85%, investors in RINC had better hope those bets beat the odds that are stacked against active managers.

        1. The breakdown was in the last post (I think) where I replied to your question asking about it 🙂

  7. Good post.
    Labour will have to win the election and then turn it into legislation.
    With the next interest rate move predicted to be down it make’s REITs look more attractive.
    Companies could just stop paying dividends fully franked and you just pay the tax.

    1. Thanks Sparky 🙂

      Yep it’s a long way off still. REITs have already been going up recently, probably because of the interest rate outlook!

      Nah companies can’t do that. Companies make a profit, pay tax, then pay you a dividend. The dividend comes with franking because they’ve paid tax. They can’t just decide to not pay tax!

  8. Labor’s claim of raising XX billions of dollars is just ridiculous.
    They claim to target the wealthy, but its the lower-middle income investor/retirees that will feel the most pain.
    If you are still working, even on a low income, it won’t affect you at all as you can still utilise all the franking credits.
    All this policy doing is shifting our portfolio allocation from Lics to more international ETF and AREITS, its going to be a hassle but not impossible to implement.

    One thing that keeps me away from international ETFs is the low AUD combined with the 10 year bull market in the US. might not be the best time to dip into that market at the moment.

    1. Appreciate your thoughts Jack. Yes this policy is just picking on poor young FI people the most – get out the world’s smallest violin 😉

  9. Do you just think some big dividend paying companies will pay dividends unfranked instead to keep their investors? Or are there rules about that?

    1. Yeah there’s rules. Companies make a profit, then pay tax. Then pay a dividend from the after-tax profit. The dividend comes with franking because they’ve paid tax. Companies can’t just decide to not pay tax.

  10. Thanks for the post, Dave.

    As someone who started investing in LIC’s this year I’ve taken a cautious approach just because of the amount of uncertainty leading up to the election so this post has helped clear up some details. I have a lump sum that I’m just averaging in over time..

    I never really included franking credit refunds in my number calculations.. I always considered it a bonus, so the 4-4.5% yield is still very attractive for me and falls in line with my trajectory. Of course I’d prefer to have them! But the change won’t destroy my plans and I have a small allocation to VGS and VAS. I’m still working and expect to for at least another 5-10 years.. maybe even longer as the idea of part-time work while FI is appealing to me.

    At the moment I’ve taken advantage of some of the 5% discounts to NTA on the old LIC’s.

    However for time been i’ll continue to take advantage of the discounts but also be adding to VGS and VAS.

    1. Cheers Scott 🙂

      Glad this post helped in some way. It sounds like you’ve got a well balanced and well thought out plan – sounds pretty good to me!

  11. Good post Dave and I think the message about being flexible and being diversified is important! I know when I did up my post (https://aussiehifire.com/2018/09/09/how-would-the-proposed-changes-to-imputations-credits-affect-fire/) on how the changes would affect people I used scenarios where people were 100% in Aussie shares but I think it’s important to be diversified and I’m not actually invested in anything close to 100% Aussie shares myself.

    One issue with your various scenarios, are you assuming that they are only receiving income from Aussie shares here? If so then Investor B who is presumably meant to be someone who is receiving over $87k from dividends and franking credits would actually be losing some of the excess franking credits according to my understanding because it’s the average tax rate which matters, not the marginal tax rate. So for example if they received $70k in dividends, $30k in franking credits then their taxable income is $100k. Tax and Medicare on this are a combined $26,497 so under the current scheme they would be getting a cash refund of $3,503 for total income of $73,503 but under the proposed scheme they would only be getting the $70,000 they’ve received from the dividend. I could be wrong on this but that is my understanding.

    In your next scenario investor C is presumably a holder through a company structure (or trust under the proposed changes) in which case there would be no effect on them, one caveat to this though is that I seem to recall the rate of tax for small companies is coming down so there might actually be an effect there as well.

    1. Thanks Aussie HIFIRE!

      In those first examples, I am trying to keep it simple as possible and it’s mainly to show how the tax brackets and franking work together. It’s very possible I’ve oversimplified it.

      It was mainly to compare those in accumulation phase, not retired. Maybe I’ll update the post to specify.

      The example down lower of the FI couple is to show how it affects retirees, and what I hoped to show is that we’re missing out on refunds (or the dividends are tax free, however you wanna look at it) until we’re hitting $95k fully franked dividends per person.

      Hope that makes sense – I’m getting tired thinking about it now lol!

  12. Nice blog Dave and its a touchy subject that of franking credits, I went along to a Wilson’s shareholder meeting and there are a lot of nervous and angry investors out there baying for Labor party blood.
    Geoff Wilson knows he will lose some business as his high fee but high dividend paying LIC’s will be hit by deserting hungry for high yield retirees. Most of the people I spoke to who were retired and living on modest incomes will be jumping to AREIT’S and other solid high yield equities, SYD and TCL were two other popular picks both who pay nothing or very little franking credits anyway. SPK NZ was another stock being spoken of and a few investors were looking across the ditch at high yield companies…
    My tip is that Wilsons along with a few of the other more modern LIC’s will switch to a trust structure for some LIC’s….they wont be losing shareholders without a fight IMO and seeing their LIC’s fall away in price. I’d expect the banks to retain popularity given their yields even without franking credits are high and I dont see too many savage dividend cuts either as they came out of the Royal Commission ok .

    I just see retirees re-tuning their portfolios to make up the lost money and fund managers becoming more inventive to work around any new environment.

    1. Cheers Mark 🙂

      Haha I can only imagine! There are lots of stocks that are unfranked, but then it starts getting riskier banking on a few REITs and infrastructure stocks, rather than a diversified LIC for example. It may cause a mini bubble in REITs and ‘real’ assets as others have suggested. I’d probably sell my REITs if that occurred.

      Wilson LICs moving to a trust structure would be far less popular in my view. Dividends will be very unreliable and if they try to time their sales to make similar profits year to year (to create more reliable distributions), it’ll probably hurt their strategy.

      Will be very interesting to see what happens!

  13. I think one issue that this debate has highlighted is that a lot of self-funded retirees rely on franking credits as a source of income (cashflow). And I can understand that given that refundable franking credits have been around since 2001. However, someone once gave me some sage advice: it is the cashflow that the asset generates that is important to financial security, not the cashflow that is generated from the tax laws. The latter is the cream on top not the cake mix. That is because what one Government bestows by way of benefits to taxpayers with one hand can be just as easily taken away by a future Government. Beware of Governments bearing gifts. Unfortunately, I think a lot of financial advisers have become complacent on this issue (refundable credits) and as result, we now have a lot of people in the community that have come to rely on them as a source of cashflow. The fact that the ALP may removal refundable franking credits may strip 1.5% off the net return. But allowing for the lower returns, I think we are forgetting that dividends (whether franked or unfranked) will continue to generate a ROI that is the envy of its counterparts.

    1. Thanks for the great comment Stephen, very good points there!

      Definitely not a good idea to expect things to stay the same, especially where the government’s concerned. At the end of the day, as you said, it’s a loss of part of the return, but the long term outlook for dividends and total returns still seems pretty attractive.

  14. Great article, pretty much in line with my approach and thoughts. I’d also be keen to see an article on REIT’s. I hold a few of them for the yield, and infrastructure like AST and SKI. I’ve topped them up over the last year as a diversification to the LIC’s I hold. Just spread it out a bit more. It’s very much a wait and see game at the moment like you said.

  15. Excellent article once again SMA!
    I subscribe to a couple of investment newsletters but what I really look forward to on a Saturday the most is your email hitting my inbox. Truly…… Not saying you should start charging me though 🙂

    Having just commenced our investment journey this year, I’ve got a lump sum to invest, and it is Labors Franking policy that is causing me most concern. I’m still in accumulation phase so it’s not so much the refund I’m personally concerned about, (although am concerned for low income investors) but what it may do to my favoured LICS (i.e. share price, structure, etc).

    For the time being, I’ve chosen to drip feed into option 2 in your “How to deal with the possible franking changes”. The election is only a couple of months away now so not long to wait to see what Australia decides to do with its future.

    1. What a nice thing to say! Thanks very much Oddshapes 🙂

      Haha no charge I promise. But equally, you can’t ask me for a refund either lol.

      Certainly will be interesting to see what happens, but great that you’re continuing to invest regardless – that’s the only sensible option in my opinion.

      1. Haha, ok truce, no charge and no refund, got it 😛

        I forgot to mention, I’d love to read your write up on REIT’s and more articles on different LICS and ETF’s etc.
        I know you’ve stated multiple times before that you don’t want to write too many ‘review’ type articles to confuse your readers, but, as someone who just genuinely enjoys reading about FIRE, minimalism, investing etc I for one would love it.

        I imagine you must get heaps of emails off people asking your opinion on things which maybe making you hesitant, but if someone was to just solely take the advice off (to copy a line from you) “a random 30 y.o. blogger” without doing there own due diligence, well, they need their head read.

        1. To be honest I don’t follow REITs closely at all so it’d be a very basic article! But in regards to the other LIC/ETF reviews, I’ll definitely consider it and in all likelihood will probably cave in do a couple more just out of interest (will just have to stress the ‘keep it simple’ message).

          Thanks for the suggestion! And yes I do worry about people trying to copy me without thinking it through for themselves, despite the disclaimers – that reminds me, you know any good low-cost lawyers? 😉

  16. Great analysis.

    Geoff Wilson is selling that he’ll just switch to trusts as if it will fix everything and think he’s relying on retirees not really understanding franking credits as I don’t see it making a material difference in theory other than making the payment amount more volatile.

    Small detail – REITs are taxpayers and do pay tax (often small), just essentially get a deduction for their distributed income.

    Probably not for your followers however the policy is aimed at retirees, with most of the money likely in SMSF’s. SMSF’s are already on the decline, however, I suspect this will speed up as pooled funds and wraps (and the indiviual account holders) will likely continue to benefit from franking credits so long as the funds have enough contributions from their members to soak up the franking credits. The devil will be in the detail and Labour could I guess close this loophole in legislation but if not it’ll be relatively simple (and not too costly in most instances) for SMSF’s to change structures.

    1. Thanks for the comment Kyle!

      Cheers for clarifying the REIT taxation position too – I wasn’t clear on the rules behind it, just that the payout ratio tends to be close to 100%.

      I’ve seen varied opinions on how super funds will be taxed following the changes – there doesn’t seem to be a consensus last I read (but maybe there is now?). What we do know for sure is that everyone who is affected will be doing their best to find substitutes and workarounds! It’ll keep a lot of accountants and planners in jobs for a while.

  17. I think Geoff Wilson is more interested in the share price of his LIC’s than dividends for his shareholders.
    GW and his fund managers have a fair amount of skin in the game and if punters sold off their holdings and the share price dropped he and his crew would be out of pocket personally a fair amount of dough…

  18. I won’t be changing anything. First of all, like you pointed out the policy might not even be implemented. Secondly, we haven’t seen the final draft, we don’t know what it’s going to look like, Labor are already watering it down, which means there might be exemptions/variations for LICs so the company structure is not so heavily penalized by the policy. Either way, I think LICs are going to be OK, and will adjust to it. Also, the loss of franking credit refunds can be offset by other things, such as investing in REITS, high yielding ETFs or even by buying individual stocks. There are plenty of 6%+ dividend yield stocks that also offer good growth opportunities. Obviously I would still have the majority of my portfolio in LICs and ETFs, however I think there is nothing wrong with having a portion of your portfolio in those to somewhat offset the loss of franking credit refunds. And then there is Ratesetter.

    1. Thanks for sharing your thoughts Gene! As you say, certainly a long way off being implemented in its current form, but we’ll have to wait and see.

  19. Another great article. Thanks so much. This whole franking credit thing makes my head hurt. I am seeking clarity on something though.
    Assuming the changes happen, if I earn fully franked dividends in a pension stream, I would not receive a franking refund. However, if I earn fully franked dividends in the accumulation mode of an industry fund then I would get the franking credit but pay 15% withholding tax. So I would be better off leaving the LICS in the accumulation fund rather than moving to pension mode. Is this correct?
    Another question I have is, would Host Plus Choice plus be classed as an SMSF?

    1. Cheers Starbuck 🙂

      Haha things like this are bound to make anyone’s head hurt!

      I can’t give guaranteed answers to your questions as the outcomes aren’t super clear (I’ve seen different explanations for what it means for industry super funds). But here’s what I understand at the moment…

      If you’re receiving no government benefits then yes you’re franking refund is stopped for a SMSF. If you hava a Hostplus Choiceplus fund, no I don’t believe it is classed as a SMSF. If you have LICs inside the Choiceplus fund for example (which I think is what you’re getting at), I believe you will still get no refunds, but franking will cover the tax.

      So the outcome seems the same. The different is, from what I’ve read, industry funds will benefit as they can use the excess franking credits from your investments, to cover tax payable on other members investments (because they’re classed as a ‘pooled fund’). I hope that makes sense and I could well be wrong – it’s not really clear what would happen and super isn’t something I know tons about!

  20. You can put me in the ’emotional investor’ bracket, because if Labor will gain just 1c from my investments, I will change those investments to ensure that they don’t get that 1c.

  21. Thanks for the great article, very clear,even for people just starting like me, this is my first time commenting or asking a question, so bear with me, as I said I am just the beginning of my journey. I wonder what you think about A200 instead of VAS, as it has lower fees. I have seen several of your articles and they always mention VAS.
    Thanks !

    1. Great to hear it was easy to understand, thanks Karen!

      Good question. A few things.

      1. If I’m buying an index I prefer to buy the ASX300 instead of the ASX200 – an extra 100 companies which are a small percentage today, but as the economy grows and broadens over the next few decades I would expect that extra 100 companies to be more important and a greater weighting in the index than they are now.
      2. I’m happy to pay more for Vanguard’s reputation of low cost and putting investors first – other ETF companies are profit motivated whereas the parent company Vanguard is not for profit. I expect Vanguard and other plain market indexes to end up at basically zero fees sometime in the next 10 years (like is happening in the US) – so why not choose the one with broader diversification, a culture of investors first and a long term reputation. Many of Betashares products/funds seem to me very gimmicky and trader focused which puts me off, because they seem more designed for selling to investors than actually a worthwhile product investing in.
      3. Vanguard have been indexing for many decades whereas Betashares is relatively new.
      4. VAS is a much larger fund which could mean better liquidity.
      5. VAS has also started doing securities lending (which is letting short sellers borrow stock to sell – a very common practice that many index managers in the US do as well) which will help them earn a little bit of extra income and could result in slightly higher returns going forward.
      6. A200 also uses a different index run by a German company, which is why the fee is lower – very similar and probably fine but hasn’t really been running very long.

      I don’t think A200 is a bad choice at all, but I’m happier with VAS for the reasons above (mostly the first 3). Hope that helps.

  22. I’m not sure if my calcs are correct but this has a huge impact on whether to invest in their name or their partner’s name, if they use a debt recycling strategy. Say someone’s on a 37% bracket and the partner is on a 0% bracket (not working and received dividends less than $18k per year). Eg: Dividends $7k, franking credits $3k, deductible interest $4k. Tax payable by the person in the 37% bracket is $2.2k, and they can claim the franking credits and get a refund of $800. The person with the 0% tax rate however cannot claim the franking credits back under this proposal. How is this fair to lower income people? Whole investment strategies have been put into place based on current rules. It would cost so much just to unwind the positions and reinvest based on the new rules.

    1. While it’s not exactly clear yet, I don’t believe the 37% payer will be able to get a refund under that example. Franking will cover that persons tax, but no refund should occur. The idea of the whole proposal is that nobody (except those exempt – charities, part pensioners) will get a franking refund, it can only be used to offset tax owing.

      You’re spot on that people have made long term investment decisions under good faith that this arrangement would continue to be honoured (much like negative gearing), and there seems to be no grandfathering provision (unlikely negative gearing). I can see both sides of the argument (tax needed for hospitals etc) but it doesn’t seem to be the best thought out policy.

      1. If the 37% payer has other income from working wouldn’t they be able to use the remaining $800 credit to offset their ordinary income? This is all too confusing… I don’t know why anyone in their right mind would vote for Labour, especially among the FIRE community.

        1. I’ve seen that argument and that could definitely be correct, but I’m just not convinced it’ll work like that. Because the main reason you’d be getting a tax refund is still because of franking credits, so I’m doubtful that’ll be allowed. Haha yes, it’s definitely a bit of a mess with different outcomes for different people.

          1. I believe James is right that you can offset the tax paid on other income with the franking credits, as long as that doesn’t result in a net refund to you from the government. So if you have $100 in franking credits at the 19% tax bracket and you’ve paid $1000 in tax on your non-dividend related income, yes you can claim back franking credits. But if you’ve got a purely dividend based income equivalent to an income paying $1000 tax, you wouldn’t be able to claim any credits.

          2. It’d be good if that proves to be the case – I get the numbers for that argument but I’m sceptical about it. The reason you’d be getting a refund is still because of franking credits – so it’s no different.
            Then it starts working like effectively a tax deduction similar to negative gearing, and we know how Labor feels about that lol. If this is the case, probably wouldn’t be long until they close that ‘loophole’. Still a tax refund because of an investment you paid no tax on in their view. I hope I’m wrong, but at the same time, I’ll wait to have it confirmed.

          3. That’s true, it essentially would be the same as a tax deduction, but that’s effectively what franking credits as a whole concept do for people in higher brackets. A deduction isn’t a refund so they won’t be able to sell it as part of the same policy. And as much as Labor says it’s against negative gearing and tax deductions I don’t really believe they’ll close the loopholes that truly benefit the rich. The fact is that Labor politicians and decision makers are still part of the group that benefits from these loopholes and the strongest lobbies are filled with people that benefit from these loopholes. I’d be happier about this whole thing if Labor *was* closing all these loopholes 😛 at least then it would be equitable.

          4. I reckon they could sell it as the same – they can point out the franking is still resulting in refunds and still no tax paid on dividends. Pretty easy to paint that up as a rort at first sight.
            Haha yes politics is a very messy place and we can’t really make any assumptions. I’m all for the govt earning enough tax to pay for things, but reform should be done in a thought-out manner considering the implications for those at different levels of income/wealth – tax should ideally be relatively simple and progressive. And pigs might fly 🙂

  23. I rather doubt that Shorten’s government will win this election so IMO this is a bit of a moot point anyway. But if it does come to pass… it won’t change my investing strategy at all.
    The thing is, this change impacts the low-mid income investors the most. I predict that a fair few of this group may start changing their investing patterns in reaction – but for us high income investors it just opens up the LIC market to let us buy in more at discount prices. It’ll only serve to widen the wealth gap which just makes it all the more crazy that Labor is using this as their selling point for this election.

    1. Thanks for the comment. You’re spot on that it’s being sold as an attack on the rich, when it’s anything but. It just sounds like a good policy, so those with little knowledge about how it all works (which sadly is lots of people) will swallow the message and get the pitchforks out lol.

      1. Dividend income is passive income. High or low tax bracket, everyone’s getting that income passively.

  24. Hi,
    I thought when you buy shares you become part owner of that business. Therefore if that business makes a profit and pays tax at 30% and you personally pay little to no tax that refund is legally yours, how can anyone take that of you?? There are situations all over Australia where multiple owners of businesses claim refunds.

    1. Good comment Roberto – strange isn’t it? The structure determines everything. Own a private business or rental property in your name and pay tax at your own marginal rate, own part share in a listed business and have those earnings taxed at a minimum of 30%. Doesn’t make all that much sense to me either.

      The intended targets (and what savings estimates were based on) were large SMSF’s who were getting massive franking refunds and paying no tax. This has already been fixed with the $1.6m tax free super cap introduced in recent years.

    2. Roberto: There is a growing awareness that Australia’s current fully refundable dividend imputation system is unsustainable. I may be mistaken but I believe Australia is one of only a few OECD countries to have a a dividend imputation system and is the only country in the world with fully refundable imputation credits. In other words, it is the only country in the world that allows people who receive dividends and pay no tax to also get the tax back that the company has already paid. In every other country a company makes a profit, it pays tax, it distributes the profit left as dividends. End of story. For some reason we have this view in Australia that if something changes it is the end of the world. Other people and countries get on just fine.

      And what is lost in so much of this debate and which Dave highlights is that no investment strategy should be based on tax. NEVER. Property investors are just finding this out. I never look at whether the company pays franked dividends or not. If a company has a 4% yield that is what I go on. Anything extra is cream and not to be relied on.

  25. Hi,
    Amazing article. With Argo trading at a discount of 4.5% according to Pats calculator is this an example of a great time to be buying?

    1. Thanks Usman, great to hear you liked it!

      Those calculator numbers are a bit off I think something was messing with them. I’ve just fixed it up and it now shows Argo currently at a discount of around 3%, which certainly looks okay to me.

  26. Hi FIRE community,
    For what its worth, I can give you a brief historical context to the franking credit issue because I am a student of history when it comes to tax law in this country (rather than a political partisan). The system was the brainchild of the Campbell Committee (not P.J. Keating as some would have us believe) that was appointed by the then Coalition Government in 1979 (Fraser/Howard). Its report came out in 1981. The Committee’s recommendations were groundbreaking at the time including the replacement of the incumbent tax system (taxing profits at the company level and again at the shareholder level with zero offsetting credits) with a FULL imputation system. The Committee designed the imputation system on a partnership style flow-through so that ultimate taxing point would fall on the shareholder (companies would withhold tax from company profits similar to our current PAYG system). The design of the system was modelled on a US-style Subchapter S company (coneheads can google this for more info) for BOTH private and public companies. The Report generated considerable excitement in the academic world and was considered ahead of its time. So much so that the Fraser Government didn’t give serious consideration to this idea and when Hawke and Keating decided to adopt the Committee’s findings in their 1985 tax reform package, they too stopped short of implementing the full recommendation of the Committee. It was left to Howard/Costello to put the final piece of the full imputation puzzle in place in 2001 (refund of excess franking credits) some 20 years after the Report was published. So the current crop of ALP pollies would have you believe that we are returning to a Hawke/Keating style of system when in fact what they are proposing is a retrograde step that took 20 years to rectify in the first place. Next time you hear the ALP propaganda on this issue, reflect on the above context.

    1. Hi Stephen, I really appreciate you giving us the rundown on the history of the franking system in such detail!

      Definitely interesting and makes the puzzle pieces fit together a little more easily. Very valuable stuff, thanks again 🙂

  27. Thanks mate for the articles, first time I have had the opportunity to read the info on LIC and Shares,
    Much appreciate the effort and the detail on the topics.

  28. Hey Dave,

    I’m still in the accumulation phase so these potential changes won’t effect me for some time to come (It looks like even if Labor wins, it’s unlikely they will get support from the senate).

    I’m just trying to wrap my head around the tax system with franking credits while still working.

    I’m on the 32.5% tax bracket. If I’ve understood correctly, during tax time 30% has already been paid on the dividend through the company so I will only be required to pay the additional 2.5% + Medicare 2% = 4.5% tax on the dividend?

    Whereas money I’ve held in HISA accounts in the past (due to fear of investing) I’ve had to pay the full 32.5% + Medicare 2% tax on the total interest earned..

    Thanks.

    1. Hey Scott 🙂

      For fully franked dividends such as those coming from LICs your figures are correct. 30% tax has been paid so you simply pay the difference between 30% and your tax bracket. Heaps simpler when thinking about it this way. And yes you’re correct that bank interest comes with no tax advantages so is completely taxable as income. Big difference.

      So given dividend yields are much higher than savings account interest, plus franking credits take care of much of the tax, plus you get growth over time with shares, it’s a lot more attractive than holding cash! The price you pay is volatility though, which some people simply cannot cope with, but that needs to be accepted to earn those attractive long term returns. Hope that helps!

  29. Hi Strong Money,
    ETF pay no tax on their earnings from the dividends they receive.
    But these dividends have paid tax so don’t these dividends have franking credits attached to them?
    In that case don’t ETF pass on these dividends to the investor with the attached franking credits.
    So if you are on a 0% tax rate you are still going to lose the franking credits.
    As a result I am very unclear of the advantage of ETF over LIC.
    Your comments would be appreciated.

    1. Hey Larry, first thanks for reading!

      I tried to explain this in the article, but maybe it wasn’t clear. Yes, an ETF investor will still lose their franking credit refunds if the changes come through. But the ETF pays no tax itself, whereas the LIC does (for capital gains on shares sold and income from companies which is not fully franked). So in this case the LIC investor is worse off.

      The difference is quite small though as I showed in the example about Milton and how much tax it pays (not much). All else being equal, if Milton was an ETF the investor would get a dividend yield of 4.4%, but because it’s an LIC the dividend yield is 4.25% (in this example), because the company has had to pay some tax.

      Maybe take another quick look at the example and it might become clearer. Hope it helps.

  30. Howdy Dave,

    New to the caper but really enjoy working through your posts.

    My thing is I’m only just scratching the investing surface. Had the mortgage paid off around Xmas but then slugged with school fees and big tax bills so had to dip into the offset account to pay them. But I thought I needed to get investing while I polish off the mortgage. FIRE and all that.

    To get things going I stuck some funds in a Six Park (robo investing) growth portfolio for the kids then I’ve just done the same for the missus and I. I like the low fees and diversification you get with Six Park (6 X ETFs – VGE, DJRE, STW, VGS, IFRA, IAF) and it’s had a 3.43% return in a month (not including sales or CMA transactions).

    So mortgage back out a bit but I’m in the game.

    So the question I’m asking myself is do I continue down the ETF path with Six Park and/or put it in Aussie share ETFs like VAS, or do I put it in LICs that may not do the trick when I’m wanting passive income from them in 10 years after Labor give franking credits the arse.

    At this stage I’m looking at investing $10k every five weeks in a rotation between the Thornhill-style LICs, like AFIC, Milton, Argo and BKI, along with VAS and the Six Park Portfolio.

    My worry is doing all those hard yards for the next ten years only to get short-changed when I retire from the incoming government’s changes.

    But then five years later I’ll be able to access my Super which I’m paying the maximum on.

    Buggered if I know.

    Kind regards,

    SOL

    1. Glad you enjoy the blog, thanks! I can’t tell you what to do obviously, but I’ll give you some general thoughts.

      Six Park looks like a good setup and that would definitely keep things simple (though you probably know a 1 month return is meaningless, it could just as easily be negative 3% and neither of these matter in the long run).

      Franking changes do not affect the growing income stream of either LICs or VAS – both will still pay around 4%+ dividends which will grow over time – just possibly no more cash refunds to boost it, that’s all. Each still meet the definition of passive growing income in my book. But if someone is concerned about it then the index might be the safest option.

      Either way you still have to invest in something. Maybe the changes come in, maybe they don’t. What I would focus on is simply buying shares regularly, growing a decent sized portfolio and if I wanted a bit more income rather than growth (which I do) then I focus more on Aussie shares. That’s probably the main consideration.

      Keep it simple and focus on building the portfolio. Whatever you choose, you’re doing much better than most and it looks like you’ll end up in a pretty good position, so pat yourself on the back! 🙂

      1. Thank you for the feedback, Dave. I think if I keep it simple and go about it that way I can’t go too far wrong.

        I find it amazing that you can go to the trouble to write back to us punters in a meaningful way so quickly. You’re a good man. I appreciate it.

  31. Well now the election dust has settled I have two great men in my mind.

    Krusty the Clown, cigarette dangling from his mouth, crying, “What the hell was that!?!”

    And Forrest Gump running along the highway with the crowd following him and he stops and says, “I’m tired. I think I might go home now.” And one of his followers says, “What do we do now!?

    So there was all the concern and deliberation about franking credits and should I flick LICs for VAS and its ETF mates and it’s situation normal.

    So has this changed your investing plans, Dave? Or are LICs firmly back on the menu?

    1. Haha! No change, I’m still planning to invest in both over the long term 🙂
      How about you?

      1. I’m in a high tax bracket so I was still going to go with LICs like AFIC and Whitefield and utilise the DSSP option. The plan is to rotate between AFIC, Whitefield, VAS and a growth EFT portfolio with Six Park to give me diversity.

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