While I don’t normally get into the topics of taxation or politics, today I’ll make an exception.
Since my own strategy for early retirement income is based on dividends, it naturally fits that I’d cover topics that affect this.
Recently, Bill Shorten announced the Labor Party wants to bring in some changes to franking credits.
There’s heaps of talk about what this means, in theory and practice. And there’s a wide range of possible outcomes, along with some likely unintended consequences.
Let’s take a look at the proposal, what the aim of it is, and what the outcome might be.
As it stands, companies in Australia pay tax, and when they pay dividends, shareholders get a ‘credit’ for the tax that the company has paid on those earnings.
Then, the shareholder is liable for the difference between that tax the company has paid (30%) and their own personal tax rate. That sounds fair, right?
This makes sense, because as a shareholder, that’s (part of) your portion of the company’s earnings. After all, the shareholders are the real owners of the company.
So the same as any other asset, the earnings are taxed at whatever rate applies to the owner.
Shareholders on low incomes, with a tax rate below 30%, have some of the tax (franking credit) refunded, as their portion of the earnings has been taxed too highly.
And shareholders on higher tax brackets (above 30%), have to pay ‘top-up’ tax, as the earnings weren’t taxed high enough, in their situation.
Sound reasonable?
The proposal is to keep the imputation system as is, but stop the refundable nature of the franking credits.
So anyone on a tax rate of less than 30%, receives no refund of the excess tax paid. And their portion of the company’s earnings have been taxed at 30%, despite those people (the end owner of the company) being on a lower personal tax rate.
Effectively, everyone on a lower tax rate than 30%, will be worse off as a result. They’ll receive lower income from their Aussie shares, and a lower after-tax return as a result.
This includes anyone working or retired, with Aussie shares to their name.
But for anyone on a tax bracket over 30%, the change will make no difference at all. They’ll continue to pay the ‘top-up’ tax and are able to fully utilise their franking credits.
While it might sound unfair, there’s a few reasons why Shorten is proposing this.
From the statements the Labor party has made, it’s very clear what their aim is.
The goal, is to raise more tax revenue.
Their weapon of choice, is franking credit changes.
And their target, is those with millions in super. Specifically, those in pension phase (retirement), who are generating massive investment income, and paying no tax.
Now, to be clear, they aren’t doing anything wrong. This is just the way the system is designed.
Because they’re on a tax rate of 0%, they get all their franking credits refunded. Their portion of the company’s earnings are untaxed, due to their personal tax rate of 0%.
So by cutting off franking refunds, Labor is hoping to raise billions in extra taxes. The taxes are to be spent on some noble causes, such as tax cuts for low/middle income earners, small business benefits and social programs.
But the problem is, everyone else is caught in their net. Despite them only wanting to catch the big fish, the little fish are caught in the net too.
The small shareholders who are self-funded or partially self-funded will be hurt the most.
Think about it this way…
Consider a self-funded retiree couple aged 70, invested in Aussie shares and receiving gross dividends of $35,000 per year (including franking credits). Their income will be cut to $24,500 – a 30% cut.
In that scenario, after the proposed franking credit changes, they’ll be back on the pension and the cost savings for the government are virtually eliminated.
There are many situations like this, where the small shareholder is missing out on critical income and will end up adding to the pension burden.
As a rule, the smaller the holder, the more important that income is.
Well, what about the big fish, who the policy is targeted at?
For those with substantial assets in the zero-tax pension phase, there are many options, should the franking credit changes come in.
Does anyone believe they’ll just hang onto their Aussie fully franked shares, accepting the lower income and lower return? I don’t.
Instead, they have the option of dumping their Aussie shares, and investing in other assets.
Other choices include, any shares that are unfranked, where no company tax has been paid here in Oz. That includes infrastructure stocks, real estate investment trusts (REITs), utility stocks and even many managed funds.
Much of these investments operate as a ‘trust’ structure, meaning they simply pass through all their earnings to the end shareholders, without paying tax. And the shareholder is then taxed at their own personal tax rate, for the income and any capital gains distributed to them.
Sound familiar?
Also, the big fish can instead choose to invest in commercial property, residential property and overseas shares. Basically, anything other than Australian companies will still be tax-free.
Why? Because their tax rate is still 0%.
So much for catching the big fish!
I’d estimate that the savings generated by the cancellation of refundable franking credits, to be somewhere between none, and not much.
Yes, that’s a figure pulled from my behind that won’t help balance the government’s budget. But most projections fail to consider behavioural changes from increases in taxes or policy changes.
Most people will simply change their approach to minimise the impact as best they can.
At the end of the day, it’s not all about minimising tax for the fun of it. More importantly, it’s about maximising returns.
The rich people they’re trying to target, will simply invest in other assets where they can still earn plenty of investment income and not pay tax. Since their tax rate is 0%, it’s no drama to sell or switch investments, to earn a higher return.
Basically, the franking credit changes would (somewhat) discourage investment in Australian companies. And it puts a minimum tax on company earnings and dividends of 30%.
If those earnings come from an investment property or wages, those earnings are taxed at the individuals own tax rate, whether it’s 0% or 48%. So why not their shares?
It just seems like a lazy, blanket approach to take, that will have minimal benefits, while hurting the wrong people.
It appears the problem is not with franking credits and refunds. But the problem is the 0% tax rate on rich retirees. And I agree, that’s overly generous, and not sustainable.
So, if the goal is to increase tax revenue from the wealthier retirees, then why not target it specifically?
The government could do this by having progressive tax rates in Super. The more you’ve got, the higher your tax rate. This would probably have a much bigger impact, while doing the least amount of damage.
Importantly, none of the small holders will be affected, which isn’t their target.
While it’s currently being debated, the franking credit changes may even affect Super Funds, due to their 15% tax rate.
I’ve seen different opinions on this. But if true, the result is a lower after-tax return for Super Funds investing in Aussie shares. And this is sad, because it will cause more capital to be invested in assets other than Australian companies.
Also, a lower return on Super Funds while we’re working, means a lower balance on retirement. Therefore, we end up with more people reliant on the government for support. Further reducing any benefit to the government budget.
Let’s pretend for a minute. Assume nobody changed their investment strategy after the changes. Here’s the outcome for two retiree couples who are invested in Aussie fully-franked shares…
Retirees A, generate $400k of gross dividends from their shares in pension phase, and pay zero tax. After the changes, their income drops by 30%, to $280k.
Retirees B, generate $40k of gross dividends from their shares in pension phase, and pay zero tax. After the changes, their income drops by 30%, to $28k.
Who is more affected?
Obviously, it’s an equal loss in percentage terms. But in reality, Retirees B will now likely need to go on the pension, while the richer couple is probably doing just fine.
So in practice, it affects the less well-off, more than the rich.
Again, the problem is clearly with the 0% tax rate on huge retirement balances, not specifically with franking credits.
Currently, the tax system is quite fair across all assets.
With the refundable franking credits in place, it puts shares in Australian companies on a level-playing field with other Aussie investments like direct property, commercial property, infrastructure and others I mentioned above.
Because the earnings from these assets all flow through to the end owner, before being taxed. But receiving earnings from the company, after being taxed, wouldn’t be fair, compared to the other assets.
To take away the refunds for people in tax brackets under 30%, means only middle and high-tax payers get to fully utilise their franking credits. But clearly, it’s the most valuable to the lowest income earners.
I’m not sure that fits with Labor’s ‘equality’ mantra.
This is a fair argument. We certainly don’t want this to happen, because the government will lose increasing amounts of revenue.
But the solution is probably not to remove the refundable nature of franking credits. Remember, that evens out the playing field for all tax rates, when compared with other sources of earnings.
There are media stories of some people getting franking refunds of hundreds of thousands of dollars. But the truth is, this will be in the minority.
And with the recent limits on tax-free super balances, this is already phasing out to some extent. These super-rich retirees will be paying at least 15% tax on most of their earnings.
As I see it, the problem is the low tax rates. With these franking credit changes, they will just alter people’s investment decisions, while raising little, if any, extra revenue.
If tax rates are higher for those holders, then whatever they invest in, there’ll be a genuine improvement in tax revenue.
At the end of the day, I think the franking system is fairer since becoming refundable. It allows people of all incomes to fully utilise the benefits, not just high income earners.
Already, it appears that Bill Shorten is watering down the policy, after backlash from genuine low income earners, caught up in the proposal.
The underlying problem is clearly that some high earners are making extremely large amounts of investment income and not having to pay tax. The solution then, is to change the tax rates.
Having progressive taxes inside super, just like outside super, is probably the fairest way to go about it. And it’ll ensure that genuine low income earners, and lower wealth retirees pay less tax, than those better off.
By retaining the system as it stands today (and fixing tax rates), it avoids the higher-wealth retirees simply changing their investment strategy, to generate a strong income in other assets, and still pay no tax. And it avoids any capital flowing away from Australian companies, to other types of investments.
While I don’t agree with the proposal of franking credit changes, I do agree with people earning hundreds of thousands in income from their investments, having to pay at least some tax!
But don’t just take it from me, I’m biased by my own self-interest of course!
Anyway, that’s how I see it. And at least it makes politics interesting for a while!
What do you think about the proposed franking credit changes?
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Lizzie changed her career, moved location, sold her home and switched investment strategy. Now she’s looking to semi-retire in her 30s.
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Agree with the premise of taxing the very wealthy but self funded retirees under $50k a year should be exempt and a staggered scale introduced for 50k plus. These people are small fish being caught in a net designed to pull in the bigger fish and and as you have rightly pointed out will only fall back on the pension and become a burden on the system. REIT’s will be the place to be, SYDney airport etc and off shore stock investments, the share price will jump on those stocks and like most of these tax grab schemes most of the required fish will escape the net thanks to teams of accountants/advisers finding other investments. It will create all sorts of flow on problems, Investors will leave the banks for example, share prices will drop and when banks bottom lines get hit they will be making up those losses elsewhere. LIC’s will also lose as investors run to REITS for more return….eg
Argo at 3.9% with No Franking credits vs eg GDF at 7.9%….not rocket science is it.
IMO it will backfire on Shorten and he will become John Hewson Mk11 and it might lose him the election…
I am biased as I earn good money from Dividends and do earn extra by running
Dividend stripping techniques where I always try and aim to claim franking credits so I am not impressed as are many of my family and friends who also rely on these franking credits to supplement small incomes.
I’d expect there to be some heavy polling in the next few months as Shorten and his sidekick Bowen gauge the reaction to the mess they want to create..
If they wise up they might think about excluding some of the little fish….
Thanks Mark. Yeah I’m with you there on breaks for the small holders, but obviously I would say that!
You’re spot on I think. My guess is those stocks would take off as you say, so yields would fall. And LICs and fully franked stocks like banks, telstra etc. would fall out of favour and become cheaper. So the difference will end up being smaller than expected, as the yield gets arbitraged away. LICs may well trade at a higher yield plus a discount, which would be nice.
Haha yeah it’s true, the wealthiest will have alternative strategies in mind to ensure they still make the most income while minimising tax towards zero. And why wouldn’t they? That’s the whole point. The tax rate is wrong!
I think we’re all biased to some degree. Non-share investors are sniffing out an income tax cut if it comes through, so they’re hardly unbiased in their views either.
Even though raising taxes on high-wealth individuals is a fine strategy for raising revenue, it doesn’t seem this is well thought out!
Hi Dave
Great insights on the proposed franking credits policy changes. Can you share your thoughts on how this policy, if implemented, would affect your early retirement income strategy of living off the dividends of a basket of Australian LICs? Would you be advocating other asset classes for early retirement? Rejig the portfolio to feature more unfranked shares or partially franked shares such as VAS or VGS?
Thanks Jon.
Well basically, because we’re currently on the lower tax rates, we’d have a lower after-tax income. But luckily we’d still comfortably have enough equity/savings to be able to generate enough income to maintain early retirement.
The changes would probably be minor, if any. It makes VAS slightly more attractive than before, as no tax is taken out before passing through dividends. Overseas exposure such as VGS would become slightly more attractive, although still quite low yielding in comparison to Aussie shares. We may well buy a few REITs or infrastructure type stocks to juice the income a bit, as they’d be more or less untaxed.
In the end nothing major would change and the bulk of our income would still come from Aussie shares, whether LICs or VAS.
Are you planning to change your investment policy?
Hi Isaac, the short answer is no, probably not. While the lower after-tax income would suck, I still find Oz LICs attractive when looking at other assets and considering long-term income potential. They may even get cheaper/trade at discount, if this played out – so you may end up with net yields a little higher.
Other stuff (REITs, overseas shares etc.) would still start to look good in comparison though, and I may well tweak the future portfolio slightly.
I would provide an update if anything definite occurred, to share any changes in approach.
Hence why I have several different buckets of investment types because you can never rely on legislation to stay the same.
I will not get rid of my LIC’s and conglomerates, but I will not be adding to them if this change occurs in 2019.
My Australian Unity Investment Bonds are all of a sudden looking even better for the future than they were last week!
Thanks Phil.
Well, for high tax payers, in comparison to the AFIC Bonus Share Plan (which is just as attractive after the proposal), wouldn’t it be roughly the same as before?
It’s a good point you raise on spreading across investment structures. This essentially would penalise the company structure only. If your tax rate is above 30%, then Aussie shares/LICs are the same as before. Below that point though, and other investments start looking attractive when looking at after-tax income or total return.
Yep, it would be the same except that with Investment Bonds you can choose when to start them and when to add to them etc – full control compared to waiting for BSP dates
Oh ok I see! Curious, what would you be doing different if the changes come through?
I have already begun pouring all available savings and dividends into my AUIB’s ( but not exceeding the 125% rule) and when I retired fully I will convert these into a tax free income stream (AU offers this for no charge) and leave all other investments in accumulation.
All dividend stocks will sit inside Super Accumulation until needed so at least the franking credits can be put to best use (until Super tax rules change at least).
In the next few years while I am well above 30% tax bracket Shorten’s will have zero impact, but seeing as I intent to retire with 5 years, (not too far off!), I am taking action now as I believe the tax change will happen in some form or other.
Any lump sums that I may run into I will open new AUIB’s and let them do their 10 year thing. These will mature at different intervals during retirement and be tax free.
I am also talking to my 5 daughters as we speak about the feasibility of opening a family investment company – still early days but has some exciting possibilities too …. but that is off topic hey 🙂
Thanks for sharing your approach Phil!
Certainly sounds like a fair plan indeed, and you’ve got your bases covered 🙂
That’s a pretty exciting idea, it’s great that you all share an interest in investing – awesome!
I read somewhere the ‘tax grab’ came from a report that landed on Bills desk.
https://www.smh.com.au/politics/federal/meet-the-48-millionaires-who-pay-no-income-tax-not-even-the-medicare-levy-20170419-gvnkxh.html
In Bills defensive 48 very clever rich people but this shouldn’t be allowed to happen. Multiple trusts per person to reduce ALL tax liability.
Shortens tax grab just doesn’t make sense and is NOT fair! Sounds like he has backed down due to public outcry!
http://www.switzer.com.au/the-experts/peter-switzer-expert/bill-backs-down-on-punishing-pensioners-and-public-servants-but-who-does-he-still-hit20181603/
Thanks willis.
It’s true, there is no scenario where it’s fair that you can earn hundreds of thousands of dollars and pay no tax. It’s not logical. I just don’t think this is the solution, there’s too many ways around it for the ones they’re trying to target. And keep in mind, the more funds one has at stake, the harder they’ll try to work around any changes, leaving the less wealthy and (perhaps) less investment savvy folks stuck in the firing line.
I didn’t realise that earnings in super funds in pension mode (please correct the terminology if I’m wrong) attracted no tax at all. That just sounds wrong. So those earnings are taxed at 15% in accumulation mode, then 0% in pension mode? Can you expand on this a bit, for my knowledge. And what effect the $1.6m limit will have on that.
There I was assuming that in retirement you’re savings (inside and out of super) morphed into one and income was simply taxed on the marginal income tax rates system (a la the rest of us)!
So my understanding is that in pension mode, you’re now allowed to have $1.6m in super where it’s earnings are taxed at 0%. Above this I believe you need to put it back into an accumulation phase account, or at least seperate it on paper in the case of a SMSF, where it starts attracting tax at 15% again. These changes have came in recently under the current government and it’s more than fair. There’s no reason to have huge balances paying no tax. That was a terrible idea to start with.
Well to be honest Todd, that’s what should probably happen. If regular rates of tax applied, or at least higher than currently, then more revenue would be raised and there probably wouldn’t be a problem.
Todd
My understanding is that once you have reached your preservation age and meets the condition of release. i.e retired, then you can convert your accumulation to pension phase and pay no tax on it. Prior to the last election, you can have unlimited asset in super in pension phase and generating millions in income without paying tax. however, they’ve changed that now and any assets above 1.6M will attract a 15% tax.
Your investments outside of super will still be at your marginal rate, however, once you’ve reached a certain age, you can access the SAPTO (senior australian pension tax offset ?) which will enable more tax benefits.
Dave
I like your analysis and think you have a clearer strategy than the Thinktanks in the government, the progressive tax strategy will work well in the Super system, and I think it will work even better capping it at company tax rate. This will have many benefits,
1. Government will collect more revenue
2. This will make our super system sustainable over the long term, lets face it, our over generous super system is not sustainable over the long term as it will have a detrimental effect on the budget. so sooner or later, they will need to change the super system again anyway…. Instead of having this “uncertainty” cloud over everyone’s head, it will work better finding an attractive yet sustainable solution…this will enable people to better plan ahead and give the government some credential
3. I think having a progressive tax strategy in super will make it even more attractive as people have certainty and hence more willing to invest their money in the super, this compares to the over-generous system we have now but with a “uncertainty” cloud over it.
Labour over the course of the past year or so have announced 2 major changes:
1. Taxing Trusts at minimum 30%
2. Non-refundable franking credit
Now, the aim of this is to raise tax, but I don’t see how this is going to work, for instance, by imposing a minimum tax of 30% on trust, you surely need to pass on the franking credit to the beneficiaries, otherwise, you are effectively double taxing the trust structure. If franking credit can be passed on, then what is the bloody point of his policy ? its no different to before. IF franking credit cannot be passed on, then it will make trust structure extremely unattractive and unfair, we can overcome this problem by simply moving assets out of trust structure and into either personal names or company structure. Also, he did not address other types of trusts such as hybrid trust, how is he going to deal with that ? Since his announcement, I have prepared for this by investing in personal names instead of adding more fund into our Family Trust, is he indeed passes the taxing 30% to Trust and not allowing to pass on franking, then I will sell an asset in the Trust, buy in personal name to gain the tax benefit and tax free threshold and leave little in the Trust structure.
As with policy 2, your article explains it very well. by removing franking, it will hurt the low income more than the wealthy. I fully agree with the progressive taxing in super and think that will work well over the long term. If labour does pass this law, again, we can overcome it by investing some assets in REIT, oversea shares or properties and access the franking credit without getting the cash refund as our income from REITs etc will be above 37K and wont get cash refund anyway. This will just simply create a shifting in asset allocation to REITs and properties, which will hurt the economy even more.
In the end, Labor is not in government yet and Bill is not yet the PM, we cannot simply change our strategy based on his proposal, which is not even well thought of…. he is taking a few extreme example of extreme wealthy people and making claims that all SMSF are like that ! he is portraying an image that all SMSF retirees are super wealthy greedy people ripping off the system….this couldn’t be further from the truth.
Just dirty tricks to get votes in and win the next election, yet, he is hurting the low income people even more on his policies. Who is labour suppose to represent again ???
In conclusion, I still think shares is the way to go, I mean Sol patts and all Lics have been around for over 50 years and this franking refundable policy was only implemented in 2000, so worst case scenario, its still acceptable, they still pretty well before 2000 right ? policies come and go, governments come and go but human innovation and economy still ticks along…I would hate to invest in REITs simply because of labour policy but might need to allocate some if they are elected.
So why is labor so stupid, they announced policies that will:
1. make most people worse off
2.people will have many ways of getting around their policies anyway, hence only increase earnings to tax planners and accountants
3. does nothing to make the economy stronger or fix the inefficiencies in the government
4. make the asset allocation shifting more towards oversea companies and REITs and hence hurting the economy even more, also increasing our transaction cost as we need to shift asset allocation
As kerry Packer said, can’t remember the exact words, “when he was a kid, the tax law book was this thin….now its this thick and thousands of pages, yet I don’t see how we are better off or live better”
Jack
Thanks for that Jack!
Agree with your sentiments. It just makes no sense that people will sit there and cop the tax on the chin, when there’s other options out there. And the budget savings estimates would (probably) assume the policy to be 100% ‘money in the bank’ revenue generating.
Super is probably too generous in it’s current form. Until recently, it was obscenely generous. There still needs to be incentive to save for retirement, so a balanced approach is necessary. Using the company tax rate for the higher super balances is a good idea I think. Then it makes no difference whether vast wealth is kept inside or outside super, so there’s little reason for manoeuvring.
I think his idea on trusts is, minimum 30% tax – so you can pass on franking, but there will be no refunds if the trusts beneficiaries are on tax brackets below 30%. So a 30% tax rate applies in all cases as a minimum, making the trust structure less attractive.
Yeah I had to laugh with the story of someone getting $2.5m in refunds. This means they’d have to have around $150m in Aussie shares, paying 4% fully franked. That’d be $6m in income and roughly $2.5m in franking credits. I’m sure there’s heaps of folks doing this!? In the future this won’t happen due to the super caps anyway, so it’s a poor example.
Maybe we’re looking at it too simplistically. But it seems rather obvious…fixing the tax rates for super will have a much larger, and fairer, improvement to the tax take.
We won’t be changing our income approach either, except maybe some tinkering at the edges. Good point on the age of traditional LICs and Soul Patts – been going long before imputation was even introduced in the late 80’s.
Thanks for your detailed thoughts and policy summary 😉
Some excellent points in Jack’s post.
In personal names the full advantage of franking credits will remain under Shorten’s proposal “provided” you have a large enough portfolio. If not then in addition to franked shares invest in some other income sources such as AReits, Infrastructure, International equities and Term Deposits etc to soak up the franking credits that would otherwise be lost. Also consider triggering CGT events.
In regard to LICs they would likely be discounted as a resulted of the change driving up the yield (before franking). Ensure you have some dry powder to take advantage of this.
As for Super there’s also strategies that could mimimise / negate the impact. Easy in pension mode given NO CGT.
In regard to Discretionary Trusts we’re in the process of winding that down as it doesn’t serve any purpose for us anymore. We’ve been taking advantage of strategies to minimise CGT in the process.
As for why Super needs to be atttactive tax wise. Why in the hell would anyone give up access to their money to potentially age 65 or more (likely in future) if there wasn’t a major sweetener in the end! Not to mention the massive legislative risk of the Super environment.
Just like Kerry Packer the Gov’t will never get more than they’re legally entitled to out of us????.
Thanks for sharing Austing.
It’s true, super needs to be attractive – but it’s also where most of the tax revenue is leaking. So we need to find some balance in the middle. Attractive accumulation tax rates, but progressive pension phase tax rates, up to a maximum rate equal to the company tax rate?
The changes will just cause most of us to engage in a new game of optimisation, especially considering the importance of creating the best after-tax income stream we can for retirement (whatever the age).
And yes, I hear you – I don’t feel like ‘donating’ any extra either.
The recent changes to Super will eventually solve most of the problem. Tax free pension capital value is limited to $1.6 Mil. The rest must be moved to Accumulation taxed at 15%. What most don’t realise is that as existing wealthy members (mostly elderly) die the vast majority of their Super will be forced out of the Super environment. So all these large balances will eventually cease to exist.
What is annoying is the lies and propaganda being used by Shorten who is intent on indulging in class warfare. This sort if thing can destroy countries. It’s why in recent years I keep banging on about “home country” risk and why we personally have been steadily increasing our exposure to International equities.
When the wealthy are no longer welcome and treated like scum they take their money elsewhere.
Good point on super caps. I think I mentioned that briefly?
So it passes to the heirs which means re-entering the taxable environment, that’s interesting. I agree, some of the examples he’s spitting out were utterly ridiculous!
Something we all have to think about – it’s a sad outcome if people are effectively discouraged from saving, investing and starting businesses. As for international shares, it’s still a long term goal for us – not on the cards soon due to income requirements obviously. But if the investing environment changes for the worse in Oz, then our future allocation to overseas shares would likely increase.
I think your final point is important – it’s hard to tax wealth if it leaves the country!
I advocate for a fair tax system, otherwise why put in the hard work in saving and investing ?
I believe the current tax system is not wonderful but fair to an acceptable level.
If you want people to not touch their money til they are 65, then of course you need to give them incentives to do so!
If you tax company profit once then there is no reason to tax them again.
If they are going to introduce new policies then the existing should be honoured, eg. When they introduce capital gains tax in 1985, all assets bought before then are exempted from cgt. This is fair. However, it’s not fair and unreasonable if they have policies set up and then after you put in the effort/resources changes again, this is called manipulation and very unreasonable.
Absolutely. It’s fair, but perhaps a little too generous. Lower tax rates for low/middle earners is a fair argument, as that’d probably stimulate more spending which would be good for the economy – and the money has to come from somewhere!
That’s a good point – grandfathering makes it more acceptable for those affected while promoting stability as well, as it avoids people dumping assets, whether shares, property, whatever.
Hopefully good sense prevails, but we’ll just have to wait and see I guess 🙂
Excellent comment written by motley fools
https://www.fool.com.au/2018/03/16/why-shorten-is-wrong-and-right-on-dividends/
Cheers for link. Yeah I read that earlier today, summed up perfectly, with a better example than mine!
Excellent post Dave. I happen to read the motley fool one first but you both have expressed the situation very well and on the same page.
I have read plenty of forum posts in recent days and from these (perhaps not a great sample who knows), the “vibe” seems to prefer some more progressive tax scale in superannuation pension phase. As well pointed out on this thread though, it shouldn’t go too far as then incentive is lost to put money into super. There is probably some middle ground here.
The reaction to Labor’s plans so far surely must boost the chances of them doing an embarrassing back flip? It has I suppose given them a chance to sense the public’s reaction well before election time.
It is always good as an investor to be prepared and ponder what if’s in terms of these potential changes and new strategies to undertake. But judging by some of the reaction and criticism to Labor’s plans I certainly wouldn’t go out now and make big adjustments to one’s portfolio.
Thanks Steve. Scott from TMF was probably a bit more concise and to the point though 😉
Yes it’s a tricky balance – super probably needs to raise more tax revenue than currently, but not too much that it deters being a self-funded retiree.
I think the dangerous part is, that some people are buying it! They actually think it’ll trap the rich and help the less well-off. We can only hope there’s more sensible and balanced ideas going forward.
You’re right on strategy – while anything might play out, it’s too early to make changes, probably more a case of having a plan in mind.
I agree with the sentiments in this article. It seems to be very short-sighted of Mr Shorten to think he can target a particular segment of the tax base without distorting other areas. Perhaps he should just stick to bagging out the opposition and try to limp over the line to win the election, that seems to have been his strategy for the last few years.
His proposition seems to be, “The current government is giving a 2.5/10 performance. Elect me and I will give you a 3/10 performance”.
It goes to show that Labor would not know what to do if they actually got in power and it came time to do something positive for the nation – the go-to strategy is just to be negative towards anything the opposition proposes.
I despair at the state of the Australian political system – hence why I try not to watch/talk about it!
But I fully agree that this policy will not deliver as intended, people will just divert their investments into more tax-effective areas.
“People will adjust in their seats until they get comfortable” – Ed Chan
It is unlikely to raise any more tax revenue in total (as you argued above), it will just distort the investing environment. Any changes to the tax system will have to be made across the board to be effective IMO – taxing super at marginal tax rates seems to make the most sense.
The same argument can be made about the proposed negative gearing changes only applying to property. The ability to deduct expenses from income is woven into the very fabric of the tax system. It applies to property, shares, business and any other investment asset you care to name.
It is interesting to see people’s self-interest come out when commentating on this proposed change. People benefiting from franking credits/super seem to be complaining the loudest. Eventually though Australia will have to realize that the current situation is unsustainable. We have had a prosperous 25 years or so, but the once in a generation mining boom has only papered over the cracks. Tough decisions will need to be made if this country is to continue to prosper economically into the future.
Surely the superannuants will need to pay some tax eventually. It is a honey pot worth trillions that the Government will eventually start taxing, and rightly so I think.
It is a hard thing to do, but people need to put their own self-interest aside and try to think of whether the current system is sustainable and in the best interests of the society we are living in. Easier said than done though!
Cheers Dave for sharing another very well written blog post.
Dave
Thanks Dave!
Appreciate you sharing your thoughts.
Agree with your points. Someone suggested making super tax rates slightly lower than outside super, and having a tax-free threshold above the age pension amount, which is a good idea I think – otherwise what’s the point?
It’s true, everyone is biased to some extent. I think we all agree that the super system is currently a bit too generous, but the recent $1.6m tax-free cap improves that a fair bit.
Sadly, not much sensible conversation on long term policies in a way that people can understand – only sensationalised stories about a couple of people to bring in a lazy blanket policy. There’s too much of a short-term focus on winning votes (somewhat understandable), but it’s at the expense of a rational long term plan for people to be pleased about.
I try to avoid politics too Dave for the most part! Plenty of better things to do 🙂
How about a level playing field though.
A pension investor in an Industry Super Fund is unaffected by the change. However a Pension investor in a SMSF loses all franking credits. Shorten looking after his union mates?
Is that true though? I’ve seen varied opinions on what it means for super funds. Does that also mean that accumulation funds are affected?
That’s another layer of inequity again. A tax increase should be fair across asset classes, income levels and across structures like super funds too.
It does appear to be true as long as the fund is a growing one memberwise. That is there needs to be enough members in Accumulation relative to pension members. Most industry funds (union run) fall into this category.
I see – thanks for that. So it’s a mess for those with SMSF, but fine for industry funds…jeez!
Enough to drive a man to drink. As if I need an excuse????.
It seems a bit reminiscent of “Yes, Minister”
Perhaps Bill’s made a nigh-outlandish proposal with no intent on that being the end state. Then he pegs it back to a more reasonable alternative that actually might work. If he goes straight to the reasonable change there will be more blowback from those most affected (the wealthy) than if he proposes the draconian tax grab to start with and works backwards.
Too cynical?
Haha not at all cynical, probably quite realistic. I guess most policies are diluted in the end, so perhaps better off going over the top to start with, then finally wind it back to where you wanted it in the first place.
It’s so stupid how they are willing to cut out franking credits but then reduce the corporate tax rate. Why not just leave the system how it is. Government in Australia are trying to encourage and discourage investment at the same time. Who let the politicians control the money?
-Money Professor
I didn’t think of it that way before – certainly strange. Because if they lower the corporate tax rate, then franking credits are naturally lowered as well. Shareholders would likely receive the same dividend income due to higher company profits, so there’d be no harm done.
Who knows what’s going to happen. Hopefully good sense prevails, rather than a sledgehammer approach.
Lots of reading here We have a smsf of $700,000
$600,000 in fully flanked shares and $100,000 in a term deposit we generate around 7.3% pa
My question is would we be better off if we closed the smsf and claimed the SAPTO THUS probably paying no tax
Sorry Kerri, I can’t answer this one. My knowledge in that area is close to non-existent!
Hopefully another reader can chime in, who might be at a similar point in life and done the research on it…
Need to wipe the board clean and start again when it comes to our political system. Too many corrupt bureaucrats indulging their own self-interests. They are meant to be doing whats best for the country and seem to be driving it further into the ground.
I know John Howard wasn’t the bee’s knees but he left the country in a better position and with an actual surplus to use. Then Labor came in spent all the money and now look at our level of debt. It doesn’t seem to me like the politicians should be in control of the countries money. They don’t know how to make it and they certainly don’t know how to spend it.
I wonder what would have happened if they took that surplus and invested it and let compound interest to do its thing. Then they could use interest from the billions of dollars invested to do what they need to do. I haven’t got a strong grasp on politics but I would assume it would be much better to have a scenario like this where essentially the whole country is self-sufficient and self-funded. Not robbing people and companies of their hard earned money.
Since we are leaving Packer quotes I’ll leave my favorite. I tend to agree with him wholeheartedly.
“I’m not avoiding Tax in any way, shape or form. Now, of course, I am minimizing my tax and if anybody in this country isn’t minimizing their Tax they want their heads read because as a government I can tell you-you’re not spending it that well that we should be donating extra.”
Howard wasted billions through tax cuts (in inflationary periods too!). The only reason he left a surplus was because he presided over the best economic conditions Australia have ever had, plus he sold off our gold reserves (at an extreme low) and Telstra. In terms of the country’s wealth, howard/Costello left us in a far worse position than what we could’ve been in.
Labor had this little economic hiccup called the GFC. You might have heard of it. Their response saved Australia from a recession, unlike what the rest of the world did.
Labour also created I think it’s called the Australia fund. This has billions in it to pay for future debts the country has (namely cushy pension schemes for ex public service officers).
What has happened is the spin doctors have convinced you of what you believe. Did you know that Abbott/Turnbull have doubled labor’s debt in the 5 years they’ve been in office?
The fact is though, we don’t have a debt crisis, nor an unreasonable level of debt. It’s manageable, and will come down as the economy picks up. Further, governments have obligations to spend money. If they “invested” the surplus we had and ignored the GFC, we’d be in a world of pain right now. Check out Greece and Portugal. They’re basket cases.
Lastly, robbing people and companies? Tax is used to pay for handy things like roads, health, education, transport. Those things that make society possible. The things that make companies able to operate, without which, people wouldn’t have jobs or money. And we’d all be running farms and hunting to survive.
Not to say that the pollies are perfect, but we really don’t have it too bad. Time to be grateful for what we have, rather than feel entitled to what we don’t.
I think the issue is that the infrastructure has not been invested in properly. So there is a double hit of the requirement of more infrastructure spending required in a time where the deficit has been run up.
Great article Dave.
I think you have really nailed the issue. This should be a debate about tax rate equality rather than dividend imputation. I think that the Shorten / Bowen announcement was clumsy and they would have gained more traction by proposing a progressive tax scale within the pension phase of super. Looks like the resistance will come from the newly formed “Alliance for Fairer Retirement” . This alliance is top heavy with super industry representatives which you can understand. So lets hope that they can negotiate a compromise along the lines that you have put forward.
The thing that caught my attention at the time the policy proposal was released by the ALP was the estimated $59 billion savings over the forward estimates. According to Chris Bowen, these savings were based on data drawn from the 2014 FY. Someone should have told him that the Coalition’s 1 July 2017 changes (super balance caps) render this data source redundant.
Thanks Stephen.
Yes I wonder if anyone has pointed that out to him. I suspect they wouldn’t really care, they’re simply making it up as they go along, then back-peddling once they realise some of the unintended consequences.
Most of the excesses will now be reduced going forward as you point out, the bulk of the savings achieved without hurting the genuine lower income earners.
Hopefully common sense prevails and a more reasonable policy will come forward 🙂
The Proposed policy by Labour was a clumsy attempt to smash Do It Yourself Super Funds and force these people into Industry Super Funds who have been exempted! Transparently these Funds through Directors who are the Union Reps. on the Boards donate their Fees to the Unions who then bankroll Labour. So blatant and yes irrational, as a person who does not claim a Pension and does all their own administration of their personal fund will be charged approximately 20 times in Fees than what they now pay if they go into an Industry Super Fund which of course has members with much greater Super Balances than people who have a DYSS! The whole proposition is so illogical and unfair it simply advertises once again the Labour Parties lack of Financial Acumen!
My last comment did not include my complete email
That’s a fun conspiracy theory. So we should ignore the billions of dollars it saves the budget which is given to wealthy retirees?
On a serious note though, could you elaborate on how it will force DIY super funds (I take it you mean SMSF’s?) into industry funds? And how industry funds are exempted from these rules?
Yes, as I understand it, the proposal is people in regular super funds in pension phase will still be entitled to franking refunds
It’s nearly 12 months old this article and I’m wondering if things have changed. It’s starting to hype up in the media about the franking credits especially in the pensioner area, the more it’s discussed in the (media, social media etc) the more confusing it’s getting. My wife and I are not retired, we are mid 50’s and are earning approximately $8000 from dividends, will it effect us much if labor get into power. I know that’s a difficult question but I’m sure we are not the only non retirees in this situation. Cheers and thanks.
Hi Don. Actually almost nothing has changed. The proposal is basically the same, it’s just chatter. The only difference is it’s getting closer to a possible change in govt making it happen (or not).
If you earn $8000 from dividends, but you’re still working, it’ll likely have no effect on you. If your personal tax rate is 30% or higher, you won’t notice anything – franking credits will still be used to reduce the tax you pay on dividend income. But if you’re receiving franking credit refunds at tax time, then you’ll lose that. If you were retired and paying zero tax, you could lose around $3000, but still not have to pay any out of pocket tax on the dividends you receive. Hope that makes sense!
Thanks mate, so what if you were under %30 tax rate. We don’t pay tax on the first $18200, I work in the health sector and an salary package $16000 this is tax free, so then I’m only paying tax on approx $27000. One step at a time, I’ll see what my accountant says at tax time as well. Any prior advice is more than welcome. Thanks mate, love your article’s.
Thanks very much Don!
If you’re under 30% tax rate, then you’ll simply be able to keep your cash dividends that you get already, but no refund. As an example, if your Aussie shares are yielding 4%, plus franking credits making it 5.7% gross – you’ll now clear 4% after tax. If the figure of $8,000 you told me is cash dividends, that will stay the same, but if that includes the value of franking, then it’ll go down.