Hundreds of people have written to a parliamentary inquiry into the removal of refundable franking credits to describe their personal situations. The inquiry may be under a cloud after Liberal MP Tim Wilson was criticised for partisanship, but there is genuine anger among retirees.
If it wins the next federal election, Labor will make franking credits non-refundable for everybody except those covered by a “pensioner guarantee”. The guarantee means recipients of government allowances (of the type paid by Centrelink) including the age pension and disability support pension, will continue to receive refunds. SMSFs with at least one member in recipient of such an entitlement, as at March 28, 2018, are also exempt.
There will therefore be two types of SMSF – those with access to refunds and those without, as the example above demonstrates. At the same time, people with their super in large industry and retail funds will largely be sheltered.
This is because those funds have lots of members still paying tax and can therefore make full use of tax offsets (a franked dividend only delivers a refund in the hands of a shareholder when his or her taxable income is low or zero).
The Financial Services Council estimates 2.6 million regular super fund members will be affected. Unquestionably, though, SMSFs have been singled out for punishment.
They typically only have two members and if both are in pension phase they have no tax liability to offset. Their credits are effectively wasted. And unlike self-funded retirees who derive income from share portfolios outside super (are in receipt of a pension payment and therefore covered by the pensioner guarantee), SMSFs moving into pension phase after March 29, 2018, will be prohibited from receiving refunds.
“Australians will be treated differently depending on whether they save through an industry or retail super fund, a self-managed super fund, or save outside super,” the Alliance for a Fairer Retirement System says in its submission to the inquiry. The alliance is comprised of a range of peak bodies for SMSFs, investors and seniors.
Rice Warner chief executive Michael Rice says another fundamental inequity will be between people who get good advice, and those who can’t.
“The policy will create two classes of taxpayer – those who alter their arrangements or receive appropriate financial advice to restructure their affairs and those who do not have the means or financial sophistication to do so,” he says.
While it is true that more than half of franking credit refunds go to SMSFs with more than $2 million in assets, Caputo says it is people lower down the income scale who will be hurt most.
“The impact of this policy change would be most felt by the self-funded retirees who have saved to build their superannuation to, say, $1 million,” she says.
“These retirees wouldn’t qualify for the age pension and are likely drawing between $40,000 and $50,000 from their super, which would be providing a basic level of living, nothing luxurious. For them, the loss of refundable franking credits would have a big impact on the annual return of their SMSF.”
Many observers say people with more than $1.6 million in super will be less affected by the change because new caps will have forced them to move some of their money back to an accumulation account, where it is taxed at 15 per cent. Franking credits can be applied to reduce this tax liability.
“The different tax outcomes arising for taxpayers in a similar situation, depending on the circumstances of the superannuation structure they are using, highlights the significant underlying problems with the franking credit changes being considered,” accounting firm Pitcher Partners says in its submission to inquiry.
“Our expectation is that more wealthy investors will largely be able to mitigate and eliminate the tax cost to them of the franking credit changes by investing in alternative assets targeting unfranked income.
“Smaller investors will be unable, or will not be in a position, to understand the benefits that a restructure out of Australian company investments may provide.”
There are other inequities too. Caputo compares single homeowner Bill, who is on an age pension and invests in his own name, with Anita, who has the same volume of assets but holds them in an SMSF. Given she retired after March 28, 2018, she is eligible for the pensioner guarantee. In this example, Anita is worse off simply because she has chosen an SMSF.
“Strangely, people who become pensioners after March 28, 2018, may be better off owning assets personally, which seems to go against the grain of building up a super balance for your retirement,” Caputo says.
It must be said that there is a lot of water to flow under the bridge before the changes take effect. Labor must first win the next federal election, which will probably take place in May, and then get its policy through the Senate.
While retirees have been busy telling the inquiry that they plan to sell down their assets to qualify for the age pension to supplement their lost income or shift into other assets, financial advisers urge extreme caution.
Caputo says Australian equities will continue to be an attractive investment option because their yield is still higher than that available with other asset classes, including international shares, direct property and term deposits.
“We are currently in a low-income environment in all asset classes except Australian shares, which remain attractive with a yield of around 4.5 per cent before franking credits,” she says.
“With 10-year Australian government bonds currently yielding 2.1 per cent, this is a good indication that term deposit rates are likely to remain low.
“Similarly, other asset classes like direct property and international shares are also yielding less than three per cent a year.”
One possibility is that investors are more attracted to high-yielding property assets or listed infrastructure, Caputo says.
Investors might also consider adding their children as members of their SMSF. “Increasing the amount of taxable contributions earned by the fund would be a way to utilise more franking credits,” she says.
But the drawback to this strategy is that it would be difficult for the fund to tailor its investment strategy to cater to members of varying ages.
“For example, the income and growth needs of parents in pension mode would be vastly different to a 30-year-old looking to build up their super.”