Steps SMSFs may take to beat Labor’s franking

Any comment about some insight provided by James Kirby (recent article in The Australian) that pooled investment structures like retail and industry superannuation funds and platforms like Netwealth may in fact NOT be able to pay franking credit refunds to members in pension mode as previously thought?

He argues that there is a conflict of interest due to the fact that all superannuation members must be treated equitably. “Taking” from those in accumulation mode to give to those in pension mode is disadvantaging some over others and may breach the rules.

If this proves to be the case the exodus from SMSFs to pooled investment vehicles in the hope of keeping franking credit refunds will be a futile and costly exercise!

Hi James

We have had several comments on this issue on this site. Ultimately, it will depend on the decisions of the trustees of any super fund, but we also have articles from AusSuper and CFS confident the franking can be paid. So there's no final word yet.

One thing that concerns me about Bill Shortens policy on franking credit refunds is he being hypocritical. Will he be the recipient of franking credit refunds within his extremely generous parliamentary retirement package when he retires. I asked him this question by email on the 7 March 2019. To this date I have not received a reply from him or one of his most capable staff.
My query was specifically to Mr Shorten and whether or not he would be entitled to franking credit refunds within his superannuation fund when he retires from politics. Is he a member of one of the select funds that would be eligible to receive franking credit refunds?
If he is eligible for franking credit refunds within his retirement package from politics, then this would be hypocrisy at the highest level.
This was a very simple question to answer, yet with a lack of reply from Mr Shorten or his office staff, I can only assume that this may be correct. Is he hiding the fact that he will receive what he wants to deny self-funded retirees.

If you have your assets managed by a union aligned super fund you will receive franking credit refunds. If you don’t you are penalised. It rewards politically aligned unions at the expense of voters of the alternative party(s).
In closing I would say to the likes of the Darrell Campbells out there who say we are whingers and well off people as you wish to believe. The majority were hard working and diligent and not looking for handouts like some people. We receive nothing from the government except franking credit refunds, which in most cases are a lot smaller than if you are on a combined pension of around $36500.00 plus, plus, plus your concessions on rates, water, car rego, phone, ambulance and your energy concession. You can fill in any other concessions or benefits that I have forgotten or do not know of thank you Darrell. We also often pay more for some medical services than pensioners do. This would equate to a pensioner receiving $18000.00 to $30000.00 from government WELFARE than self-funded retirees receive in franking credit refunds. I did not waste my money at the pub, TAB or on cigarettes. If you are in the position where you are justified in denying self-funded retirees because they have tried to do the right thing, and not be a burden on the government for handouts. Then state your ‘position’. The majority of the working public are in a position to better themselves in retirement, but some wish to waste this opportunity and then expect the WELFARE and all the benefits that go with it, and then WHINGE about other hard working tax payers who helped support your lifestyle.

If the cost of maintaining franking credits for smsfs is so much as to make it impossible to continue, then in terms of equity, what is the revenue forgone in not applying the new rules to industry funds and not for profits?? In terms of equity, this selective disallowance is outrageous.

The proposed ALP new rules apply equally to both SMSF's and retail and industry funds. If a retail or industry fund had the large majority of its members in pension phase they would also lose franking credits.

One option is to add super fund members who are not in pension phase and another is to change your asset mix.

The real issue is asset allocation of SMSF's. Most retail and industry default funds only have around 30% of their investments in Australian shares. The remainder is in international shares, bonds, fixed interest, real estate trusts and Infrastructure none of which carry franking credits.

Most SMSF's hold too much investments in Australian shares anyway. Australia is only 2% of the world's share markets and yet many SMSF's have over 50% of their assets in Australian stocks or businesses.

I have given the loss of franking credits much thought and my approach for my SMSF will be to increase holdings of REIT's, international share trusts, growth focussed Australian share trusts, and hold some cash of course. LIC's will be no good for me as franking credits will not be refunded. In pension mode a pension can be paid out from the cash balance and income from the REIT's and trusts & if/when the cash is depleted, then I sell a tranche of the growth trust paying no capital gains tax.

Ed - similar to Ross, I gave up with AusSuper "thinking about" LICs/LITs and moved my funds to ING Living Super DIO which is about as flexible as I can find and allow corporate actions (buybacks, etc). They still have limits (i.e. specific %ages you can allocate to a specific share etc) but not too onerous. So far I'm fairly happy. I'm not sure if / how they allow advisors to participate though (suspect not) ....

I'm not sure why the focus is always on what Australian Super does by way of direct investment options.

There are retail direct investment options, both in and out of super, which do not restrict you to 80% of your funds in equities - go 100% if you wish, and which have an expansive list of LICs to choose from if that's your game, and which probably cost less overall.

Yet every article is about the Australian Super option?

Hi Geoff, yes there are retail direct investment options, but as CFS has said, they may not be able to pay their franking refunds due to the large number of pension assets in the pool. See this article:

https://cuffelinks.com.au/not-all-public-funds-same/.

AustralianSuper has told the market that with its younger clients, it will be a tax payer. Any other fund is welcome to write an article and reveal their position and we will publish it. We can only publish what we receive. G

Hi Graham

I must be missing something here. My reading of the direct investment option in an industry fund is that currently the dividend and the tax credits are paid into your account and you get the refund of those tax credits if you are in pension phase. If the Labor proposals are adopted, those refunds from your account would stop. How is that different from the current position in an SMSF?

Wayne

Hi Wayne, the crucial point is that Labor is not abolishing the use of franking credits, it is removing the refund of excess franking credits. Any taxpayer who pays tax can still use the franking credits.

A retail or industry fund (with some exceptions for wraps) is a single taxpayer. They pay tax on the contributions received from members, plus earnings in the accumulation phase. Therefore, there is taxable income which can use the franking credits. A single SMSF is a unique tax entity. If its members are in pension mode and not making contributions, there is no tax paid to use the franking credits. At the moment, in an SMSF in pension mode, a refund of the excess is received even if not tax is paid.

When will the franking credit (SMSF) whingers shutup and acknowledge that they are a group of well-off people who are not "battlers who have struggled to save". They have done well out of Govt Concessions, and who are receiving excess WELFARE franking credits. It is not rocket science...
Imputation means no double tax on dividends. You will still get this under Labors policy. This is what Imputation was meant to do.
This is all on the basis that the Govt gets 30% of company tax on profits, and shareholders get 70%. And the SMSF whingers want part of the 30% as well.
And even $10,000 in franking credits, means $600,000 in shares, and therefore probably $1m in SMSF. And we are supposed to shed tears for them??

"Govt Concessions":

There are no tax concessions, just taxes.

"receiving excess WELFARE franking credits":

Like employees are receiving 'excess WELFARE' when they receive a refund of over paid wage tax?

Where the 'excess WELFARE', aka franking credit refunds, come from:
https://cuffelinks.com.au/franking-credits-made-easy/

"Imputation means no double tax on dividends":

Imputation and refund of 'excess' franking credits results in income being taxed at the recipient's legislated tax rate - taxed once.

Taxing 'excess' franking credits at 100%, by not refunding them, is double taxation.

"Govt gets 30% of company tax on profits, and shareholders get 70%":

Should government get 30% of a worker's wage and the worker get 70% on which they then pay tax? Or should the 30% wage (withholding) tax be imputed to the worker?

"probably $1m in SMSF":

Leaving them not entitled to the savings and risk free Age Pension ($36k) and with a risky and lower income than Age Pensioners ($10,000 / 30%) = $33k.

I could get really angry about a comment like Darrell's, but I'll stay calm.

Let's just debunk one of the falsehoods in there. $1mn is not enough to make someone rich. This is 2019, for goodness sake, not the 1960's when Old Jed became a millionaire and moved to a mansion in Beverly Hills!

Someone who's been earning average weekly earnings for the past 40 years, who invested their super contribution in a growth option fund, would have somewhere between $1 - 1.5 million in super today.

Ordinary average earners.

Someone earning less than average could also have accumulated up to $1mn.

This is why the cap on tax free super was set at $1.6 million - it's just beyond that amount that long term savers could have accumulated.

We're not talking about people who got paid a million dollars one year and dumped it into super! We're talking about people who've worked for decades and saved to get to the point where they can fund their own retirement.

These people have EVERY RIGHT to keep on arguing their case that they shouldn't be shut out of the process of integrating the company and personal income tax systems.

Warren, to debunk your unqualified opinion above, less than 1% of super balances are above 1 million dollars (source: Aust Institute of Super Trustees).

Phillip, that does not debunk anything.

Someone on average earnings could easily accumulate $1mn in super over 40 years. Whether a lot of folk have or not doesn't change that mathematical market fact.

Let's try another tack. If you have $1mn invested then you will earn an income on that at current interest rates and dividend yields of around $40,000 - $60,000. That does NOT make you rich.

There may be low super balances because people haven't been saving for 40 years. Or they've also put money into property.

The average household wealth in Australia is close to $1mn (it was A$575k per adult in mid-2018).

Would you like any more 'qualifications' to my so-called 'unqualified opinion'?

People arguing their case on this point are not whingers who should shut up as Darrell said in the comment that got me started here, but are quite average Australians!

How about we all try to engage this issue in a much more respectful and dignified way than telling people to shut up?

I think the point Phillip is making, is that the average income earner does not have 1 million in super. I fact checked the AIST and indeed only 5 out of 1000 superanuants have a balance over 1 million. Around half of 1 percent. Your mathematical market fact has no relationship to the real world average wage earner in Australia. On your assertion regarding why the cap on tax free super was set at 1.6 million, please provide some qualification of this claim.

. "could easily accumulate $1mn in super over 40 years",
. "does not have 1 million in super":

The two are readily reconciled. The first is in the future tense. The second in the present tense.

For a couple to exceed $1.5M in super over 40 years requires (as examples):

. contributing 2 * $25,000 per year which is 28.9% of 2 * 52 * 'Full-Time Adult Average Weekly Total Earnings' of $1,666.20 and earning 0.0% real yield and having paid 15% contribution and earnings tax,

or,

. contributing 1 * $25,000 per year which is 14.4% of 2 * 52 * 'Full-Time Adult Average Weekly Total Earnings' of $1,666.20 and earning 3.2% real yield and having paid 15% contribution and earnings tax

I consider both easy; many would not as it requires saving slightly more than is common.

$1.5M would put a couple only slightly above the Age Pension SweetSpot income of $54k so is debatable if worth attaining.

“The two are readily reconciled. The first is in the future tense. The second in the present tense.”. The numbers on the average wage calculation have zero relevance to warrens claim “someone who’sbeen earning an average weekly earnings over the past 40 years”. Another unqualified opinion does not debunk the AIST fact check.

(This, dear people, is my final comment on this issue. I've written articles and made comments galore since it was proposed. Nothing that its supporters are saying is new - I've responded to every argument several times already. The attitudes towards those who are going to be hurt by this change has been sickening at times and I grieve for the quality of policy debate in our country when I read such remarks as the one that kick started this particular thread of comment. I've got one more thing to say on that, so here goes ....)

Sorry, Greg, I wasn't saying that the average person HAS that much. My point is that those who do have $1mn have gotten there simply by investing in super for 40 years from their average earnings in a growth oriented option.

If we're now defining someone as 'rich' simply because they're part of a rare breed of people who've actually taken advantage of the super system, then that's a very sick situation. It means that as a society we're saying to average people, 'you've been provided the incentives to build a nest egg so that you don't have to draw on the pension in your retirement, but now that you've done that and others haven't, well that makes you a rich bastard and we're going to slam you for it."

The real world means that most people have put money into their homes. The average net wealth in Australia is more than $1 mn per household. My point is that having $1mn in wealth - in super, houses or whatever - does not make you rich. It's average these days!

Folk who have been in the genuinely upper income categories their whole lives have much more than $1 million in assets. It's right that they pay a more normal tax rate on their investment earnings. Hence the $1.6 million cap for tax free super - far from a perfect way of handling things from a policy perspective, but at least the line in the sand is clear.

And to answer the question about that cap, the whole debate in 2016 when it was introduced was about where the line should be drawn to define those who should benefit from the social contract to encourage saving for retirement and those who had simply taken advantage of excessively generous provisions. The Budget overview for 2016-17 said that the cap was introduced as part of a package of measures that meant the system was "better targeting superannuation tax concessions to support working Australians build independent wealth for their retirement." That is, ordinary folk should be able to aspire to build up to $1.6 million in super and those who already had were not regarded as 'rich'.

Let me finish by getting back to the original reason why I wrote this in the first place. Darrell Campbell made an inflammatory comment demanding that people shut up, calling them whingers. That's unacceptable as a contribution to the debate in my view, both in terms of fact and also in terms of the abusive tone of such remarks.

I'm not going to be hurt by the changes personally. Nothing I've written on this topic has been motivated by any personal desire to stop a tax change that affects my financial situation. I've been writing from the point of view of what makes for sound policy making. I get very annoyed when others don't try to do the same and make the sort of comments that Darrell did.

The franking credit refunds change is bad policy, pure and simple. I've said why many times and in many ways. I've read nothing that convinces me otherwise.

“The numbers on the average wage calculation have zero relevance to warrens claim “someone who’s been earning an average weekly earnings over the past 40 years. Another unqualified opinion does not debunk the AIST fact check."

The calculations show that it would have been possible to arrive at $1.5M in super. Those average earning households extant for 40+ years which have not chose not to despite it being a mathematical possibility. This using current more constrained contribution caps.

Further: ($86,642.40 - $25,000) [gross income] - $12,208.26 [income taxes] = $49,434.14 [net income]

Rubbery numbers debunk your calculations again Dudley. Fact: 80% earn less than the average gross wage used in your calculation (source ABS). Your mathematical formula already precludes 80% of all wage earners from obtaining the super balance you state. Your calculation for the remaining 20% is still incorrect as you haven’t used the correct historical average wages and tax rates. I guess this is why 5 out of 1000 superannuants have a balance greater than 1 million.

"Rubbery numbers":

Same result using actual Average Weekly Ordinary Time Earnings (AWOTE) from 1979 to 2019 ( https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=40 ) and 32.5% tax rate.

Save 22.63% of gross AWOTE income, inflating at 4.99% compound, for 40 years with an investment yield of 2% greater than wage inflation results in $1M in 2019 money.

The only requirement for saving $1M is an average wage or more and an above average saving rate.

Darrell - if you think you know what imputation was meant to do, then I suggest you look the word up in a dictionary. You do not understand what it was "meant" to do at all, I'd suggest.

Darrell,
Assuming you think your government funded centrelink pension is not WELFARE and that you have worked longer, harder and contributed more to society than SMSF members

It is the bit they don’t tell that you that have to worry about. Matthew has forgotten to mention that the trustee of the industry fund owns the shares – not the member. They let you think you own the shares in the self-invest option, but you don’t.

This is evident in the fine print and also from the fact that the franking credit is paid to your account on the same day as the dividend. Clearly the franking credit is not being paid from a tax return which would only happen after the end of the financial year.

As the trustee owns the shares and not the member it explains why these shares can be sold without the members knowledge or consent, eg. if insufficient money is held in one of the managed options to pay the regular pension. It also means that the member does not automatically benefit from share ownership – eg. buybacks.

The “dividend’ is actually paid by the fund, not the share registry, and the “franking credit” is also paid by the fund, not the ATO. The reason the fund does this is because the self-invest member knows their “entitlement” to their franking credits whereas members invested in the managed options have no idea what they are invested in, or their entitlement to any franking credits. But this arrangement depends entirely on fund policy, not legislation and so it can be easily changed.

Finally, there is no advice - you are on your own. You take all the risk of the investment decisions and the fund accepts no responsibility for your investment outcomes. You are even charged extra to use you own stock broker. The rationale is simple - if you need assistance you should invest in one of their managed options and that is their preferred outcome because that is where they charge their high fees. This arrangement seems to be designed for people who may want dabble in shares, while leaving the bulk of their money in their managed options. What if you want to run a large portfolio this way?

Note that under Labor’s proposal, franking credits can only be used to pay tax, there will be no refund for excess credits. Why then, are some credits refunded to you in the self-invest option? Does that mean that other members of the fund are paying more tax? How sustainable is that?

One has to ask what happens when the fund is overwhelmed by large numbers of people from SMSFs seeking to keep their franking credit refunds? How sustainable is this generosity? Remember, all it takes is a change of fund policy – not legislation. By then you have closed your SMSF. Will you take the bait?

For those seeking ongoing advice, Superannuation wrap platforms have the ability to inspecie transfer direct holdings and some managed funds from smsfs without incurring brokerage.

Wrap structures are also allowed to refund franking credits the same way industry funds can.

Worth analysis as some admin/advice fee structures are competitive with industry funds plus you get advice

Great post Jon! Some very valid points and not so obvious considerations brought to light, thank you!
The grass always looks greener, but if everyone moves to that paddock the franking credits dry up.

Buyer beware!

Adam, you say:

“Wrap structures are also allowed to refund franking credits the same way industry funds can.”

How is that so? Are you saying that an investor in pension mode can still get franking credits because other members in accumulation mode in the “master fund” are paying investment tax on their holdings? Seems improbable to me. A genuine question.

Mark, an explanation of which public funds (including wraps) will refund credits is here:

https://cuffelinks.com.au/not-all-public-funds-same/

'There will also be a period where investments will be ‘out of the market’ during the transfer process. This process may end up taking a couple of weeks.'

A suggestion that may partly alleviate this timing 'risk':-
If you have some spare cash, move this to the industry fund first, then sell down one SMSF holding at a time and buy the same holding within the industry super fund on the same day. Transfer the cash proceeds from SMSF to industry fund and when it arrives, repeat the process.
Obtain advice first because I am an amateur.

Why would I do anything with an industry super fund? Shorten is bringing in this legislation to force us all into a union based super fund. Then he has more money, more power.

Thanks for the analysis,

Further in the Upfront cost, if the individual is under the age of 60 Capital Gains Tax would also need to be considered.

Thanks for your comment RJM. I hope my comments below provide some clarification.

Depending on circumstances and year of birth, some individuals can / have commenced an account based pension between the ages of 55 - 60.

Asset held with in an account based pension can generally be sold without any capital gains tax, regardless of a persons age.

As always, this is general advice and you should seek professional advice before undertaking a transaction like this

Hi Matthew
I have read your article and Tom Garcia's and I feel this is still not clear.

If Australian Super is taxed at an entity level and then directs franking credits back to the Aust shares section of the Member Direct area, this is just saying those members can use the credits to offset tax, what is not at all clear is whether someone in the account based pension phase gets a refund of those credits or not.

Based on your example above, using $1m, for someone 100% in an account based pension, who puts 80% ($800,000) of their funds into the Australian Super, member direct area and invests it 100% in Australian shares - will they get a refund of franking credits back into their member account, yes or no?

Thanks

Hi David and Carlo

Here is the most comprehensive explanation I have seen, among our White Papers.

https://cuffelinks.com.au/cuffe-article/labor-dividend-imputation-announcement/

Just to clarify my understanding :
It is the remaining tax credit , after tax on concessional contributions (15%) for that year is subtracted, and which I would previously get refunded, which is being proposed to be eliminated, is it not ?

Thank you for your straightforward step by step plan for putting some of one's monies from SMSF into an Industrial or Retail fund. However, it still sticks in my gullet that us retirees mainly, are picked on by this despicable policy, while others will continue to reap the full benefit of FCs. Also I am quite leery about putting money into super funds, where personal control over investment is lost, often investments offered are limited and fees can be so easily increased.

What is more is that it is quite evident that Labor will not reap the bonanza it is hoping for, since shares sold by those who lose the benefit of refundable FCs will be bought up by those than can make use of them either to offset taxes or to reap the extra cash. So the end result for retirees is more than likely a greatly reduced income, total disruption of investment plans which will always incur extra costs, stress and angst, while union funds, charities etc will reap all the benefits. The government will gain very little. I just wonder if the discriminatory nature of the policy can be challenged in court.

If Labor's policy comes to fruition we intend to move more of our SMSF monies into corporate bonds. We have already been doing this for about the last five years and find a reasonable return can be obtained, especially if focusing more on buying new issues and selling before maturity, if the price increases, which it generally does. So far we have done quite well, but of course, the higher the coupon rate, the more risky the bond.

What about the over 65s that have got health care cards that where grand fathered upto and on Dec 31st 2014 for holders of SMSF? that card is worth thousands of dollars to some retired SMSF holders depending on health problems they may have and calculate its worth about $2,000 year to me....they would loose that health care card if they changed to an account based pension. Best option in my opinion is to put your children in your SMSF up to max 4 persons per SMSF under Labor or buy unfranked growth shares or overseas shares.

Grand fathered pensions, which are exempt from the Health Card assets test, are certainly an issue for some. Your comment is confirmation that a person should get advice before entering a transaction like this. As I said in the article, I only "scratched the surface" of the issues to be considered.

To your comment in relation to children joining the fund, this will work for some in my view. However, issues such as who will control the fund along with estate planning, should be considered. There are a growing list of legal disputes between estate beneficiaries involving superannuation.

I’ve used the Direct Investment Option of a couple of large industry funds for a few clients over the last couple of years. My main criticisms are:

– the lack of an adviser transaction portal. All trades need to be done by the client logging into their online account. You first need to move money to the DIO and then (generally) the next day you can trade. Most clients would prefer the adviser just make the trades as some clients can be a little nervous when placing trades as it can be a bit foreign to them. Normally I’d have the client with me and we’d do it together, but sometimes it’s not convenient for the client to see me two days in a row to place trades so we can’t necessarily buy when we want to; and
– when contacting funds for updates on client portfolios they’ll quote the total invested in the DIO but not provide the breakdown (eg number of shares etc) which seems a little crazy (as an aside, the discussions with one particular fund suggests only the client can sell assets within the DIO, so we’re not 100% certain what would happen in the event of death of a client in terms of transacting. The DIO guide of this particular fund was very light on the detail about that situation).

Other than that, for the clients that are seeking direct equity/ETF/term deposit exposure the DIOs of some of the big players are normally ok to deal with.

There’s a couple of other large industry funds that I wish had direct equity capability – hopefully soon.

I’ve been speaking to a number of clients already about what we may need to consider if the ALP’s franking credit changes become law. Clients certainly appear to be appreciative of the fact that we may have a solution for being able to retain some of their franking credit refunds. We do however wonder if the revenue the ALP is banking on will be received (we tend to think that the discussions we’re having would be replicated around the country so the revenue is likely to be a fair bit less than expected).

Interesting times ahead.

They are really good insights Mossy. I have had some general conversations with industry funds on this issue. They have indicated that not a lot of resources have been invested in direct investment options in the past because they haven't been that popular. I wonder if this will change. Perhaps adviser involvement will become possible.

Paragraph 37 onwards of the APRA circular below may be of interest as it discusses issues relating to an APRA fund managing member choice.


https://www.apra.gov.au/sites/default/files/superannuation-circular-ii-d-1

i did this 2 years ago when I was unhappy with my SMSF advisory group and I can vouch for it. It has the additional advantages of accessing some asset classes that are hard to get to such as unlisted infrastructure, unlisted property and alternatives. You can do this by levering the fund's various model portfolios eg balanced, conservatively balanced etc. I am in pension mode so rather than wonder how I can generate the majority of my income I apportion a large chunk of the pension fund to one of these portfolios. Another advantage is the ability to tilt the growth/defensive leanings by swapping from one model to another without having to incur broker fees and choosing new assets. I use the direct investment option to try and gain extra alpha (and some franking credits if required). The biggest disadvantage has been the lack of LIC/LIT access (only 4 local and NO global stock LICs) and a small number of ETFs (no access to thematics like NDQ, ROBO, Healthcare etc.). The addition of access to more growth oriented LIC/LIT/ETFs would be welcomed.

Thanks, Ed. Yes, the LIC/LIT access is an issue, and I expect fund managers and their lead brokers will start to market at IPO stage to DIOs to include their funds in their range. If this franking change goes through, every industry fund that offers a DIO can expect the LIC/LIT industry to start bashing down the door. It will become a major problem for industry fund trustees who may need to offer special a range designed for SMSFs. The industry has not realised what a big change this may be under Labor.

I contacted Australian Super and apparently their Investments team is looking at expanding their universe of LIC/LITs (but nothing about ETFs).

Another downside to buying shares (in one of the industry funds and I assume true of others) is that you cannot participate in buybacks and SPPs which is unfortunate.

Ed,

I have pension money with IOOF and they allow participation in buybacks. In fact, I recently bought 180 WOW shares (no scale back for this small quantity) to put straight into the buyback.

IOOF have an advantage over Australian Super in that case. I wish AS would do it as well as add global shares. If they could my pension portfolio would look a lot different

As an adviser would be happy to use the Australian Super Direct option if they would allow the deduction of our advice fees to come from the fund. Until they do that, Australian Super is not serious about member advice.