SMSFs, member-direct and Labor's franking

Hi I was on age pension until my wife turned 65 and 6 months last year does that mean I will continue on with receiving the total full amount of credits or have I forfeited that now I am self funded. I don’t think it has been debated I hope you understand what I am trying to say. Thanks Darryl.

Although I actively monitor my SMSF it is through one of the many well known wealth management companies where I rely on the advice of my financial adviser. If it eventuates that member-directed investments through an industry or retail fund becomes the 'best' option will this be the advice that my fund manager provides? Or is it unlikely because my current investment adviser (company and employee) will no longer be offering me the product that I require?

Can anyone imagine the total waste of effort expended and loss of confidence in the super system due to proposed changes year on year. If you contribute legally to YOUR fund and can not trust that the stated benefits will be retained as intended who can trust the system ????

With the ongoing debate on the ALP's franking credits proposal, I thought I should add in something else that I haven't seen any commentary on in the media. It concerns the impact of the proposed policy on Family Tax Benefits ("FTB")

FTB is paid to families provided they meet the applicable income tests, with there being two main components to FTB, known as FTB Part A and FTB Part B.

For FTB Part A the maximum rate per child is paid if the family's income is $52,706 pa or less. If the family income is above $52,706 pa, FTB Part A is reduced by 20 cents per $1 over this limit. FTB Part A is $182.84 per fortnight per child when the child is under 13 and $237.86 per fortnight per child when the child is 13 and up to 19, if the child meets study requirements. Another component to the FTB Part A is the FTB Part A Supplement, which is paid at the rate of $737.30 per child provided the family's income is below $80,000 pa.

FTB Part B, is paid per family and depends on a couple of tests. If the primary earner in the family earns more than $100,000 no FTB Part B is paid. For two parent families, if the primary earner's income is $100,000 or below, the secondary earner's income is tested. The secondary earner can earn up to $5,548 pa after which FTB Part B is reduced by 20 cents per $1 over $5,548. The maximum rate of FTB is $4,055 per family, if the youngest child is less than 5 years old. There is also a Part B supplement of $357.70 per family per year.

The problem with the ALP's franking credit policy is that although the franking credits will no longer be refundable, the franking credits will reduce the amount of FTB, as the franking credits will continue to be included as part of the family income for FTB purposes as follows:

Family comprising of two parents and three children under 13.

Primary Income earner's salary from their job is $75,000 pa.

The secondary earner, stays at home to look after the children and does not work in paid employment.

The couple have been saving hard to get a deposit on a home and through this process have accumulated $100,000 in savings. To maximize returns, the funds are invested in the secondary earner's name in fully franked shares paying a 5% dividend. This equates to dividend income of $5,000 pa and franking credits of $2,142 pa.

The family's total cashflow income before tax is $80,000 ($75,000 + $5,000).
The family's income before tax for FTB purposes is $82,142 ($80,000 + $5000 + $2,142).

Although the family will not get a refund of the franking credits, the additional $2,142 of family income will reduce the amount of FTB Part A by $482.40, the amount of FTB Part A supplement by $2,211.90 and the amount of FTB Part B by $318.80.

Agree John. Another example of our policy makers or policy advisers in Canberra not thinking through all aspects of the plan. ALP have already "back flipped" for pensioners. What happened to protecting the young Aussie couples who are seeking to raise a family and secure a home. If this is not fixed, it smacks of hypocrisy on the part of the ALP.

James' comments highlight an inequity in the ATO system of tax collection.

ATO requires (after the first year of assessment) taxpayers to pay as you go (PAYG) the annual tax liability without waiting for the year to be completed, by estimating the likely tax (with an uplift of 10%). Taxpayers must pay this periodically during the year, but can adjust it if they believe the amount demanded is too high in the light of the likely year end position. There are penalties for material under-estimation.

Contrast this with a SMSF that under current rules is eligible for a large refund (say a pension phase fund or even a hybrid fund). The fund must wait till it lodges its return to obtain the refund. Not for the taxpayer PAYG in reverse. Perverse?

For an individual, it is possible to reduce taxes withheld from salary taking account of expected franking credits, but her again, asymmetry: you can only reduce it to zero, cannot make it a refund.

They say there is no symmetry or equity in tax. The above is an example!

James

The work test that until 30 June 2017 required members to have no more than 10% of their income from employment to be eligible to claim concessional contributions has been scrapped from 1 July 2017 (17/18 tax year).
But the work test for the over 65s to contribute to super (40 hours in 30 continuous days) remains.

I am sure tax experts will correct me if this is wrong.

Ramani,

The work test is proposed to be modified from 1 July 2019.

From this point in time if you are aged 65-74 with a total super balance under $300k in the last year that you met the work test, you can make voluntary contributions for 1 single year afterwards without meeting the test (subject to all other rules like caps).

Hi Graeme
Would a stay at home mother receiving FTB parts A and B be defined as receiving a benefit under the ALP policy. I have read the policy and it's not at all clear.

Hi Worried, probably not although who knows what the final legislation will say. The Labor Party policy proposal says:

Under the Pensioner Guarantee:
o Every recipient of an Australian Government pension or allowance with individual shareholdings will still be able to benefit from cash refunds. This includes individuals
receiving the Age Pension, Disability Support Pension, Carer Payment, Parenting Payment, Newstart and Sickness Allowance.
o Self-managed Superannuation Funds with at least one pensioner or allowance recipient before 28 March 2018 will be exempt from the changes.

You are correct Jon, most superfunds pay the franking credits from "their" money well before they receive any credit from the ATO. The ability of the superfund to do this depends upon its underlying ledger system to correctly forecast the overall funds net tax postion. If the fund has outdated systems it may take them longer or they may only pay any net credits after they have received the ATO return which could be some months after the dividend.
At a higher level, the superfund needs to be a net payer of tax to rebate franking credits, if it has many older pension phase members (tax free) then this may be not be feasible.
i use netwealth.com.au and they rebate franking credits currently at the time of dividend and have wide range of shares/LICs/overseas stocks and a simple death benefit form.

It should also be possible for John to contribute up to $25,000 each year concessionally and soak up to $3750 of his 15% contribution tax liability from the franking credits which would otherwise be wasted, until age 65. After age 65, the work test must be met.

Like the food chain hierarchy where nature spawns predators ready to feast on available prey, every cleverly thought-out (or not) revenue measure attracts tax accountants and lawyers in their hordes to legally game the system. It has always been thus, and always will be. The immortal Kerry Packer be praised....

The work test is no longer? i think anyone can contribute up to age 75 now?

James,

That isn't correct.

Right now the work test remains and we don't even have the exposure draft of the Federal Budget proposal for this measure.

The proposal is that, those aged 65-74 from 1 July 2019 with a total super balance under $300k in the last year that they met the work test, can make voluntary contributions for 1 year afterwards without meeting the test (subject to all other rules like caps).

Matthew has certainly raised an interesting option. My enquires with the industry fund that I left to establish my SMSF reveal some interesting points that I offer here.

My holding of shares, chosen from their extensive list, can be no more than 85% of my super balance. The remaining 15% must be in one or more of their other investment options such as conservative, balanced or growth etc
.
In pension phase the pension can only be paid from the other investment option and must also hold at least 13 months of forward pension payments in cash. The member-direct option must also hold a transaction account to manage the share trading in that option.

The main problem, as I see it, is that the fund is the taxpayer (not the member) and that is why they can use the accumulated franking credits to pay the overall tax in the fund. They say my franking credit will be credited to my account as “soon as is practicable” after the dividend is announced, so clearly this money is paid from their bank account before their tax return is lodged. That puts me at the mercy of their policy which could change at any time.

More important, it means that the fund is the owner of the shares in my account, not me. If push comes to shove, for example, if there is insufficient money in the other investment option to pay my pension, they will sell “my” shares without my consent.

The information on death benefits is scarce with this option and there may also be a problem with holding a reversionary pension in this arrangement, but I could not find enough information on that.

All this means loss of control of how I invest, and how much cash I choose to hold. So while it would relieve me of the compliance obligations of a SMSF, it clearly is not like investing in a SMSF and introduces an additional set of regulations and conditions on top of everything else. I suggest that you do your research thoroughly before you jump – it may be difficult to change your mind.

Jon, it is the fund and not the member that pays tax, and this is true for SMSF, industry fund, retail fund, or any other type. It is also the case that, regardless of the fund, it is the fund that is the owner of the shares and not the member. The assets are pooled, but each member's benefit separately accounted for.

Just ask the Fund to confirm its policy on franking credits each year in writing.

When you say that "if there is insufficient money in the other investment option to pay my pension, they will sell 'my' shares without my consent" - what would you expect them to do, given the Fund is legally required to pay you a pension?

Finally, if you die, then your pension account would become part of your estate, and you can apply a Binding Death Benefit Nomination to the account. If the beneficiary is not of pensionable age, then an Account Based Pension could not be paid to them, but they can keep the money in the Accumulation part of the Fund instead.

Yes, do your research thorough before you jump, but also before you stay where you are as well.

Control is overrated. I am not interested in control, only performance. This is why even though I have more that enough in super to commence a SMSF, I have chosen not to (much to the annoyance of my accountant who was hoping to make a few thousand dollars setting up the fund, plus a couple of thousand every year in admin fees).

So what have I done? My super in an extremely low cost industry fund which uses an indexing strategy. The breakup as I understand it is about 30% in Aussie shares (using a low lost index fund) about 35% in overseas shares (using low cost index funds), and the rest in fixed interest and cash. Simple and effective, and over the long term, (such as the thirty years or so I expect to remain in super), it will outperform about 70% of all other options, including SMSF`s with a similar investment profile.

The other benefit is I have none of the compliance nightmares of running my own SMSF, none of the worry of being fined by the ATO for making an error or lodging late, none of the meetings with accountants or other advisors or poring over share prices or research notes, and no staring at my computer screen.

None of that worry for me. The irony is even though my compliance costs and time spent is lower, using this indexing strategy I will perform better than the majority of funds.

Bizarre isn`t it?

Great comment Peter C . This strategy may work well for those who have that time frame but i am not sure if it works so well for say those who are doing 15 years or less . Certainly the potential performance is there and as you have mentioned the time involved in compliance is gone . Thanks for the post it has helped me clarify my thinking on a few issues

Now I am confused. My case is that I am a fully self funded retiree. I am 63 going on 64.I have been retired for 3 years. I do not receive so much as 1 cent from the government. No health card, rates, car rego, nothing.

My SMSF receives approx $8,000 a year in franking credits. Under the proposed Labor changes will the fund keep or lose the franking credits?

Hi John, assuming no member of the SMSF was a pensioner (in the welfare sense) on 28 March 2018, your SMSF will not receive a REFUND of excess franking credits. However, if your fund is still in accumulation and earns taxable income (such as non-franked dividends, interest from term deposits or property), then you can still use your franking credits to offset the tax. Assuming you have enough taxable income, you will not lose the value of your franking credits. The proposal is only about REFUNDS.

Seems that any SMSF trustee who becomes a means tested pensioner after a prescribed date, will not be able to receive franking credits.
At this stage,would this be correct?

Apart from the uncertainty regarding the next election winners,the difficulty is making investment decisions in view of Labor's announcement vagueness.

Hi Mike, that's correct. In an SMSF, under the proposals, a person needed to be 'pensioner' by 28 March 2018.

Peter and Roy

Sadly, Graham is correct. Below is a link to the Labor party fact sheet which explains what is meant by a "pensioner"


https://d3n8a8pro7vhmx.cloudfront.net/australianlaborparty/pages/7652/attachments/original/1522101043/180327_Fact_Sheet_Pensioner_Guarantee.pdf?1522101043

Hi Ramani

your comments are, again, very interesting.

Given what is at stake, if the legislation is enacted, I would hope that the trustee will provide clear guidance in relation to how they will allocate tax credits.

I certainly agree that nothing should be done until we see what happens politically. Having said that, I have plenty of clients who will be significantly worse off so I think it is healthy to talk about some potential strategies.

Matthew

Thanks for alluding to my comments on the subject. Due to space limitations, I could not elucidate the challenges facing trustees in achieving equitable allocation among member cohorts (and hence members). A lot depends on individual fund rules, crediting rate practices and the sophistication of IT (including legacy systems). Many will recall the recurrent episodes of unit pricing errors APRA and ASIC had prosecuted years ago, culminating in a joint guide. A lot of remediation followed.

For a list of the conceptual complexities, see the two APRA speeches:

http://www.apra.gov.au/Speeches/Documents/ASFA_Auckland_November-2008.pdf

http://www.apra.gov.au/Speeches/Documents/CMSF-150310-2-_amended-120310-FINAL.pdf

The ‘unknown unknowns’ are whether Labor will gain power; whether it will enact the mooted policy; the actual legislation; then critically, How ATO will implement it given Part IVA.

Perhaps we should hold our horses for the time being?

I thought that Labor had amended its proposal so that existing smsf’s with a member already getting a pension would continue to receive cash refunds of franking credits. Is my understanding incorrect?

Hi Roy, you are correct but the 'already getting a pension' date was 28 March 2018 so it's not expected to be the date when the legislation is passed. Labor estimates there are only 13,000 'pensioners' in this category.

Hi
Can you clarify pension... is this cover pension mode in SMSF
Not on Govt pension

Cheers
Jo

Hi Peter, that's not a correct interpretation of Shorten's 'clarification', on my reading. He did not say existing SMSFs in pension mode would continue to receive refunds. This is a confusion on what he meant by 'pensioner'. The statement about already receiving a pension on date of the announcement (28 March 2018) was a reference to social security pensions such as the age or disability pension, not a pension from an SMSF.

Labor offered a ‘Pensioner Guarantee’ which protects all pensioners (welfare recipients) from the abolition of refunds except for SMSFs.

From Chris Bowen’s website: https://www.chrisbowen.net/media-releases/labor-s-plan-to-crack-down-on-tax-loopholes-protect-pensioners-and-pay-for-schools-and-hospitals/

“The Pensioner Guarantee means pensioners and allowance recipients will be protected from the abolition of cash refunds for excess dividend imputation credits when the policy commences in July 2019.

Self-managed superannuation funds with at least one pensioner or allowance recipient before 28 March 2018 will also be exempt from the changes.

This means that every pensioner will still be able to benefit from cash refunds.”

It should be borne in mind that at the time Shorten made this announcement (a few months ago?), he also 'clarified' a few days later (under pressure) that existing SMSF balances already in pension phase at the time of his announcement would continue to receive franking credit refunds. It remains to be seen how much we can trust a pollies' word!