Plans by the federal opposition to scrap cash rebates for retirees with franked dividends have triggered a range of questions.
Indeed, for investors with their self-managed super fund in retirement phase, franking credits represent a valuable part of their income strategy. So investors need to understand the full implications of the proposed changes which could become a reality if we were to see a change of government at the next federal election.
What’s more, these investors have to contend with these planned changes along with the serious overhaul of pension and superannuation rules already undertaken by the Coalition this year.
A sensible investor, especially if you are retired or are approaching retirement in the 45-plus age group, should keep these four points in mind:
1. The system keeps changing, make sure you keep up
Jeremy Cooper authored the Super System Review of 2009 and 2010 and is now chairman of Retirement Income at Challenger.
“Private provision of an age pension-like outcome will be an increasingly important part of retirement income plans,” he said. He made the point that the future won’t just be about products, but about getting financial advice.
We don’t live in a static world and change is going to be a constant. More than half of Australia’s national wealth resides in the 45 to 64-year-old age group. With ongoing change, planning is essential before and during retirement. This means there is no such thing any longer as a “set and forget” retirement plan. In short, the changes to superannuation and those that may lie ahead make wealth management and planning an important ongoing activity.
2. Know the value and the limitations of franked dividends
While I have been critical of what I believe are incorrect asset allocation strategies by some investors, I do recognise the benefits and value of Australia’s unique franking credit system. Taking the value of these franking credits — potentially with the expectation of these being rebated — into account is not just a “nice to have” but the bedrock of many retirees’ income strategy.
I have also been critical that in many instances payout ratios among major listed companies are too high in the Australian domestic market due to the value that is attributed to franking credits. Sustainable earnings, and therefore dividends, should be the focus of company selection, supporting companies paying out a lower percentage and reinvesting in growth opportunities is what equity investing is about. It is not about yield.
Some parts of the market, such as stockbroking, have expressed concerns that the Shorten plan would draw investors away from fully franked big dividend payers such as the banks towards often riskier assets such as property.
Likewise, others have commented that greater asset allocation to foreign equities could introduce new risks such as foreign exchange risk. We are being asked about these issues too.
I do not believe these are valid concerns. Part of getting good advice is to obtain that advice around a discipline on asset allocation. Successful, investment is about balancing risk with capital growth and income depending on an individual’s risk profile, income needs, and personal values.
3. Make tactical asset allocation shifts gradually
Your portfolio should be across all asset classes and remain diversified at all times. Tactical asset allocation shifts should be gradual depending on underlying valuations including, where necessary, hedging on international assets.
Likewise, it is being suggested that one strategy to counter the proposed ALP measures for those in pension mode is to have your children included as members (in an SMSF you can have a maximum of four members).
The idea is to have the adult children who pay tax and consequently also have the use of franking credits to absorb the excess franking credits the fund might have.
I do not advocate this as SMSFs should be run as discrete accounts, if you have more than two children you also have a problem as the SMSF fund member limit is four. In other words, this can be very messy.
4. Seek advice — and not just about products
The federal opposition’s mooted threat to the franking credits regime, combined with the potential threat to negative gearing, has created a spike in demand for clarity among many obtaining financial advice. Despite back-pedalling by Bill Shorten, the proposed changes discriminate against those in retirement and are clearly targeted at those with an SMSF.
It is interesting to note that retirees are asking about the new transfer balance cap and many also have savings outside superannuation. Removing the refundability of franking credits will impose a tax on hundreds of thousands of Australians. This could be significant and could see them lose up to 30 per cent of their income.
By Will Hamilton
14 April 2018
Will Hamilton is the managing partner of Hamilton Wealth Management, a Melbourne- based independent wealth manager.