How Labor’s proposed superannuation change will hurt you as an investor – The Australian Investors Association

The Australian Investors Association (AIA) is Australia’s leading financial education non-profit organisation helping its members to make improved investment decisions. The AIA does not provide advice. It provides information and education to its members to help them become better investors.

The Association has approximately 1500 members nationwide drawn from all walks of life, brought together by a common interest in achieving improved investment returns.

With limited resources, the AIA provides information meetings, discussion groups, workshops, seminars, and a national conference to provide its members with a smorgasbord of ideas for their consideration as they implement their own investment strategies. The topics covered include all investment asset classes, superannuation, the domestic and global economy, estate planning, and aged care. Our motto is “investors helping investors”.

The AIA produces a quarterly publication “The Investors Voice”, as well as regular emails to help its members keep up to date. The AIA tries to advocate on behalf of its members on key issues, but does not employ a paid secretariat.

As a group, our members can be characterised as being very determined to be self-directed investors. Many members are retired, and they have the time and resources to research and pursue their interest in investing. Many do not use an adviser because of the demonstrated conflict of interest, and many do not use a stock broker as they prefer to conduct their own research. Many members have been successful independent investors for a long time, achieving handsome returns.

As self-directed investors, our members are fully aware of the tax concessions offered by superannuation, and many use a self-managed super fund (SMSF) for that legitimate purpose. Consequently, our members are well informed about changes to policy and legislation as they impact on investment outcomes.

Our members have a keen understanding of the rules around super, tax and imputation credits because they have been investing in Australian shares, LICs and ETFs for a long time. Our members are well placed to offer their insights into Labor’s proposal to remove the cash refunds of franking credits.

The Effects of Labor’s Proposal

The only investment where the income arrives in the hands of the owner with tax already paid is Australian shares. The prepaid tax arrives as a tax credit, for the company tax already paid before dividends are distributed. The dividend received is paid out of the after-tax portion of the company’s profit as the company tax has already been paid. Therefore, in order to account for the company tax, the dividend has to be “grossed up” to include this tax already sent to the tax office.

Franking ensures that Australian shareholders always pay tax on their dividends at their marginal tax rate. If the company tax rate were zero, Australian shareholders would still pay tax on their dividends at their marginal rate, but foreign investors would pay no tax in Australia.

The franking credit is thus additional taxable income, but the shareholder can use that tax credit to pay their own tax. Since 2001, if that prepaid tax exceeded the taxpayer’s own tax liability, the ATO has refunded the excess in cash, in exactly the same way that PAYG taxpayers receive a cash refund of excess tax already paid.

Under Labor’s proposal, franking credits will not be abolished. Franking credits will still be able to be used to pay a tax liability; it is only the cash refund of excess tax credits that will be confiscated. Therefore, the proposal affects all taxpayers who generate franking credits that are greater than their tax liability.

In recognition of the impact on taxpayers with low marginal tax rates, Labor announced an exemption to their proposal for those who receive a Centrelink pension or allowance, and those self-managed super funds (SMSFs) where a member was also a Centrelink pension recipient prior to the 28th March 2018.

As Labor’s proposal operates on the difference between the tax liability and the franking credits Australian shares generate, the whole superannuation system, with its concessional tax rates, is exposed to this policy. It is clear that SMSFs will be more affected than APRA funds with the biggest impact being felt by SMSFs in pension mode. Clearly, age pensioners will be unaffected.

Superannuation funds in accumulation mode pay 15% tax on contributions and income earned by the fund and they are single taxpayers on behalf of all their members. APRA funds will not be affected by this proposal because the majority of their members are in accumulation mode and the fund generates income from many assets besides shares. Their franking credits can continue to be used to pay their tax liability. Large SMSFs that have a significant portion of their funds in accumulation mode are in exactly the same position.

All super funds in pension mode pay zero tax on the income earned by the fund. This has been the case since 1992, when super became universal and compulsory, and has remained in place through the Costello super changes in 2007, the period when Mr Shorten was Minister for Superannuation in 2010, and the Morrison super changes in 2017.

SMSFs solely in pension mode are used almost exclusively by self-funded retirees. Therefore, any Australian shares owned by an SMSF will generate franking credits in excess to a tax liability of zero. This proposal means that SMSFs in pension mode will lose all of their cash refunds from franking credits, and this can represent a significant reduction in the fund’s income, depending on its asset allocation to Australian shares. That reduction in fund income has a significant impact on the living standards of the members who draw pensions from it.

Since 2017 the age-pension assets test has been tightened so that now couples with assets greater than $848,000 are no longer eligible. Since 2017, there is also an upper limit of $1.6million that can be held in a super pension fund. SMSFs with assets above that limit are now required to hold the excess in a taxable environment where franking credits can be used to pay the tax. Multi-millionaires will not be affected either.

There is a group of self-funded retirees caught in the middle, not eligible for the age pension and not enough assets to generate taxable incomes. They will be denied both the age pension and the refund of excess franking credits. Many of them are members of the AIA. On our analysis, a couple needs to have more than the $1.2 million to earn more income (without franking credits) than couples who receive both the part-age pension and the refund of franking credits.

The proposal to withhold the refund of excess franking credits from selected groups has inflamed huge numbers of investors, retirees, and those preparing for retirement. The investment in franked Australian equities is the backbone of many retirement incomes and the incomes of those with small investments and low additional incomes. Not surprisingly, this proposal has caused great angst because these retirees are not in a position to return to work and accumulate more assets to assure them of a comfortable retirement.

There is real anger at the betrayal of trust, even among life-long Labor voters. Many of our members are not wealthy, but through frugal and prudent saving, they spare the taxpayer the cost of their age pensions every year. Their savings have replaced the age pension as successive governments have encouraged them to do, and now they feel they are being unfairly targeted.

Even though the purpose of superannuation has recently been legislated to supplement or replace the age pension, Labor’s proposal will bring new pressure on the age pension system:

In the short-term there will be enormous incentives for self-funded retirees to arrange their affairs so that they qualify for both the part-age pension and franking credit refunds.

In the medium term, self-funded retirees with lower incomes will deplete their savings more quickly and then depend on the age pension sooner.
In the long-term, this proposal destroys the trust that young people need to invest in a superannuation system that is overhauled every time a government is looking for new revenue.

The projected revenue of this proposal is simply not credible. The projections are based on superannuation figures collected in 2014-15. Since the latest overhaul of super in 2017, the large SMSFs in pension mode that Labor hoped to target with this proposal, no longer exist. They are now required to hold the amount in excess of that required for a comfortable retirement outside this zero-tax area, and that income is already taxed. Moreover, almost everyone will be able to find ways to avoid this new tax on selected taxpayers who own specific assets.

This proposed policy discriminates against SMSFs in favour of industry funds. It discriminates against self-funded retirees in favour of age pensioners, and it discriminates against Australian equities in favour of other assets.

We should expect a significant electoral backlash from self-funded retirees and their families at the perceived theft of a legitimate tax refund that has been the basis of lawful retirement planning for many people for many years.

About Jon Kalkman

Jon retired from the position of Principal in the Queensland Education Department in 2007. On retirement, he and his wife established an SMSF to provide a superannuation retirement income stream. Their confidence in doing so came in large measure from their exposure to the invaluable information provided by the AIA.

Jon has been a member of the AIA since 2005 and is a Director on the National Board. He has a particular interest in retirement income streams and estate planning.

Find out more about The Australian Investors Association (AIA) by visiting www.investors.asn.au.