22 November 2019
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4 ways to get around Bill Shorten's retiree tax

Paul Rickard
13 December 2018

The latest Newspoll shows that despite a lot of noise and agitation, community opposition to Bill Shorten’s retiree tax hasn’t grown over the last several months. According to the poll, support for the tax has only dropped from 33% to 30% between March and December, while opposition has remained relatively steady at around 48%. Reflecting that a lot of people don’t understand the proposal, 22% are uncommitted.

The retiree tax is a proposal to abolish the refunding in cash of excess franking credits that go with share dividends. It will particularly impact around 1,000,000 self-funded retirees who are drawing a pension from their SMSF (self-managed super fund) and who do not receive a government pension. It will also impact other low rate taxpayers such as a non-working spouse or adult child who owns some shares, and may impact the investment returns of SMSFs and other super funds in the accumulation mode of super (that is, when monies are being paid in).

Take this example. Bill and Mary are retired and have a combined total of $1,500,000 in their SMSF. This is above the assets test threshold so they don’t receive the government aged pension. They want as much as possible to preserve the capital of the fund to provide for their retirement, so they draw down the fund’s investment income each year as a pension. If the fund is invested 50% in fully franked shares yielding 5% and 50% in other assets (cash, term deposits, international shares) yielding 3%, this provides them with a total income of $76,071,  including a cash refund of $16,071 for the franking credits.  A nice sum, but not an exorbitant sum to live off. Under Shorten, the cash refund goes and the sum available to take out as a pension will drop to $60,000 – they will be $16,071 worse off!

Like all tax changes, Shorten and his ALP team will need to pass supporting legislation through both houses of parliament. The position of a “populist” Senate cross-bench has been in doubt, and news yesterday that nine out of 10 of the current cross-bench oppose the plan (the other Senator is undecided) will come as a relief to self-funded retirees. Of course, the ALP and the Greens could yet achieve a majority in the Senate in their own right. A more likely scenario is a compromise with the cross-bench, which caps the amount of franking credits that can be refunded in cash each year at (say) $10,000 or $20,000. This way, most of the 1,000,000 retires are spared from the tax grab, while Shorten gets a victory and stops the multi-millionaires retires from receiving what he believes is an unfair tax break.

While these scenarios will no doubt play out over 2019, the question is: can you, or should you do anything now about the tax? The answer is that you can’t do that much, and given the uncertainty about the change itself, the prudent strategy is probably to wait. However, if you are still worried, here are 4 actions to consider.

1. Switch to other higher yielding investments

There is no doubt that over the medium term, SMSFs overweight the major fully franked dividend paying stocks such as the 4 major banks, Telstra, Woolworths and even BHP, will diversify into other stocks and alternative income producing assets. Property, both direct and indirect through syndicates and property trusts, infrastructure assets and infrastructure stocks such as Transurban or APA, and “riskier” fixed interest assets including corporate bonds, mortgage trusts and direct financing will be on the shopping list. Hybrid securities and listed investment companies trading at a premium will be on the exit list. SMSF trustees in the pension phase won’t be a slave to the franked dividend, but will evaluate income returns on pre-tax basis.

But the market has already anticipated some of this switching, with property trusts and infrastructure stocks bid up in price and down in yield, and the major bank stocks down in price and up in yield. While there are other factors at play, yields on the major bank stocks now sit around 7% (without franking). My sense is that there isn’t much left in this trade and that the switching will happen over the medium term.

The other thing to remember is that only a small part of the market is impacted by the tax. Foreign investors aren’t impacted, domestic fund managers and most institutional super funds aren’t impacted, individuals paying tax at 39% or 47% aren’t impacted and most SMSFs in accumulation phase aren’t impacted.

2. Upsize

A more radical action, and something that requires very careful consideration, is to upsize. Yes, that’s right – not downsize, but upsize to a more expensive family home.

The strategy here is to let the Government help with your income needs and become eligible for a part-aged pension. The family home is of course exempt from the pensioner assets test, so by withdrawing money from your super and putting it into the family home or upsizing into a more expensive home, you get below the assets test cut-off.

The cut-off for a home-owning couple to receive a part pension is assets below $848,000 and for a single, $564,000. Assets include super balances, motor vehicles, home contents and financial assets outside super such as money in the bank.

There could be some big financial downsides with this strategy. By withdrawing money from super and accessing the Government’s help, your income will probably reduce. Critically, will the upsized  home appreciate enough in value to cover the transaction and investment opportunity costs? And what is the long term strategy? Do you downsize at some later point, or leave the home to your kids? Do they provide income support as you use up your super and become more dependent on the government aged pension?

3. Can you access a part pension and invest outside super?.   

The ALP has announced that it will exempt from the tax change persons who are in receipt of a government benefit (not SMSFs – only the 13,000 who had a member in receipt of a government benefit on 28 March 2018). So, If you are approaching pension age, you may  want to consider investing outside super into shares paying franked dividends to maximise the tax free income threshold of $18,200, while ensuring that you qualify for the age pension. To get under the assets test limit and qualify for a part pension, you may have to invest in the family home or spend (not gift) some of your funds.

4. Accelerate the payment of private company dividends

If you own a private company, you may want to check the franking account balance and if positive, pay a franked dividend. The ALP has said that the change will (at the earliest) take effect from  1/7/19, meaning that fully franked dividends received this financial year won’t be impacted. Just as several public companies will accelerate the payment of dividends into the first half of 2019, private companies should also consider if this is appropriate.

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