Builders specialising in home renovations could be in for boom times, particularly those that are established in the suburbs of our capital cities frequented by self-funded retirees. If Bill Shorten’s plan to end cash refunds of excess imputation credits (aka franking credits) on share investments becomes law, retirees will be advised to stick their money into the family home and secure access to a government part pension – however small. By doing so, they will continue to get their cash refunds.
This is what could happen because bad policy (Shorten’s naked tax grab) is being met by a bad backdown. I applauded Shorten for having the courage to admit the policy was going to cause considerable pain (read more here). But because the back down is being implemented in an inequitable manner – government pensioners are winners, self-funded retirees are losers - it has the power to create a huge financial incentive for self-funded retirees to access the government aged pension.
And as we know, people will act rationally. To increase their income, a rational action for some self-funded retirees will be to get under the aged pension assets test limit by either buying a more expensive home or investing in their current home.
Let me explain.
Shorten’s back down is to exempt approximately 300,000 recipients of a government aged pensions (part or full) and a handful of Self-Managed Super Funds (SMSFs) where one member is receiving a government pension. Labelling it as the “pensioner guarantee”, this means that they will still be eligible to receive cash refunds of excess imputation credits.
But because eligibility for the government pension is largely determined by application of the assets test limit (currently $837,000 for a homeowning couple), refund eligibility is similarly like a cliff. Assets of $837,000 or less – get cash refunds – assets of $838,00 or more – no cash refunds.
Without cash refunds, the retiree’s income is slashed. The following example shows just how big this impact could be.
Let’s assume that a homeowning couple has assets of $800,000, which is under the assets test limit of $837,000. This comprises $100,000 in non-financial assets (car, home contents etc) and $700,000 in super through their SMSF. Of the super assets, 50% or $350,000 is invested in fully franked shares yielding 5.0%, and $350,000 in cash, term deposits and fixed interest yielding 3%. The SMSF has dividend income of $17,500 plus imputation credits of $7,500 plus interest income of $10,500, which sums to $35,500. The couple is also eligible for a part government pension of $2,886. If they draw all the investment income in the SMSF (and don’t access any capital), their total income is $38,386.
A second homeowning couple has total assets of $1,000,000. This comprises $100,000 in non-financial assets (car, home contents etc) and $900,000 in super through their SMSF. Of the super assets, 50% or $450,000 is invested in fully franked shares yielding 5.0%, and $450,000 in cash, term deposits and fixed interest yielding 3%. The SMSF has dividend income of $22,500 plus imputation credits of $9,642 plus interest income of $13,500, which sums to $45,642. Under current arrangements, they could draw $45,642 as income and not eat into the capital of their SMSF. Post Shorten, because the credits will not be refundable, the income drops by $9,642 or 21% to $36,000. They will be worse off than the couple with $800,000 in assets!
Rational action? Get under the pension assets test limit and maintain access to the cash refunds.
How to do it? While they could consider taking a very expensive overseas holiday, the most strategic financial option will be to invest in the family home as it remains exempt from the pensioner assets test. This could be via a renovation or upsizing to a new/better home. Gifting to relatives won’t solve the problem, as CentreLink counts gifts made in the preceding 5 years.
So, take a lump sum from their SMSF of $200,000, invest it in their family home and get their total assets back under $800,000. Access a part government pension, and a higher income! And potentially, improve the value of the family home!
Noel Whittaker, author of Making Money Made Simple and numerous other books on personal finance has pointed out that self-funded retirees who have invested in shares directly could also be impacted. Couples who share income for taxation purposes and are eligible to access the Seniors and Pensioners Tax Offset will face the same fate as couples living off their super.
And please don’t think I have gone hard on Bill Shorten. I have chosen an example where the couple has 50% of their assets invested in Australian shares. There are many couples who have 80% or 90% of their life savings in blue-chip Australian companies paying fully franked dividends. This proposal is really going to hurt.
Time to rethink, Bill.
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