Labor has proposed a new policy where they want to eradicate cash refunds for excess franking credits. This means that if Labor wins the Federal election in 2019, thousands of SMSF holders could see a cut to their income. As a share investor, if this happens, it is important to understand the different strategies available to minimise the damage.
A franked dividend means the company has already paid 30% tax on the income. This pre-paid tax on a dividend is a franking credit which tax payers can used to reduce their income tax as an individual, or super fund. Shareholders who were not paying any tax could convert these tax credits into a cash refund from the ATO. This would predominately affect SMSF’s in the retirement phase where earnings are not taxed and they would receive the refund. These are the 7 strategies to implement in your portfolio if Labor does execute this policy.
1.Buy property trusts
SMSF holders can use listed property trusts to gain a high-yielding investment. These do not have imputation credits attached to their income streams. These property trust can have yields ranging from 7.1 – 7.6 per cent which is comparable to the blue-chip companies.
2.Buy Utilities
Many utility stocks are unfranked but they provide investors with earnings stability and dividends. These companies are consistently in demand regardless of the economic climate as they support basic living needs. Utility stocks are suitable for conservative investors who are seeking stocks with a regular dividend payment. As these are usually unfranked, portfolios which consist of these stocks will not be affected if Labor proceeds with changes to the imputation dividend refunds.
3.Buy Infrastructure stocks
Infrastructure stocks offer high yields but unfranked dividends. Stocks such as Sydney airports were considered bond proxies as they offered the yields equivalent to bonds. Demand will grow for these stocks as SMSF members looking for unfranked dividends but high yielding stocks start buying shares in this sector.
4.Stocks that have earnings from operations overseas
This dividend imputation refund system only operates in Australia. There is no other country in the world that offers these franking credits to shareholders. Investors should consider investing in companies which have earnings generated overseas as dividends are likely to be unfranked. Companies which have earnings overseas include Cochlear, Resmed, CSL, James Hardie and Aristocrat Leisure.
5.International shares
SMSF members should think about diversifying their portfolio to hold international shares. As mentioned above Australia is the only country which offers franked dividends to shareholders. International shares will not have franked dividends. This makes portfolios with these shares less sensitive to changes to the Australian imputation tax system. Investing in international shares would also be a good diversification strategy if Australian stocks fall in value due to a decrease in demand from these dividend imputation changes. (As a side note, Fairmont Equities has access to international shares, not just Australian equities)
6.Buy growth stocks
Capital gains under an SMSF will be entirely tax free if the SMSF is in pension phase. There is however a cap of $1.6 million limiting the amount of super than can be transferred into pension phase. SMSF members could circumvent the Labor dividend imputation refund changes by buying high growth stocks and forgoing the dividends for capital gain as they will be tax free if in pension phase.
7.Avoid hybrids
The attractiveness of high yields with bank hybrids are lost with the proposed Labor franking refund changes. These products could return 5 percent if investors could claim back the franking credits. The distribution rate without the franking would to decline to be about 3.2 per cent. Without the franking, hybrids would have similar returns to bonds but carry the risk of shares. Therefore the returns do not justify the risk of hybrids if the policy changes go through.
Lauren Hua is a private client adviser at Fairmont Equities.
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