No franking credit refunds for SMSFs. How equitable is that?

Executive Manager, SMSF Technical & Private Wealth, SuperConcepts
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Close your eyes and think of the future: a future where your retirement income may be reduced because of the super fund you belong to. Some super funds will use the benefit of all franking credits on share investments, while other funds will get no benefit, although they should have received a refund of any excess tax paid.

How inequitable is that?

One of the underlying principles of our taxation system is horizontal and vertical equity. Sadly, it seems to go out the window when it suits those who have the power or those wishing to ascend to the throne. Vertical equity is where the higher your income, and presumably wealth, the more you will contribute to the broader tax system.  Horizontal equity is where those on the same or similar incomes and wealth contribute about the same to the system.

Now let’s apply those principles to a proposal where there will be no franking credit refunds for superannuation funds. This will have a huge impact on those who are members of self-managed superannuation funds (SMSF) and small APRA funds, who have listed and unlisted company shares, which come with franking credits attached. It will also have an impact on some of the larger APRA based funds, which may have a high proportion of pensioner members.

Let me illustrate this point.

Nancy is a member of an industry fund and her husband Sam is the only member of his SMSF. They have both retired and are in receipt of account-based pensions. Co-incidentally, they both commenced their account-based pensions with the same amount: $400,000.  This is approximately the median or most common balance for someone who is a member of an SMSF.

As Nancy and Sam are in their early 60s they are required to withdraw a minimum annual pension equal to 4% of their opening balance in the financial year. In the first year, this will be a minimum of $16,000, which is not a king’s ransom, although it will be tax-free to both.

Let’s assume the investment strategy of both the industry fund and the SMSF is the same and is a ‘balanced strategy’ by the industry fund, as follows:

If we use these proportions to work out the estimated franking credits, the approximate proportion of Sam and Nancy’s balance in equities will be used, which is $123,600 or 30.9% of $400,000. If the average dividend received on those investments was 4% plus franking credits, the income received would be $4,944 plus a franking credit of $2,119, assuming the dividends were fully franked.

If the proposal to stop franking credit refunds for superannuation funds came into place, then Sam’s SMSF would not receive any benefit but Nancy’s fund would be able to use the franking credits against its taxable income for those members who have an accumulation phase account in the fund and are making taxable contributions to the fund. In addition, Nancy’s balance in the fund may take into account some of the franking credit benefit the fund has received. But Sam’s fund gets none of that because he is totally in pension phase.

By taking away the franking credit refunds, in the long term, Sam’s balance in his SMSF is more likely to be less than Nancy’s. This means for the many members of SMSFs, relying on social security benefits may become a reality, something that they probably think would not be required.

Where’s the equity in all that?

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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