Q: Why is a fully franked dividend yield of 6.5% worth more in the accumulation and pension phase of an SMSF? How do you work it out?
A: Augmented yields arise because fully franked dividend are grossed-up to the amount of $428.57 cents for every $1,000 of dividend income ($1,000 + $428.57 = $1,428.57). The formula to calculate the franking credit is ‘cash dividend + 30/70’. This is a franking credit based on the company paying tax at the company rate of 30%.
The SMSF receives this franking credit as a cash payment, claimable from the Australian Tax Office (ATO) at the end of every financial year.
An SMSF in accumulation mode (paying 15% tax) has a franking credit roughly twice its tax rate (15% of $1,4286 = $214.29 cents). This means it gets a tax refund of $215 (rounded-up) for every $1,000 worth of fully franked dividends it receives ($428.57 – $214.29 = $214.28).
An SMSF in pension mode (ie., when the assets have been transferred into the pension account of the fund) has a tax rate of zero on income and capital gains from the assets. Because the tax rate is zero, the fund does not need franking credits as there is no tax payable; but it still gets a full refund of the franking credits – that is, $428.57 cents for every $1,000 of dividend income it receives.
Working out the yield
Because an accumulation fund receives a $215 refund on every $1,000 of fully franked dividend income, you can multiply the yield by 1.215 to get the effective yield to the SMSF; for an SMSF in pension mode (paying zero tax), it receives a full refund of the franking credits, so multiply the yield by 1.428 to get the effective yield to the SMSF in pension mode.
So a fully franked yield of 6.5% becomes an effective yield of 7.9% to an SMSF in accumulation mode and 9.3% to an SMSF in pension mode.
If the shares are not held in an SMSF and your taxable income is, say, $50,000, by my calculations you are paying 17.1% in tax (the tax rate in that bracket of $37,001-$80,000 is $4,650 plus 30% of the excess above $37,000), ie. $4,650+$3,900 = $8,550, on $50,000 that is 17.1%. Add the Medicare levy of 1.5%, your tax rate is 18.6%.
Therefore, say you receive $1,000 of dividend income. It is grossed-up to $1,428.57.
Tax on that at 18.6% comes to $265.71. Subtract from that the franking credit of $428.57 and the tax payable on the dividend becomes a refund of $162.86, for every $1000 of dividend income.
Thus, a fully franked yield of 6.5% becomes, to you outside the SMSF, an effective yield of 6.5 x 1.1629 = 7.56%.
Important information: 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. Anyone should consider the appropriateness of the information in regards to their circumstances.