The “retiree tax”, which will mean that excess franking credits will no longer be refundable in cash, will hit the incomes of self-funded retirees who draw a pension from their SMSF. Because SMSFs in pension phase don’t pay any tax, or more correctly, are taxed at a rate of 0%, franking credits on share dividends are refunded in full in cash by the Australian Taxation Office. This refund helps preserve the balance of the retiree’s super nest egg and allows a bigger pension to be taken.
The “retiree tax” will require the passing of legislation through both houses of parliament. With the ALP and Greens unlikely to command a majority in the Senate, support from the cross benches will be required. Given the retrospective nature of the ALP proposal (a change to the investing and super rules “after the event”), most cross benchers have said that they will oppose the plan.
Shorten will claim that he has a mandate, so some form of compromise is likely. I expect a cap that allows cash refunds of up to (say) $10,000 per legal entity. The majority of self-funded retirees will be spared the pain of the change, while the handful of super funds getting “millions of dollars” in cash refunds will still be impacted. A victory of sorts for Shorten.
But even if it doesn’t play out this way, don’t fall for one of the other “strategies” doing the rounds. This strategy says to close your SMSF and roll your super monies into a tax paying super fund, such as a large industry or retail fund, and then access one of their self-directed investment options where you can select a high proportion of shares paying fully franked dividends. As the super fund is a taxpayer, they can utilise “your” franking credits and they will then pass on the benefits back to you, putting you in roughly the same position as if you were getting a cash refund in your SMSF.
There are two major problems with this strategy.
Firstly, not all large super funds are taxpayers. Most are, because they have members in the accumulation phase where earnings are taxed at 15%, and members making concessional contributions which are taxed at 15% when they hit the super fund. These concessional contributions are the employer’s compulsory 9.5% and any salary sacrifice contributions.
The larger super funds publish a ‘tax transparency report’, which shows whether they are a taxpayer or not and how much tax they pay. The latest report from Australian Super, which can be downloaded from its website and covers the tax year ended 30 June 2017, shows that they paid tax of $1.37bn for that year. So, no problem with Aussie Super.
While the chosen super fund may be a taxpayer today, there is no guarantee that it will be a taxpayer in 5 or 10 or 15 years’ time. As the fund “matures” and more members move from the 15% tax rate accumulation phase to the 0% tax rate pension phase, the tax bill drops and the fund is less able to use the franking credits as a tax offset. In the extreme case where thousands of SMSFs move their monies to a particular super fund such as Aussie Super, there could be so much money invested in franked shares and franking credits to go around that the fund won’t have a tax bill. It will cease to be a taxpayer.
However, there is a bigger problem. Fund trustees are required by law to act in the best interests of all their members. If refunds of excess franking credits are canned, that is, they become “illegal”, on what legal basis can a trustee allocate a “refund” to the member in pension phase at the expense of the member in accumulation phase. Who is to say that the member “paying the tax” isn’t entitled to some of the net benefit?
Sure, the fund’s overall tax bill will be reduced, but who gets the benefits and in what proportions is a different ball game. This is a whole new area of super and trustee law.
I am not aware of any super fund, industry or retail, that has stated in writing that it can guarantee that the benefits will flow to the pension phase member. And they are unlikely to do so, because until the law is changed, they are dealing with a hypothetical.
Until you know that the fund is a taxpayer, that there is a very, very high degree of confidence that it will continue to be a taxpayer in the long term, and the trustees confirm in writing that they can “refund” the benefits, this strategy is a non-starter.
Take no action. This has a long way to play out.