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Under Labor’s new policy, how will those with a balance over $1.6 million fare? Will it be worth them having their money in super? Let's explore the material impact of some of the changes.
Newsletter
Labor's new policy and how your SMSF clients will be affected
03 April 2018
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11 minute read
The Labor policy will adversely impact SMSFs with significant investments in shares and managed funds that produce franking offsets. To help explain the extent of this impact, we will use the following example:
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• Rob and Mary both have account balances of $1.6 million each in their SMSF
• The fund’s investments yield 5 per cent before tax and franking offsets each financial year
• 50 per cent of these investments is in Australian shares and managed funds that produce franked dividends (i.e. $1.6 million)
• We first analyse the tax position of the fund assuming both Rob and Mary remain in accumulation phase
• We then assume both Rob and Mary commence account-based pensions (i.e. assuming they both have retired — after reaching their preservation age or attained 65 years)
Treatment of franking offsets under current law
If Rob and Mary’s SMSF balances remain in accumulation phase, the franking offsets generated on their investments of $34,286 per financial year would fully offset the fund’s tax liability of $24,000. The fund would also obtain a refund of $10,286 in franking offsets from the ATO.
If, instead of remaining in accumulation phase, Rob and Mary’s SMSF balances were converted to pensions, then the fund would have $3.2 million generating earnings that are covered by the pension exemption. This would result in no tax being payable by the fund. However, $34,286 of franking offsets would be refunded.
Under both the accumulation and pension scenario summarised above, Rob and Mary’s fund benefits under the current franking offset regime since franking offsets have value to either offset any tax payable by the fund and if there is no further tax payable, by way of a refund of any excess franking offsets (which is close to the value of money).
Treatment of franking offsets under Labor’s proposals
If Rob and Mary’s SMSF balances remain in accumulation phase, the fund would have a $10,286 wastage in franking offsets. This is because Labor will not allow a refund of franking offsets after 30 June 2019 apart from certain circumstances, e.g. the member receives a government pension. Rob and Mary’s SMSF is now $10,286 worse off.
If, instead Rob and Mary’s SMSF balances were converted to account-based pensions, then this would result in no tax being payable by the fund. However, $34,286 of franking offsets would be wasted since there is no tax payable by the fund. Rob and Mary’s SMSF is now $34,286 worse off.
Indeed, Rob and Mary may decide that the pension exemption achieves nothing for them or their fund since franking offsets reduce the tax payable on the fund’s taxable income to nil anyway. Thus, if they commute their pensions back to accumulation they are no worse off as they still waste $10,286 of franking offsets when they are fully in accumulation phase. Moreover, the administration of their fund is far simpler while in accumulation phase (compared to pension or retirement phase) and there is no need for any minimum pension payment each financial year of $64,000 each for Rob and Mary or $128,000 in total.
Therefore rolling back to accumulation reduces the wastage in foregone franking credits and enables their fund to retain an additional $128,000 in superannuation (given there is no longer any need for pension payments). This retention, over time, should result in earnings on earnings providing an additional boost to their retirement savings (compared to remaining in pension phase).
Some financial commentators estimate that the overall reduction in yield with the loss of refundable franking offsets is typically in the order of 1 per cent per annum yield for many SMSFs with significant franking credits. In Rob and Mary’s case, they are $34,286 worse off in pension phase on their $3.2 million portfolio; which equates to a 1 per cent reduction in yield.
Broadly, Labor announced on 27 March 2018 that SMSFs where a member is entitled to Centrelink benefits such as the old-age pension would not be subject to the loss of franking offsets. This is estimated to apply to around 13,000 SMSFs.
Conclusions
The Labor policies will adversely impact many SMSFs – the initial estimate was 200,000 and the exception above for pensioners has spared an estimated 13,000 SMSFs from this impact according to Labor’s figures.
SMSFs are likely to revise their portfolios in view of the reduced attractiveness of Australian shares and managed funds compared to other alternative investments such as overseas shares, property and other asset classes.
If Labor is elected and implements the proposal, the return in companies may also be adversely impacted by Labor’s other policies relating to increasing the overall rate of company tax and opposing further cuts in the company tax rate that the current government has planned.
Daniel Butler, director, DBA Lawyers
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