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Labor’s franking policy is a ticking bomb for all super funds

The Australian Labor Party (ALP) proposal to limit cash refunds of franking credits will clearly impact many pension phase SMSFs, but we believe it also has the potential to impact many other superannuation funds.

In this paper, we build a model of the key variables which determine whether a superannuation fund is likely to lose refunds of net franking credits under the ALP proposal. Our model is consistent with and helps explain an article in The Australian which reported that $309 million in franking credit refunds were paid to over 2000 APRA-regulated superannuation funds, including 50 (out of a total of 240) large APRA funds, in 2015-16, impacting 2.6 million member accounts.

The ALP proposal

On 13 March 2018, the ALP announced a proposal to abolish the net refunding of franking credits to Australian investors other than for charities and endowments. The initial proposal was expected to impact 1.17 million individuals and superannuation funds and generate $59 billion in government savings over 10 years.

On 26 March, the ALP revised their proposal in the light of significant public criticism. Direct investments by welfare pensioners (part and full aged, disability and other Centrelink pensions) were also excluded, ensuring 306,000 pensioners will continue to receive cash refunds. SMSFs are also exempt if they had at least one welfare pensioner before 28 March 2018. Our understanding is this exemption does not apply to other superannuation funds.

Which super funds are affected?

Note that franking credits themselves are not abolished. Australian investors can continue to use franking credits to offset income tax payable and for a superannuation fund, contributions tax payable.

The ALP believes the main superannuation funds impacted by this proposal will be pension phase SMSFs. However, ATO taxation data (as quoted in The Australian) and analysis of APRA statistics show that many APRA-regulated funds will likely also be affected. This implies the impact may be far broader than initially predicted.

Analysis of key drivers (to losing franking credit refunds) and their potential magnitude.

Franking credits will be lost if total tax payable by a superannuation fund is less than franking credits received. Tax payable is a function of tax on investment earnings on the accumulation portion of a fund, as well as contributions tax payable on normal contributions. The percentage of pension phase assets, the level of taxable earnings and the level of contributions will vary from fund to fund and may vary from year to year.

For example, taxable investment earnings will be largely determined by the state of investment markets. The level of franking credits can also vary between funds and over time. We base our estimate of the typical impact of imputation assuming an average SMSF exposure to Australian shares based on March 2018 ATO statistics of 31%, and the franking credit yield of the S&P/ASX200 Index which has averaged approximately 1.5% pa over the 10 years to December 2017.

Investors with higher allocations to Australian shares, or allocations to higher-yielding Australian shares could earn even higher levels of franking credits. They stand to lose more if franking credit refunds are denied. In our analysis we double the level of franking credits in our high-franking scenario.

Loss of refunds depends on pension v accumulation and franking levels 

We then varied the proportion of a superannuation fund devoted to pension and accumulation as well as the levels of franking credits, contributions tax and taxable income [1].

Figure 1 illustrates the outcome of our sensitivity analysis varying the proportion of pension assets and the level of franking credits.

Clearly funds with 100% pension assets will lose all their franking credits. We estimate that for a typical level of franking credits, funds with 70% or less in pension assets should not expect to lose franking credits. For funds with double the typical level of franking credits, this number drops to 50%.

If accumulation phase (or 15% taxed) members aren’t paying contributions and therefore aren’t paying contributions tax, funds are more likely to lose franking credits. Funds with higher levels of taxable income would be less likely to lose franking credits. Higher levels of taxable income are usually associated with strong markets or the realisation of capital gains.

The number of funds impacted will vary from year to year in response to the level of investment returns. When investment returns are very low or negative, tax on investment earnings will also be low, increasing the chance that the value of franking credits received by a fund exceeds tax payable.

Accordingly, when investment returns are low, a higher percentage of superannuation funds may miss out on some or all of their franking credits, exacerbating the low investment returns.

The winners and the losers

We find that the loss of franking credits is likely to be positively related to:

1) The percentage of assets in pension, with maximum loss at 100% pension assets, but losses starting to occur from 50% to 70% pension assets

2) The level of franking credits generated by the underlying assets (the more franking credits generated the more likely you are to lose some).

The loss will be negatively related to:

3) The level of taxable income generated from the underlying assets (with losses in franking credits more likely in periods of weak investment markets meaning investors may receive a double hit to returns)

4) The level of contributions and contributions tax payable by accumulation members (the less contributions tax payable the more likely a fund loses franking credits).

Our model explains why The Australian reported that 50 large APRA-regulated superannuation funds (out of 240) received net refunds of franking credits in the 2015/16 tax year.

Mature funds may suffer most from loss of refund

Our scenario analysis finds that any relatively mature superannuation fund, where maturity is defined by the percentage of member balances in pension mode, may be in a net franking credit refund position.

While many SMSF members have been vocal critics of this proposal, we believe members of other superannuation funds probably don’t even know they receive franking credit refunds (they are not reported on investment summaries) and probably won’t know whether they might miss out on franking credits should this proposal be enacted.

Finally, we believe that as the superannuation industry matures as a whole, as more members migrate to pension status, the loss of franking credit refunds will impact a growing number of people, be they members of government, industry, retail or SMSFs.

As such we believe this proposal may represent a ticking time bomb for the whole superannuation industry.

This article was authored by Dr Don Hamson. Dr Don Hamson is Managing Director at Plato Investment Management Limited. This article is for general information only and does not take account of any person’s financial circumstances.

1. We vary pension proportions in rests of 10% from 0% to 100%. For franking credits we used a normal level of franking credits as discussed above and then we doubled the level of franking credits to reflect a higher exposure to Australian shares and/or a higher franking yield from the Australian portfolios. We use two levels of contributions – none (reflecting for instance pension phase SMSF with greater than $1.6 million balances per member) and 7% of the accumulation balance which attract contributions tax of 15%. Similarly, we varied the taxable income level which can be caused by (for instance) realisation of capital gains. Full details of our assumptions are available on request.

Powerful data reveals strong link between our nation’s happiness and financial planning

People happiest with their lot in life are most likely to have a financial plan, according to the FPA Live the Dream report. The national research of working-age Australians also includes insights into the regrets, dreams, and attitudes to matters of money and life across generations, genders and geographies.

Almost one in four Australians (23%) surveyed believe they are living the dream. These enviably content people who dream big and are prepared to act of their plans are nearly three times more likely to seek the advice of a financial planner (24%) than those who describe themselves as not yet living the dream (9%).

Not everyone is content, however. The research also shows 80 per cent of working-age Australians are stressed about money and finances, with 1 in 4 indicating acute stress levels. Gen X and Gen Y are the most stressed about money and finance, and are the generation most likely to struggle with planning. Half of Gen Y (53%) finds planning their life hard. Two in five Gen X Australians feel the same way (44%), while Baby Boomers are the most likely to find planning easy to do (25%).

Read the full report here.

Changes to Centrelink assessments mean less age pension!

 

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Concessionally assessed, deeming provisions… unless you are a trained financial expert, determining how the changes to Centrelink assessment rules will affect your individual circumstances can be confusing. The good news is, it doesn’t have to be and there are a number of ways to minimise the impact. This particular legislation however, does come with a deadline (January 1, 2015) so it is critical that you seek advice regarding your options sooner rather than later.

The changes: The rules in regards to how your pension is assessed for Centrelink entitlements changes on January 1, 2015. These changes became law on 31st March, 2014. Going forward, normal Centrelink deeming rules will now be applied to superannuation account-based income streams. Currently these income streams are concessionally assessed for Centrelink purposes, which results in higher entitlements. According to the rules, indefinite grandfathering will apply to any superannuation pensions that are in place by January 1, 2015.

Who will be affected?

  • Retirees who change their superannuation product on or after January 1st, 2015 will be subject to the new deeming rules.
  • Retirees who choose to commute their superannuation pension on or after January 1st, 2015 will be subject to the new deeming rules.
  • Anyone looking to claim or getting close to qualifying for a pension, needs to do so before January 1st, 2015. If they are not receiving the pension by this time their super pension will be subject to the new deeming rules.

How will it affect you?

Currently, retirees whose Centrelink entitlements are affected by the income test, may choose to optimise their entitlements by investing in non-deemed investments, such as an account-based pension. An investment into an account-based pension entitles you with a non-assessable amount to reduce your chosen income payment. This often results in a much lower income assessment and, therefore, a potentially higher Centrelink entitlement.

From January 1st, 2015 new account- based superannuation pensions (started on or after this date), will be subject to deeming (applied when assessing a person’s eligibility against the Age Pension Income Test). This investment will be treated for example like a share or term deposit and may no longer be ‘income test friendly’.
This may result in a much higher income assessment and, therefore, a potentially lower Centrelink entitlement.
Those who may be most affected by the new deeming rules are individuals with additional income sources such as Government superannuation pensions (including pensions from overseas).

What to do:

The new rules will have a number of implications for many Australian’s and their retirement strategies. A good financial planner will be able to provide clarity around the issues and show you a range of likely outcomes. The important thing is to seek advice and plan now!

Finding lost super

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Have you lost $3,000?

That’s the average balance of a lost or ATO-held super account in Australia.

If you’ve changed jobs, done casual or part-time work, moved house or changed your name, then you could be one of the many Australians who have some lost or ATO-held super waiting to be found.

What is lost super?

Your super account will generally be considered ‘lost’ if:

  • No contributions or rollovers have been added to your super account in the last year and either your super fund never had an address for you, or mail sent to you by your super fund has been returned unclaimed,How can you find it?
  • or for employer default super plans, no contributions or rollovers have been added to your super account in the last five years.
If your super account is considered lost it could be transferred to the ATO if:
  • your account balance is less than $2000, or
  • your super fund is unable to identify you as the owner of the account based on the information reasonably available to them.

Your super could also be transferred to the ATO in certain other circumstances.

The ATO could also be holding other super amounts for you:such as Super Guarantee amounts paid to them by a previous employer or Government Co-contributions or Low Income Super Contributions paid by the government.

How can you find it?

Speak with your financial adviser today. A good advice firm will have an integrated service that will easily track and consolidate your super for you.

Another way to find your lost super is through the ATO SuperSeeker service, all you’ll need is your tax file number.

’10 x Income’ is Not Enough

Rice Warner
December 3, 2013

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The widely-used life insurance equation of ‘10 x annual earnings’ is not enough to secure a family’s long-term lifestyle, the latest underinsurance research from Rice Warner has revealed.

The consulting firm has released its annual ‘Underinsurance in Australia’ report, which found that in order for a family’s standard of living to be maintained in full, life insurance cover of an amount equal to 15 years’ income is required.

Similarly, TPD cover equivalent to 15 years’ annual earnings is required to ensure sufficient long-term finance for a family if one income-earner became permanently unable to work.

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According to Rice Warner, cover of around 10 times the annual earnings of an average Australian couple aged 40, with children, would only extinguish debt and cover existing expenses, until the youngest child reaches the age of 21. It would not replace any savings that could be accumulated if the missing family member was still earning an income, or match their predicted superannuation benefits.

In addition, the researcher warned families that they should not rely on government benefits, such as the Family Tax Benefit, or childcare benefits, as these provide only a modest contribution towards overall living needs.

Co-author of the report, Thierry Bareau, also warned that the rising cost of insurance could lead consumers to question the need for cover.

Rice Warner’s study showed that the average cost of death and TPD insurance in employer-based superannuation funds increased by 10% between June 2012 and June 2013, with some superannuation funds raising prices significantly more.

“The underinsurance problem could grow over the next few years if the insurance affordability issues are not resolved,” Mr Bareau said.

“As the cost of insurance inside super increases, members may start to feel that premiums are eroding their retirement savings, and they may decide to opt-out of the cover. Similarly, super fund trustees may decide to reduce the amount of cover they offer to their members to reduce costs.”

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He also highlighted the potential anti-selection issues which may be occurring within group insurance through superannuation, as members who may not be eligible for retail cover are taking advantage of introductory offers which enable them to top-up their cover without underwriting in the first 6 months of joining a fund.

Mr Bareau said one of the ways the industry could work to avoid this potential underinsurance crisis was to review the insurance benefits currently offered within superannuation, particularly in relation to the default level of life cover provided.

“The definitions around TPD may also need to be reviewed. TPD in super was originally intended to provide cover for people permanently unable to work in any role. But now, because of competitive market forces, these definitions have become looser, and people can receive benefits even if they can work in a different role than the one they originally performed. I think the industry definitely needs to take a look at this,” he said.

Reducing Aged Care Fees with Investment Bonds

As we get older it is a safe assumption that many of us will need to access aged care services. Like any other service we should also expect to pay for it, but what sort of fees should we expect and what strategies should we be thinking about to minimise them?

Aged Care Fees – At A Glance: 

If you need to move to residential aged care you can expect to pay several types of fees:

  • Entry fees – this is to pay for the right to live in the facility and is asset based
  • Daily care fees – pays for your care including food, cleaning services, nursing staff, electricity
  • Extra service fees – payable for higher levels of accommodation or services if the facility is accredited as extra-service.

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Note: The above chart shows fees current to 31 Dec 2013

The basic daily care fee is 85% of the single rate of age pension to ensure everyone can afford to pay these fees. If you have higher levels of income you will pay a higher fee. This extra income-tested fee could be up to $72.48 per day (current to 31 Dec 2013).

Planning Strategies

With good advice and careful planning, there are strategies you can implement to minimise aged care fees and potentially maximise age pension.
For example if you can reduce assessable income (using Centrelink rules) you can also reduce the income-tested daily care fee.

Some strategies include:

  • Pay a higher accommodation Bond
  • Rent and keep the family home
  • Gifting (limited to $10,000 per financial year or $30,000 in any five year period)
  • Funeral bonds (invest up to $11,700) or prepay funeral expenses
  • Investing in an investment bond through a family trust.

Investment bonds and the family trust

Family discretionary trusts can be used to hold assets for a number of reasons. This might be for management of family finances or taxation planning. If combined with an investment bond it can also be used to reduce assessable income for Centrelink and aged care purposes.

Under this strategy, a family trust is set up and money is transferred into the trust. The trust then uses this money to buy an investment bond.

Money held in a family trust is not assessed under the normal deeming rules for Centrelink/aged care purposes. Instead, the assessable income is the same as taxable income. This is where an investment bond can be handy. Earnings on an investment bond are taxed in the hands of the product provider, not the investor. So as long as no withdrawals are made (in the first 10 years), there is no taxable income to the trust. And if there is no taxable income, there is no assessable income.

If there is no assessable income, the daily care fees in aged care can be minimised and your age pension may be increased if you are on a lower pension due to the income test.

Is it always a good idea?

Everyone has a unique situation and the strategy can work differently for different people. The investment bond/discretionary trust strategy works better for people moving into aged care who:

  • Are self-funded and wish to reduce taxable income to retain the Commonwealth Seniors Health Card
  • Have high levels of Centrelink assessed income (for example from a super pension)
  • Are paying an income-tested fee.

As with many strategies, there is an upside and a downside. You should always seek advice to determine if this strategy works for you.

This information does not consider your personal circumstances and is general advice only. Before making any decisions based on this information you should consider its appropriateness taking into account your objectives, financial situation and needs. 

Copyright © KeyInvest Ltd (2013) All rights reserved.  Except as provided in the Copyright Act 1969, this work may not be reproduced in any form without the written permission of KeyInvest Ltd.

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