Understanding franking credits: more than icing on the cake
A broker once described dividends and franking credits as the icing on the cake but they are so much more than that.
Dividends are a crucial part of investment returns. For example, dividends made up 4.6% of the 7.7% total annual return from the S&P/ASX 200 Index over the past 10 years.
Then add in the franking that comes with dividends that is about a 1.5% credit and the total amount of dividend income becomes 6.1%, or about 68% of sharemarket returns.
Australia is one of only three countries, with New Zealand and Malta, that pay franked dividends to prevent double taxation of company profits.
Shareholders are given a franking credit from listed companies to offset against personal income tax.
As most superannuation fund members hold about 25% of their balanced super funds in local equities, dividends and franking credits are an important source of income.
Now 15% tax rates for superannuation accumulation funds and zero tax for pensions are much lower than the corporate tax rate of 30%. The Association of Superannuation Funds says, over 35 years, the dividend imputation adds about 8% to a retirement nest egg.
A franked dividend of $100 generates an after-tax return of $122 for an accumulation fund member and $143 for a pension fund member. These highlight how important franking is for retirees living on their pensions.
ASFA estimates that dividend imputation alone is worth about $4000pa in superannuation pension income for someone on average wages.
Self-managed superannuation funds hold even more Australian shares than managed super funds.
The tax office statistics for SMSFs reveal an average holding of 50%. Yet, remarkably, the government has mentioned targeting dividend imputation and possibly abolishing it.
"Removing or changing dividend imputation may seem like a quick revenue fix for the government now, but it will have negative long-term effects on Australians' retirement savings," says Pauline Vamos, the chief executive of ASFA.
"Initiatives like franking credits help to incentivise Australians to put money away for retirement as early and as often as possible," she adds.