The probability of Labor winning the upcoming federal election is high. Accordingly, fears are growing that Labor's proposal to abolish surplus franking credits could become a reality. However, there are still many hurdles to overcome before any such measure may come to fruition, so we continue to recommend that clients think carefully before taking any action.
What has been proposed?
From July 1, Labor proposes to remove the ability to claim surplus franking credits from investments and superannuation accounts. A surplus credit results when franking credits received from dividends are greater than the investor's marginal tax rate. Franking credits can still be used to reduce income tax to zero.
The proposal means those members with retirement pensions where the effective tax rate is zero will not be able to rely on franking credits "topping up" the pension account balance, effectively reducing the overall return for that account.
Changing investment strategies
Understandably, clients want to know if they should consider switching to alternative investment strategies. Should they switch out of Australian equities and move towards other asset classes such as international equities, hybrids or even property?
Our response to this is that if you are intent on changing your investment strategy make sure you have a realistic expectation of the type of returns other asset classes may provide. Remember, a higher rate of return usually means a higher level of risk. Are you comfortable taking on more risk in the chase for income?
"Just buying higher-yielding assets isn't always the right thing to do as the new asset might be less liquid or more risky and you might end up losing more in capital than you picked up in extra yield. As we see in equities all the time, a high-yielding stock often just means that a dividend cut is on its way. So don't just move out of a stock due to changing franking laws unless you can find assets that better suit your risk and yield requirements." (Impact and Opportunity: Bracing for Labor's franking credit overhaul - Lex Hall, Morningstar, Oct 2018)
It is also important to consider that most Australian shares provide a dividend yield and, even without franking credits, can still be better than a cash or term deposit rate. Indeed, many investment experts are suggesting the controversial franking credit changes may be an opportunity for investors, including SMSF members, to adjust long-standing biases towards Australian equities and diversify into other sectors where opportunities may be greater for income and total return. However, be cautious of re-structuring investment portfolios into more complex products where the only outcome is additional risk. Maintaining a balance of risk-adjusted returns without compromising the investor's risk profile will be the key.
In closing
When uncertainty sets in it's easy to forget original plans; that is, why retirement strategies were established as they were in the first place. It is also important to remember nothing has been set as law and while Labor is keen to introduce this change if elected, there are still hurdles to overcome in getting any legislation passed. Therefore, we believe it is too early to abandon existing retirement strategies.
Changing the asset allocation of an investment portfolio is certainly one solution to overcoming the proposed changes but make sure you are not introducing additional risk (volatility). Are you comfortable taking on more risk in the chase for income?
You should not move out of an investment due to a possible change in law unless there is an alternative investment that suits your risk and income requirements. However, this might be a time to consider what other investment opportunities may be available e.g. global solutions that offer comparable risk-adjusted returns. It is best to speak to your adviser before making any investment decisions.
- Boh Burima Financial Adviser Authorised Representative: 000341081 Morgans Financial Limited ABN 49 010 669 726 | AFSL 235410
