Many of you will have seen the term franking credit appear on your share dividend statements, but what does a franking credit actually mean and how you can benefit?
What is a franking credit?
When an Australian-listed company posts a profit, it is standard practice to redistribute those profits to its shareholders in the form of a dividend. As the profits have already been subject to Australian company tax of 30 per cent the shareholder is entitled to a rebate (partial to full) from the ATO for tax already paid if their marginal tax rate is less than 30 per cent.
On the dividend statement, the company tax paid is referred to as a ‘franking credit’.
In the case of retirees that pay zero tax, franking credits are 100 per cent refundable, which means they can significantly boost the returns for pension phase investors.
The importance of franking credits for retirees
The graph below compares the after tax return of a $1 dividend franked vs unfranked for pension phase investors, super funds and individual investors on the top tax rate of 49 per cent. As you can see per dollar of dividend the zero tax rate applied to pension phase investors allows them to benefit most from a fully franked dividend, leaving them approximately 22 cents and 70 cents better off than super and top tax rate investors respectively.
The after-tax value from a $1 dividend franked vs unfranked for differentAustralian investors.
What difference does franking make?
The table below, compares the performance of the standard S&P/ASX Accumulation Index with that of a new ‘tax aware index’ (the S&P/ASX 200 Total Return Tax-Exempt Index) which fully values franking from the perspective of tax exempt investors such as charities or pension phase investors. The additional returns from franking credits are close to the current cash rate and, when accumulated over three years add an extra 7.2 per cent to returns.
Performance of Australian shares before and after franking for the three years to 31 December 2014
As you can see, over time franking credits can have a significant impact on your returns, particularly if you are in pension phase or are a tax-exempt investor. Therefore, if you are a retiree or nearing retirement, you need to understand the benefits of franking and how you can structure your investment portfolios effectively.
Source: Plato Investment Management
To find out more, speak to your Leenane Templeton financial planner today on 02 4926 2300.
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