Retirees out of pocket under proposed tax imputation policy

25 September 2018

By buying Australian shares that are fully franked people actually end up with a real kicker to their investment return.

Economic modelling from ANU has found the Australian Labor Party's proposal to end cash refunds for excess imputation credits will result in a significant hit to the hip pocket of retirees, and that the effect would be similar to reducing the average superannuation fund balance at the point of retirement by up to nine per cent.

The research also showed under current laws, excess imputation credits deliver on average a five to six per cent increase in spending power over the course of retirement.

The dividend imputation scheme was introduced by Prime Minister Paul Keating in 1987 to prevent the double taxation of dividends: once as company profits and then again as personal income.

The Howard Government later modified the scheme to allow individuals and super funds to claim cash refunds for any excess imputation credits not used to offset their tax liabilities.

The Federal Opposition proposes to reverse the Howard Government's changes, if it wins the next federal election.

Associate Professor Geoff Warren of the ANU College of Business and Economics said according to the modelling, Labor's proposed changes would have a significant impact for many retirees, particularly those that are self-funded and don't qualify for the pension.

"It's a pretty hot button issue amongst retirees at the moment," Associate Professor Warren said.

"By buying Australian shares that are fully franked people actually end up with a real kicker to their investment return.

"That benefit we found is worth up to five or six per cent in income during retirement on average. It's a pretty large number.

"So threatening to take it away is quite significant for some," he said.

Associate Professor Warren said the modelling also looked at how the policy change may lead to a shift away from Australian stocks.

"Under the current system, having access to imputation credits can support holding a portfolio with a considerable 'home bias' towards Australian equities. Equity home bias is often seen as unjustified, but the research suggests it is a rational response to return differences. 

"For example, consider a retiree starting with a super balance of $500,000 at age 65, who targets spending $42,764 per annum.

"Our modelling suggests when imputation credits are included, this retiree should hold 46 per cent in Australian equities on average over the course retirement to achieve that target.

"When imputation credits are excluded in the analysis, retiree should hold 26 per cent in Australian equities.

"It's a considerable difference."

"A change in policy might result in retirees providing less support to Australian companies via the investments they make," he said.

The study also analysed the net cost to the government of providing access to imputation tax credits to retirees. The results showed an estimated total net cost per individual over the course of their retirement of about $30,000 for retirees that retire with a $100,000 balance, and around $80,000 for those retiring with a $500,000 balance.

The three authors of the paper are Associate Professor Warren, Associate Professor Adam Butt and Dr Gaurav Khemka.

The full paper titled What Dividend Imputation Means for Retirement Savers is available on SSRN at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3238995