What the election could mean for your Investments.

The final days are drawing near as Australia readies itself to vote.

The tax has been one of the main battlegrounds for the two major parties, with Labor’s proposed taxation policies set to make sweeping changes to franking credits, capital gains tax and negative gearing.

Here’s Kofkin Bond & Co’s guide to what the proposed changes could mean for you if Labor gets elected.

·        Franking Credits

·        Capital Gains Tax

·        Negative Gearing

 

Franking credits

What is it?

Dubbed the ‘retiree tax’, Labor plans to remove cash refunds for franking credits for everyone who doesn’t receive a government pension or allowance.

ASX listed companies can pay franked dividends to their shareholders. A franked-dividend is a dividend with an attached tax credit – equivalent to company tax paid.

Fully franked dividends are valuable to retirees because the tax credits can be claimed back as cash. Retirees with a 0% tax rate in their account based pension can receive an increase of up to 43% on the cash value of franked dividends.

Who will be most impacted?

Generally, self-funded retirees and SMSFs. Refundable franking credits cost about $5b per year and are enjoyed by 6% of the population. A large number of self-managed super funds use excess franking credits to claim cash refunds.

While the proposed changes bring the rules back to what they were prior to 2000, many investors and super funds have become reliant on the refunds for income and are fighting to maintain them.

Women will be disproportionately affected by the potential changes as women make up 56% of self-funded retirees. 68% are over 60 and 47% are single or widowed. The income many women rely on could be greatly diminished.

How would it change how self-funded retirees and SMSFs invest?

One measure retirees may be considering is to sell their Australian shares to pick up the age pension (or more age pension) and then invest the proceeds in renovating the family home. The disadvantage of this strategy is that it puts all your eggs in one basket and limits your ability to enjoy portfolio growth and income going forward. You can’t earn an income from your family home nor sell the bathroom if you need a lump sum of cash.

A more advisable strategy for SMSFs with concentrated exposures to Australian shares could be to re-balance investments to increase taxable income from other sources. A very effective way of doing this to invest in ETFs which provide taxable income from a variety of investments sources like bonds and global shares.

Including different diversified ETF investments will reduce SMSF and self-funded retiree reliance on franking credits refunds, which they’ll no longer receive, and also reduce their portfolio risk. It’s now about the best total return before franking credits.

Kofkin Bond & Co does this through our diversified portfolios. We’re already
seeing some SMSFs and self-funded retirees transitioning their portfolios from concentrated Australian shares to a diversified Kofkin Bond & Co portfolios which have a focus on total return, rather than just income?

120,000 SMSFs own ETFs already. Of the $42 billion invested in ETFs in Australia, roughly half has come from self-managed super funds abandoning direct shares for a better diversified, lower risk strategy. This figure will rise should Labor win the election, particularly in global share market ETFs and Australian bond ETFs.

How could it impact Kofkin Bond & Co portfolios?

With the Kofkin Bond & Co portfolios, you receive the benefit of franking credits but are less reliant on them because your portfolio is diversified across different Australian and Global sectors and asset classes. For example, the Kofkin Bond & Co portfolios returned 0.270% to 0.685% in franking credit value in 2018.

We expect SMSFs and self-funded retirees will be more interested in adding Global shares to their portfolios to benefit from international companies better growth prospects should franking credit cash refunds be removed.

Capital Gains Tax

 

What is it?

Labor plans to halve the capital gains discount for all investments purchased from January 1, 2020. Capital gains tax is applied to the profit difference made between the buying and selling price of an investment (after costs are deducted) and is added to your income and taxed at your marginal rate.

If you’ve owned the investment for more than a year just half the capital gain is added to your taxable income — a 50 per cent discount. Labor’s policy will reduce the capital gains tax discount for investments that you own for longer than 12 months from the current 50 per cent to 25 per cent. Importantly, all investments made before January 1, 2020, will NOT be affected and will be fully grandfathered (ie: you keep the 50 per cent discount).

Who would be most affected by Labor’s proposed changes to capital gains tax?

Similar to income tax, higher income earners account for most of the $6.7 billion per year in realised capital gains. Of the 540,000 Australians who do pay capital gains tax, 29% are in the top 10% of earners by taxable income.

Partnered women are over-represented, paying 19.4% of personal income tax but an outsized 28.7% of capital gains tax. This is what you would expect if couples planning to minimise tax put the asset they were planning to buy and sell in the name of the lower paid partner.

How could it change how people invest?

Franking credits has stolen the limelight but the proposed CGT changes could have a longer lasting impact on more people especially when considering future inheritances many decades into the future. Unfortunately, this policy would make investment less attractive. Fewer people may invest instead of leaving money in the bank or simply hold on to poor performing investments.

However, since existing investors will be grandfathered before 1 January 2020, it could lead to an unprecedented amount of money flowing into shares and investment property over the second half of the year to take advantage of the future tax benefit. All other factors being equal, investing $10k in a diversified portfolio returning 7% for 10 years you’ll be $1,000 better off investing with the 50% CGT discount compared to a 25% discount.

This new tax will not affect investors in SMSF’s or Account Based Pensions when they are over age 60 and in the pension phase. A zero tax bracket will still only attract a $0 CGT liability within the fund. E.g. an investment property bought within an SMSF for $600k sold some date in the future when the members are retired and over age 60 for $1.6mill will have a $1mill realized Capital Gain but $0 tax payable. This same property in an individual’s personal name could attract a CGT liability of $375,000. Correct and beneficial ownership of assets is vital in long term planning.

How could it impact Kofkin Bond & Co portfolios?

If Labor win and are able to push ahead with this policy Kofkin Bond & Co clients who make regular top-ups may consider bringing forward some of their long term investment into 2019 to take advantage of the higher tax shield. Investing ahead of the changes is more attractive the longer your investment time horizon. Also, we have a low turnover of assets within our model portfolios which helps lower yearly tax liabilities.

Negative Gearing

 

What is it?

People invest in properties to make money on the value of the property increasing in the long-term (ie the capital gain) and the rental income. Quite often the rental income doesn’t cover the costs of the mortgage, maintenance, agent fees and land tax. However Australian law allows investors to deduct losses they make on their investment property from their taxable income, this is called being ‘negatively geared’.

Labour proposes to limit negative gearing to newly built housing from January 1, 2020. As with the CGT changes, all property investments made before this date will not be affected. So if you already own investment properties you will still be able to claim deductions on those properties against income.

Who will be affected?

Approximately 1.26 million Australians own negatively geared residential investment properties and high-income earners are more likely to be negatively geared.

How could it change the way people invest?

Australians have a love for a property like no other nation. Yet it’s likely owning an investment property after January 2020 will become less attractive without the added benefits of a tax discount.

We expect we’ll see more money flow into the share market as investors seek growth from other growth assets. Opponents to the proposed policy change say it could lower property prices and push rents up and plunge the economy into a recession.

How could it impact Kofkin Bond & Co portfolios?

This change won’t directly impact the Kofkin Bond & Co portfolios since we don’t advise clients to borrow to negatively gear but have always been proponents of neutral gearing and we also only recommend brand new properties. However, the share market and ETFs are likely to be beneficiaries if the tax benefits of owning investment property are discontinued.

What should I do?

If Labor wins the election, we’ll update this page with our take on what actions investors may want to consider before the changes take place. Until then, happy voting on 18th May.

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