Article by Noel Wittaker as published on Noel News by Noel Wittaker
This newsletter is being written in Los Angeles where all our family are gathered for the wedding of our middle child James Whittaker who’s latest book gets a mention later in this newsletter. As you know markets are having a shocker, but I am comforted by the following words from Don Gimbel who runs the Geneva Advisors Global Equity Income Fund in which I have an investment. Don is a close friend of mine and has been managing money for high net worth investors around the world for more than 50 years. He will be our house guest next month when he visits Australia. He was referring to last week.
“For equity traders it was a very tough week. For those of us who are long term investors it was a week when the potential for a trade war and continued concern about direction kept us awake at night.
Our view is that the global economy continues on solid footing. We believe that economic growth during the balance of 2018 and well into 2019 will reward well managed companies.
Certainly there are worries, but remember that the market climbs a wall of worry.”
Labour's Tax Grab
The papers have been highlighting Labor’s latest attack in the class war they have created. To put it simply they are proposing that our imputation system be changed, so that excess imputation credits will not be available to low income taxpayers after next June. Of course, they claim it's taking away rorts from the rich but in fact it's the poorer people who will be the worst victims. So, let’s look at the proposal in details.
Labor claims that millions of dollars in franking credits are being unfairly claimed by members of large self-managed super funds. Once that may have been true; but not any more.
Until last July, self-managed superannuation funds could hold all their money in the tax-free pension mode and so get a full refund of all franking credits. But the Turnbull government axed this, and from July 2017 the most any fund can hold in pension mode is $1.6 million per member.
So a fund that had a balance of $10.2 million last June has had the goal posts moved. Now they will hold $3.2 million in pension mode, with the remaining $7 million in accumulation mode, where it pays 15% tax on earnings. When the self-managed funds do their tax return for the year ending June 2018 it will become clear that the amount of imputation credits refunded has already been massively reduced.
So Labor’s claims of $59 billion in extra tax revenue are not credible.
If the government introduces a tax like a GST, they can depend on a growing source of revenue over time. But the really large self-managed superannuation funds are on the way out. Remember that now, thanks to the Turnbull government, upon death of a member the most that can be left to a beneficiary inside superannuation is $1.6 million.
Given that the majority of members of really large funds are at least 65 years of age now, it is obvious that within 25 years most of them will be dead, and funds with these big balances will no longer exist, due to the removal of most of the money when a member dies.
So the new tax will not produce a growing income stream from surplus imputation credits being forfeited. It will be a rapidly reducing income stream.
Let's look at this on a case-by-case basis. Members of large retail funds will be unaffected, because these funds invest in a wide range of assets including cash, property, international shares and bonds as well as Australian shares. Only Australian shares carry franking credits so it's a simple matter for the funds to work their asset mix to optimise their after-tax returns.
Large self-managed super funds will do exactly the same thing. They are already making adjustments because of the increase in tax from zero to 15% on a large part of their income, and they will continue making adjustments as need be in the future. After all, it's not difficult to replace a share paying 6.5% plus franking credits of 2% with an investment in non-residential property, which pays an unfranked 9%. Furthermore, they may well raise their exposure to international funds, which favour growth at the expense of income.
In my view a large self-managed fund can change easily strategy to completely avoid Labor’s proposed tax hike.
Ironically, it will be the vulnerable who will be hit hardest. Think of a couple on the full pension with $70,000 in the bank and $200,000 in blue chip shares, paying dividends of $9000 a year plus franking credits of $4000 a year. Under Labor’s proposals they would no longer be able to claim a refund of those franking credits, and so would be $4000 a year worse off. That sum might be the difference between having private health insurance and going without.If you follow my reasoning, it is obvious that Labor’s new tax will go the way of the mining tax: it will create a lot of angst for a tiny return at best. It really is a pity that the weak will be those that get hurt the most.
Change the asset mix or else individual investments. For example, I have money in both the IML Equity Fund and the IML Concentrated Share Fund. For last five years their respective numbers per annum are:
Income 8.4% Growth .97%
Income 5.2% Growth 5.5%
So I could just switch to the higher growth option and reduce the fund’s income. There are alternative investments like the Blue Sky Water Rights Fund that doesn’t pay franked dividends, or the Sentinel Property Group paying around 9% per annum unfranked. My fund is in both of these.
There are loads of alternatives around. And more will be created if Labor gets in. Never underestimate the ability of ordinary people, and of course their advisers.
Cash out of the super system and buy property. In my view that would be a very silly idea but I reckon a lot will regard Labor’s changes as the last straw, buy rubbish property yielding a net 3% and do their dough.
Simply close the SMSF and roll over to a large retail fund as I mentioned above. The outcome would be no refund of franking credits for Labor. For example, the Sunsuper balanced pension fund has averaged 10.6% per annum over the last five years.
Move part of your fund back to accumulation mode. There would be no net tax saving as part of the franking credits would wipe out both contribution tax and earnings tax, but it would stop the mandatory drawdowns that must be done in pension phase. Also, you may be able to add the children as fund members and soak up their 15% contributions tax with excess franking credits.
They will be the ones hit. Think about a pensioner with $300,000 in shares outside super paying $15,000 a year plus franking credits of say $6000. They would lose $6000 a year but as the asset is deemed – no increase in pension to compensate.
I reckon most SMSFs owner will take steps to defend themselves leaving only the very poor to cop it. But, above all I really do believe it’s is the last straw for people in super. Turnbull got the ball rolling – now Shorten has picked it up. These latest measures simply confirm what most people think now.
To make matters worse for everyone, the Turnbull “reforms” have made it practically impossible for the younger generation to build big superannuation balances. If they make a concessional contribution of $25,000, and earn more than $250,000 in that year, the government will take 30% of their contribution. If they choose to make an after-tax contribution of $100,000, the maximum, they will be paying tax at up to 47% on the income from which the after-tax contribution is derived.