Much has been said and written about the Labor party’s policy to stop franking credits from producing tax refunds, about how this policy is unfair and how it could result in many SMSFs being wound up.
If this policy became legislation, however, I believe it could result in an increase in numbers for SMSFs instead.
This seems counter-intuitive, given many of the arguments floating around at the moment, but let me explain.
Members of funds that have double the typical level of franking credits will be adversely affected if 50 per cent or more of the fund’s members are in pension phase. This means in addition to members of SMSFs, members of smaller industry funds with many older participants could also find that Labor’s franking credit policy disadvantages them.
To understand how pension members will be disadvantaged if there are not enough in the fund in accumulation phase, you need to understand how the current system works.
A fund with two members in pension phase earning $14,000 in fully franked dividends, with $6000 in franking credits, now receives a refund of $6000. Under Labor’s policy, no tax refund of the franking credits would be received and the members would be $6000 worse off.
If the same fund had two other members in accumulation phase that made concessional contributions of $40,000 in that year, the pension members would get the benefit of the $6000 in franking credits, as they would be used to pay the income tax of 15 per cent on the $40,000 in contributions.
If, instead, the fund had only one member in accumulation phase, who made concessional contributions of $20,000, the pension members would be worse off by $3000, as the fund would not get a tax refund of the excess franking credits.
This means a fund with a greater number of members who make taxable concessional contributions has a greater chance of its pension members not being disadvantaged under the proposed policy.
One of the stated objects of the policy is to close a supposed loophole that SMSFs are allegedly exploiting.
Recent modelling by Dr Don Hamson, managing director at Plato Investment Management, shows traditional Labor voters in industry funds could be in for a rude shock.
“We believe that as the superannuation industry matures as a whole, as more members migrate to pension status, the loss of franking credit refunds will affect a growing number of people, be they members of government, industry, retail or SMSFs,” Hamson wrote in his study.
Funds totally in pension phase – in practical terms, SMSFs – will be the biggest losers with this policy, Hamson’s research outlines. The modelling also shows that members in funds that have a typical level of franking credits will not be affected, as long as the proportion of members in pension phase is less than 70 per cent.
So rather than Labor’s policy resulting in people with SMSFs moving into Australian Prudential Regulation Authority-regulated funds, it could result in more SMSF members.
This is because, while increased administration and complexity often work against having children join an SMSF, it could make a great deal of sense for an SMSF with two parents in pension phase to have up to two of their children who are in accumulation phase join the fund.
If Labor’s policy becomes legislation, it could result in SMSFs becoming intergenerational family institutions. This would result from parents starting an SMSF, having their children in accumulation phase join when they commence pensions then, after the parents die and their children go into pension phase, having their children (the grandchildren on the original members) join the fund, and so on for each successive generation.
If the Coalition’s plans to increase the limit on number of SMSF members from four to six become legislation, and then Labor’s franking credit policy becomes law, the increase in SMSF members could be even more dramatic, given our ageing population.