Interest rates are on the rise, and retirees who choose to leave the bulk of their savings in a bank account will be rejoicing. However, such rises - when they do occur - will be small and spasmodic and won't do much to help.
Why do people choose to keep so much money in cash? I'm not sure, because it is a choice - and there are such great alternatives available in the form of shares that pay franked dividends.
Given the extraordinary advantage they offer, I am amazed that when I give a speech and talk about franked dividends, usually 80 per cent of the audience have no idea of their existence.
In the bad old days, dividends suffered double taxation. First the companies paid tax on any profits they made, then shareholders were taxed when they received the tax-paid profits as dividends.
As the top marginal tax rates then were over 60 per cent, it meant the total tax-take could be as high as 78 per cent. Many turned to devices like the infamous "bottom of the harbour" schemes to try to reduce their tax burden.
Fortunately, since July 1, 1987, dividends from companies that have paid Australian company tax carry imputation credits. "Impute" means to "give credit for" and this is exactly what the imputation system does.
It allows shareholders to receive credit for the tax paid by any company in which they hold shares, so that they pay tax only on the difference between the company tax paid and their own tax rate. Dividends that carry imputation credits are called "franked dividends."
Suppose a company made $1,000,000 profit, paid tax of $300,000, and distributed the after-tax profit of $700,000 in dividends to its shareholders.
The $300,000 of tax paid entitles the shareholders to $300,000 in imputation credits. If you had $140,000 worth of shares in that company, and it paid it you a dividend of $7000, it would include $3000 of franking credits.
Those credits are as good as cash. This means you have to pay tax on them; so, even though you received only $7000, you have to declare $10,000 ($7000 + $3000) as taxable income.
That's the bad part - now comes the good bit. You can use those credits to offset your tax bill and possibly even reduce it. And if you have more franking credits than you owe in tax, the balance will be refunded to you.
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Case study: You are retired, drawing a tax-free account-based pension and receiving a part age pension. Your only other income is $2000 from bank interest, and $7000 from the dividends we mentioned above. Your taxable income is: Age pension $10,000; Bank interest $2000; Dividends $7000; Imputation credits $3000; Taxable income $22,000.
This is below the effective tax-free threshold, so you get a full refund of $3000 of imputation credits. That dividend wasn't just tax-free, it carried a tax-free bonus. Your initial yield of 5 per cent has turned into 7.1 per cent.
But the benefits of franking credits don't stop with self-funded retirees. For a person in the $45,000 to $120,000 a year bracket, with a marginal tax rate of 32.5 per cent, the tax on franked dividends is minimal, as 30 per cent of it is already taken care of with franking credits.
This begs the question - where can a retiree get "safe" investments that will pay the franked dividends? One of the simplest options is an index fund that matches the All Ordinaries index.
Certainly, its price per share will fluctuate in line with the stock market, but it's impossible for it to go broke, and these funds are currently paying around a 4.5 per cent dividend, which is 80 per cent franked. That sure beats trying to live on bank interest!
Just remember to keep enough money in the bank for three years' planned expenditure so you can switch to spending that during any significant drop in the market, which is bound to occur.
You wouldn't want to sell perfectly good index fund shares at a loss just because you didn't have a buffer, would you?
Noel answers your money questions
My wife is 58 and I will turn 65 soon. She stopped working last year for health reasons, and I would like to finish work in the near future. I have $800,000 in super and she has $150,000 in super. We own our home, have no debts, and hold $150,000 in term deposits and cash. We can live comfortably on $60,000 a year.
We are not high risk takers and would like to leave our money in super, but invest most of it in low risk areas, hoping to earn 5 per cent a year. Do you think we can achieve this as I would prefer to stop working if possible?
This is a challenge - you say you are not risk takers but to my mind leaving all the money in very conservative assets is one of the riskiest strategies of all. If you go to the retirement drawdown calculator on my website www.noelwhittaker.com.au you will find that $1 million of capital earning 5 per cent per annum will last for just 21 years if you draw an indexed income of $60,000 a year, but if you could achieve 7 per cent per annum the money would last for 28 years.
The latest report from Super Ratings shows that for the 10 years ended September 2021 good balanced funds achieved 9.1 per cent per annum, whereas the capital stable funds achieved just 5.5 per cent. You really need to talk to your adviser about designing an asset mix inside super which would give you the right balance of reasonable growth and defensive assets. This should suit your goals and your risk profile.
My widowed mother does not own a house and her dementia has reached a point where she needs to go into an aged care home. I am looking at paying the bulk of a refundable accommodation deposit (RAD) for her for the aged care home (the small balance of the deposit being paid by another sibling). When my mother dies would the accommodation deposit be paid back proportionally to the contributors, or would it be paid to my mother's estate, in which case others would benefit. I understand that because of my mother's dementia, she cannot make a new will to cover this situation.
Andrew Biviano of the Alteris Financial Group says that where a RAD has been paid to a residential aged care facility that provides government-funded services, the balance of the RAD needs to be paid to the estate of the resident when they die. This is an important consideration, as assets of the estate are then distributed according to the will, or the rules of intestacy in the event of no will.
Accordingly, this may lead to a scenario where the person who paid a RAD on behalf of their loved one does not receive the funds back as they may have thought. As wills and estate planning is a complex area, it is important to seek legal advice as there may be options for changing the will or putting other agreements into place to have the monies repaid.
Accommodation costs can be paid in numerous ways, which includes a lump sum, daily payment, or any combination of the two. RAD payments can only be made by residents who meet a means assessment at the time of entry. Although RAD payments are exempt for age pension purposes, they do count as an assessable asset for aged care purposes which can affect the means-tested care fee payable by the resident.
Seeking specialised aged care advice can help you clarify these items, understand the financial implications of a move to care and the options that are available to fund these costs.
I am surprised that in your references to capital gains tax on investment properties you never mention the fact that the interest claimed against rental income during the time of ownership must come off the cost base and therefore increases the capital gain, induces any capital loss on sale. I think people buying investment property should be made aware of this.
That is not strictly true. Interest does not reduce the cost base of a property, ever. However, non-deductible expenses such as renovations are able to be added to the cost base. Just keep in mind that any properties acquired after August 20, 1991 get special treatment.
Even if they are not eligible for a capital gains tax exemption, provided they have not been producing income, all expenses such as interest, rates, and land tax are allowed to be added to the base cost. This is particularly appropriate for holiday houses which are not rented.
We lost our pension because our assets increased over the asset test cut-off point. However the assets have now reduced to $847,000 and we are looking to revive our pension. Will Centrelink pay us automatically or will we have to apply again.
You will need to reapply for the pension, but keep in mind that Centrelink only back pay the pension to the date that your claim was submitted for processing.
For example, if you submitted your claim on 1 November and it was granted on 1 December you would receive one month's backpay. All pensioners have an obligation to notify Centrelink of changes to their circumstances within 14 days to avoid an overpayment.
This includes changes to income and assets such as, but not limited to, bank accounts, personal investments, superannuation, home contents and motor vehicles.
- Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance. Email: firstname.lastname@example.org
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