Franking Credit and Tax Benefit

Today we would like to share a strategy with you to boost your income! Sounds exciting right! If you’re looking for ways to boost your retirement income, there’s a simple and smart strategy to get more out of your investments. The returns you’re receiving on your shares could be even higher, by making the most of Franking Credits.

How it works

Franking credits are tax credits that a company distributes to its shareholders with its dividends, representing tax the company has already paid. When your shares return a profit, the company pays corporate tax on the dividends. You receive the dividend with a franking credit attached to it for the amount of tax the company has already paid – which you may be able to get back as a rebate. If the amount of tax you’re required to pay is less than the franking credit, the ATO will give you a refund on the difference.

Make savings on tax

For example, your share in a company returns a dividend of $100. The company pays 30% tax or $30, which means you receive the remainder of $70 plus a $30 franking credit. But if your marginal tax rate is 10%, you should only have paid $10 in tax.

You’re required to declare your dividend income each year on your tax return. So when you declare your taxable income of $100 in dividends, you’ll get back the difference between your franking credit ($30) and the tax you should have paid ($10) – a saving of $20. And if you’re not eligible to pay tax, you’ll get a refund of the entire amount of the franking credit.

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Power of franking credits

Now let’s look at the effects of taxation on this investment by comparing four investors, all on different tax rates:

Investor 1 Investor 2 Investor 3
Tax rate 15% 25% 45%
Dividend $750 $750 $750
Imputation credit $250 $250 $250
Taxable income $1,000 $1,000 $1,000
Gross tax payable $150 $250 $450
Franking credit rebate $250 $250 $250
Tax payable/ (refundable) ($150) $0.00 $200
  • Investor 1 receives refunds.
  • Investor 2 does not have to pay any extra tax despite having received $750 in income.
  • The higher income earner, Investor 3, has to pay some tax on his $750 dividend but he has reduced his tax rate on this income considerably due to the franking credits attached.

 How do imputation credits fit into your portfolio?

Before considering the tax advantages of dividend imputation, it needs to be understood that to benefit from imputation credits it is necessary to invest in the share market. Such an investment carries risks as well as rewards.

Once you have determined, our financial adviser can provide you the guidance on, how much of your portfolio you are going to invest in Australian shares, you can then look at how valuable imputation credits will be. A very small exposure to shares is not likely to produce significant tax benefits from imputation credits.

Within a superannuation fund, imputation credits can reduce (or eliminate) tax on investment earnings, and on new contributions to the fund. Superannuation funds are also entitled to a refund of excess imputation credits.

The selection of fund managers and/ or direct equities to satisfy the asset allocation requirements for your portfolio requires considerable market research and product knowledge.  The experienced advisers at iAdvice have resources available to assist you with selection of investment assets to meet your longer-term wealth accumulation strategy: in determining your strategy.

Generate a retirement income stream

Now imagine this difference multiplied by all your investment dividends – and it can really start adding up. The trick is to work this to your advantage, and turn your franking credits into a secondary income for your retirement. Because your shares pay dividends on a regular basis, usually every six months, by growing your investments you can generate a secondary income stream to help boost your pension payments.

Want to know more?

Every financial situation is different and franking credits may not be a tax advantage for everyone. If your marginal tax rate is higher than corporate tax, you may even end up paying more on top of your franking credit come tax time. To know more about dividend imputation click here.

For advice and investment strategies tailored to your financial goals, speak to us today on (03) 8658-8875; or arrange an appointment.[maxbutton id=”2″]

 

Sources:

https://www.ato.gov.au/Business/Imputation/

http://www.investors.asn.au/education/shares/understanding-shares/franking-credits/

http://www.continuumfp.com.au/dividend-imputation-and-franking-credits/

http://frankingcredits.com.au/

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