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How imputation changes will hit retirees

with Adam Butt and Gaurav Khemka

The Australian Labor Party has proposed a change in policy under which imputation tax credits can only be offset against existing tax liabilities, with some exceptions such as pensioners and charities. Retirees are the major group that would be impacted by this policy, given that most are untaxed and hence currently able to claim the full value of imputation credits as a tax refund.

Such a policy change would effectively reduce the returns that such retirees receive from investing in Australian equities by the amount of imputation credits, which average 1.3%-1.4% per annum for the Australian market overall. This is a significant number, noting that the expected long-run equity market return might be in the order of 7%-8% per annum. It is no wonder this policy is a subject of heated discussion and much consternation from those nearing or in retirement.

The portfolio effects of franking credits

Our research addresses what full access to imputation tax credits means for Australian retirees in two ways.

First, we ask how imputation could affect how they might invest. Specifically, we find that retirees are justified in having a considerable bias toward Australian equities in their portfolio to capture the imputation credits.

Second, we estimate how valuable imputation credits are to retirees. We confirm they are potentially the equivalent of a 5%-6% increase in spending during retirement.

Our approach involves modelling rational behaviour for retirees who are funding their retirement out of an account-based pension, and may access the age pension under existing eligibility rules. We model retirees with starting balances at age 65 ranging from $25,000 up to $1.6 million (i.e. the cap on tax-free retirement accounts). We assume retirees form their portfolios and drawdown on their pension accounts to maximise their spending outcomes until they die.

We also model two types of retirees with differing preferences. One type prefers a higher level of spending spread over the course of their retirement. The other type has a target spending level, based around either the ‘comfortable’ or ‘modest’ retirement spending standards of the Association of Superannuation Funds of Australia. (In technical terms, the first type is modelled using power utility, and the second using a reference-dependent utility function). The model is run both excluding and including imputation credits, and the difference compared.

Our first finding is that access to imputation credits can support holding a portfolio with a considerable ‘home bias’ to Australian equities, largely at the expense of lower exposure to world equities. The exact portfolio breakdown depends on how the analysis is set up, including the assumed type of retiree, their starting balance, and their age.

To illustrate the tenor of the results, consider a retiree starting with a balance of $500,000 at age 65, who targets spending at the 'AFSA comfortable' of $42,764 per annum. Excluding imputation credits, our modelling suggests that this retiree should allocate their portfolio on average over the course of retirement to 26% in Australian equities, 33% in world equities and 41% in fixed income. When imputation credits are included in the analysis, the portfolio breakdown comes out as 46% in Australian equities, 15% in world equities and 39% in fixed income – a notable home bias.

The reason for the sizable switch away from world equities under imputation is that Australian equities offer substantially higher returns for a retiree who can claim the full credits, but without a meaningful increase in overall portfolio risk. The limited impact on portfolio risk arises because Australian and world equities are substitutes to a large extent. The retiree is swapping one form of equity market risk for another in order to improve their outcomes on a risk/return basis.

The value of imputation credits

We then estimate the value to retirees of having access to the full tax refunds from imputation credits. We do this through converting the uplift in benefit (utility) arising from imputation into three measures that can be readily interpreted. Again, the exact estimates vary with modelling set-up, so we will convey broad averages across retiree types and starting balances.

We find that imputation delivers a value equivalent to an average 5%-6% increase in spending over the course of retirement, an 8%-9% larger superannuation fund balance at the point of retirement, or a 0.6%-0.8% per annum increase in returns on the portfolio during retirement. Such not-insignificant numbers underwrite the consternation among those in or nearing retirement about a potential change in policy.

Portfolio and policy implications

Our study suggests the policy change will have important implications.

First, academics have tended to view home bias as a ‘puzzle’ to be explained. Our findings suggest that equity home bias might be at least partly explained as a rational response to tax effects that lead to differential returns on investment choices which contribute similar amounts to overall portfolio risk.

Second, the benefit removal would likely have some substantive effects. To the extent that imputation credits supplement income in retirement, the loss of tax credits could exacerbate the problem of the adequacy of superannuation balances for supporting a reasonable level of retirement spending. To some extent, access to imputation credits in retirement might be seen as an alternative to making higher superannuation contributions while at work in order to generate retirement income.

Third, a change in policy might also result in retirees providing less support to Australian companies via the investments they make.

We also highlight the net cost to the government of providing access to imputation tax credits to retirees, accounting for the fact that there will be some offset through reduced age pension payments if tax refunds are retained. For example, we estimate a total expected net cost per individual over the course of their retirement of about $30,000 for retirees that retire with a $100,000 balance, and around $80,000 for those retiring with a $500,000 balance (in 2017-8 dollars). The largest benefit in dollar terms accrues to retirees with the largest initial balances, raising some questions around equality of the policy.


Dr. Gaurav Khemka and Associate Professors Adam Butt and Geoff Warren are from College of Business and Economics at The Australian National University. For the full research paper, click here.

The Australian Investors Association recently asked its members to send in their views on Labor's franking credits proposal. The replies have been compiled in a single document, linked here.

September 08, 2018

Still almost all the talk is about retirees and the impact on super funds.

What about a very low income earner who has saved a few thousand dollars in a LIC which invests exclusively in international equities. Under Labor’s proposal they will effectively pay a 30 percent flat tax on the one hundred dollars or so in fully franked dividends flowing from the LIC. A wage earner has to earn about 180k a year before they pay this (average) 30 percent tax rate.

This is one of the worst thought through and inequitable policies I have seen in many years. Labor are taking full advantage of the fact that few people understand it. I’m not convinced that messrs Shorten and Bowen do either for that matter.

Geoff Warren
September 08, 2018

The comments on our work are all very interesting, and much appreciated. (Except for the trolling about academics knowing nothing about the real world, presumably because of an assumption we have never had a real day job - far from the truth in my case.) I would like to shed light on a couple of matters.

Regarding James' comment that the numbers look too large, there are two things going on that explain the results. First, the value from imputation reflects both the direct value of the credits, and the fact that under our model the retiree increases their portfolio weight in Australian equities to capture the credits. About 60%-70% of the value is the direct effect, and about 30%-40% is due to the shift of weights. Second, compounding effects are at play. Income is being drawn out of a balance that is boosted by returns over a long period of time (i.e. through retirement). Adding a modest amount to those returns, say +0.40% on top of 6%-7% pa, goes a long way to boosting what that balance can provide over time. Having said that though, we a only talking about average results arising from a model. Is an indication, not a truth.

The other issue is how retirees might react in their portfolios if they loose access to the tax refunds. Greg Hollands suggests that they will still stick with the Australian companies they know. I'm sure some will. But I don't buy that a substantial change in after-tax returns will have no effect on behaviour. John De Ravin raises one mechanism by saying he'll think about closing his SMSF, and going to the big funds. For people that do this, a good portion should end up in balanced funds which will effectively change Australian/world equity mix. Taking away an explicit tax benefit will have its won effects, given that plenty of people seem willing to do things purely for tax reasons. (Right, Greg?) I also don't accept that investors are unwilling to buy overseas equities. Rather overseas stocks are typically held via ETFs and managed funds. Cuffelink readers may recall estimates by Graham Hand that SMSFs already have overseas equity holdings in the mid-teens when this aspect is accounted for. The stunning success of Magellan is testimony of the willingness of some to embrace overseas investment if motivated to do so.

September 09, 2018

Thank you Geoff and collaborators for the excellent analysis, the link to your paper, and your tolerant explanation to those who don't quite get it.

The availability of numerous ETFs and LICs in addition to managed funds makes it quite likely that older investors will consider switching to international equities; encouraged by their better performance over the past few years and with less concern for the franking credit 'cash back' if it is taken from us.

Your paper provides support for the potential changes to investing behaviour in the ASX by a huge number of individuals and SMSFs.

September 07, 2018

So many people claim they want the tax system to be fair - and they then embark on a class based or politically based rant.

Let's face it - the proposed change will remove one of the fairest processes in our tax system. Currently, what is collected from one payer is returned in full to the recipient irrespective of their position. The recipient is then taxed according to their tax rate.

Those supporting this change are not voting for equality and fairness.

There are many other aspects in the tax system that are unfair and those supporting this change don't bother to seek them out and debate them. Instead they adopt the propaganda of politicians.

If you really want fairness in our tax system then you will reject this proposal and look to other aspects of our tax system instead.

September 08, 2018

It would be the 'green' voters who are doing so, because they are the ones who want to redistribute the wealth from the 'evil rich', those who have or are currently working hard, sacrificing to be self-funded retirees (as all Gen X and Y will be, and will have to be by necessity...there won't BE a pension when we retire and even if there is, you won't want it.).

Ironically, the target of Robin Hood (the Greens) - the super wealthy - have systems in place and good accountants to play the tax game and quarantine their wealth - legally - from these things, whereas the general populace don't and will be the ones to suffer. If anyone thinks that feudalism really went away, they are sadly mistaken.

Once a law is in place, it's very hard to get rid of.

I say this because it is Gen X and Y who will inherit these measures, once the seed of an idea is planted, it won't go away. The boomers will likely never see it because by sheer weight of numbers, they would never vote for anyone who wanted this because it affects them most of all and the younger generations less.

September 07, 2018

Still almost all the talk is about retirees and the impact on super funds.

What about a very low income earner who has saved a few thousand dollars in a LIC which invests exclusively in international equities. Under Labor's proposal they will effectively pay a 30 percent flat tax on the one hundred dollars or so in fully franked dividends flowing from the LIC. A wage earner has to earn about 180k a year before they pay this (average) 30 percent tax rate.

This is one of the worst thought through and inequitable policies I have seen in many years. Labor are taking full advantage of the fact that few people understand it. I’m not convinced that messrs Shorten and Bowen do either for that matter.

September 06, 2018

Living frugally and working hard over our lifetimes as Primary school teachers, and still living in a 13 square house and utilizing the legislation of the time to our advantage we have managed to build a super amount large enough to be self supporting and have not taken a single dollar of pension and cost to the community
Now with super changes last year and labors impending stripping of excess franking credits,not even allowing for grandfathering for people who structured their finances of the laws of the day,we are regretfully thinking of restructuring our financial affairs if franking credits are removed to enable us to qualify for pension so now COSTING the government instead of being hitherto proud
self funded retirees doing their bit for the country.
How many others like us will now access pensions with these new labor ideas?
Have labor costed/considered fully the implications and effects of such changes?

John De Ravin
September 06, 2018

Hi Geoff, Gaurav and Adam

Thank you for the high level summary of your work on the value of imputation credits. That all makes sense, and as you say, provides a rational basis for the home equity bias.

I would like to make one observation however about responses to the new policy (assuming that Labour is elected and implements the policy). Whilst some individual taxpayers will be impacted, I foresee a potential shift out of SMSFs into industry or retail funds that allow “choose your own” investment options. I reckon SMSFs in pension will either wind up or at least dispose of the Aussie equities inside their SMSF and roll over the resulting balances to an industry or retail fund where they can reinvest in the same stocks and will continue to get the benefit of the imputation credits (because the fund is in a tax paying position). That is certainly what I will do. I won’t be happy about it because it’s a bit of a hassle but I will get full credit for imputation, and the new Labour government won’t benefit at all from the policy change. What it will do though is cause a lot of damage to the SMSF industry.

Thanks again for your article.

September 13, 2018

The Labor government will benefit if you roll your funds into union-supported industry funds.

September 06, 2018

I totally agree Chris.

Why is the bigger picture not being put out there? Every person in Australia with funds in super will be affected by this proposal not just retirees.

Lets get the message out now before an election happens.

September 06, 2018

Not seeing how the imputation credits changes could affect retirement balances that much.

Superannuation being taxable should still be able to use credits effectively (unless the fund has made a loss or tax has been reduced to nil by other deductions e.g. insurance premiums).

Given the changes to tax on TTR pensions prior to age 60, the proposed changes will likely reduce retirement earnings in the 5 to 7 year lead up to retirement where pre-retirees have implemented a TTR pension.

Using your 1.4% figure and a 25% Assumed allocation to Aussie shares in the lead up to retirement on $400k. At maybe an impact of half a percent per year I would think clients would expect about a 3% drop in retirement balance? This would also mean over 22 year drawdown the client would need to draw about 3.5% less income.

While not as big as your estimates, they're still big enough to mean one less domestic holiday every other year... Now that's my idea of the Australian dream

Greg Hollands
September 06, 2018

Well the analysis is somewhat flawed because, as usual, the academics who constructed the portfolio allocation have no idea of what goes on in the "real" world. Let me tell you from experience as a tax practitioner for over 35 years, that there is precious little "world equities" in the average retiree's investment portfolio, whether held within an SMSF or directly by them. Any such investments are generally quite small asa proportion of the whole and are tolerated rather than sought out by the majority of investors. The reason? Very simply that this demographic does not follow portfolio theory and they will generally invest in an Australian company they know ( and probably use) rather than an offshore one. So, the net result is that the financial impact of the proposed change is dramatically understated. I have done the same figures on several of my SMSF clients and the result is, in most cases, a huge reduction in net "take home" income for the year. This has focussed their attention on who might win the next election, and I am sure that once the wider community understands the impact ( Libs - where are you on this?) it will factor through in their voting options come the election.

September 05, 2018

Again, it's not purely about retirees. Stop joining with the politician's favourite game of "Divide, Conquer and Control" by pitting generations against each other.

My super fund as a Gen-X, like everyone else, gets franking credits and either pays tax due to the fund or gets them reimbursed if there is an excess and a difference between the tax paid and the MTR of the fund.

It is an issue that affects everyone who holds a super fund that invests anything in shares, pure and simple.

Gen Y
September 06, 2018

Chris haven’t you learned by now that Cuffelinks could be called ‘the baby boomer investing digest’... clearly their target market. the outrage over the $1.6m balance transfer cap was enough to see that, now we’ll see the vested interests lobby for coalition votes on here for the next 9 months to ensure the precious baby boomers never have to pay their way.

September 13, 2018


Interesting burn thrown your way here, or are you looking to change the name?


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