What Is All The Fuss About Dividends?
Tracy Askwew | Oct 21, 2016 12:15
Many of my clients know how much I love dividends and the franking credits attached to them. So I thought I should go over them again after reading recent research from the Association of Superannuation Funds of Australia (ASFA).
ASFA found that if you had 30% of your Superannuation money allocated to Australian equities over a 35 year accumulation period then your lump sum at retirement would be approximately 8% higher from the franking credits attached to your dividends than it would be without them.
It is certainly worth learning what Dividends and Franking Credits are all about if you could end up with more money from them when you retire.
Firstly for those of you who aren’t familiar with investing in shares, when you purchase shares you become a part owner of the company. For example when you buy shares in Woolworths Ltd (AX:WOW) you become a part owner of not only your local Woolworths store that you may buy your groceries at but a part owner of all the other stores around the country and everything else they own such as Big W, BWS and Dan Murphy’s to name a few.
When Woolworths makes a profit they keep part of the profits to grow the business and pay the remainder to shareholders. These profits are called dividends and are paid every six months.
On top of receiving dividends you may also receive franking credits, which is a reduction in the amount of income tax that must be paid on the dividends that you receive. Basically the reduction is the amount of tax already paid by the company. In a Super Fund these franking credits can be extremely beneficial.
Retail Food Group Ltd (AX:RFG) (some of the companies they own are Gloria Jeans, Crust Pizza, Pizza Campers, Brumby’s and Donut King) is just about to pay a dividend to shareholders so let’s take a look at the returns we could expect from their dividends and franking credits over a year period.
Retail Food Group is trading at $7.15 and is paying a $0.145 dividend in October and is likely to pay another $0.13 in April next year. Let’s assume you purchase 1,000 shares costing you $7,150 (not including brokerage).
In line [1] you can see that regardless of what tax rate you are on if you owned 1,000 shares in Retail Food Group you would receive $275 cash into your bank account (this is the $0.275 of dividends times by the 1,000 shares you have purchased). The company would also provide you with $118 of Franking Credits (you do not receive these as cash you receive a statement showing them and use them when you lodge your tax return) so your total assessable income would be $393.
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In my example I have shown a person who is on a tax rate of 30%, a Super Fund in Accumulation Phase paying 15% and a Super Fund in Pension Phase paying no tax at all. If you were on the 30% tax bracket you would be paying $118 in tax but this would be reduced by the franking credit of $118, therefore, as you can see in line [2] no tax would be paid at all on the dividend received. If you had bought the Retail Food Group shares in your Super Fund and were in Accumulation Phase you would pay tax of $59 but once again this would be reduced by the franking credit of $118, therefore, you would actually receive $59 back from the tax department. Are you starting to see why I love franking credits so much! Finally if you received these dividends in your Super Fund and you are in Pension Phase you would not be paying tax at all, in fact when you lodge your tax return you will receive the franking credit of $118 from the tax department.
So as you can see the return on the cash received in your bank account is 3.85% (this is the cash dividend of $275 divided by your initial investment of $7,150) regardless of what tax rate you are on. The grossed up yield which is the cash amount you received plus the franking credit is 5.49% this is also regardless of what tax rate you are on. Lastly the after tax yield if you are paying tax at 30% is 3.85%, 4.67% if you purchased the shares in your Super Fund and are in Accumulation Phase and 5.49% if you purchased the shares in your Super Fund and you are in Pension Phase.
Now you know why I love dividends and their franking credits, because these after tax returns sure beat 2.5% in a bank account. Don’t forgot though risk and return go hand in hand. You are receiving a better return than cash in the bank because the Retail Food Group shares can go up and down in value.
Also I should mention franking credits are not like Capital Losses that have to be offset against Capital Gains, therefore, if you do not have any tax to pay you will still receive a refund from the tax department. You can also see why my retired clients who are in pension phase are so fond of lodging their tax returns. For some of them it is the first time in their lives that they have received a refund from the tax man rather than paying him.
I would also like to point out that I am not an accountant so please don’t forgot to speak to your accountant for advice if you are interested in investing in shares for the possible tax advantages both inside and outside of Superannuation.
I hope this information has been helpful to you!
Originally published by OpenMarkets
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