Franking credits dilemma

Not unexpectedly, several defined benefit fund and commercial annuity pension recipients have asked how the proposal to stop cash refunds of imputation credits would affect them. The short answer is that so far only federal government employees, including politician members of defined benefit funds, know they wouldn't be affected.

Along with charities and pensioners, the income tax-exempt $140 billion Future Fund - established to ensure that the Commonwealth honours its unfunded defined benefit commitments - would continue to be eligible for imputation credit cash refunds. How other defined benefit and annuity funds would be affected remains to be seen.

The implicit assumption is that along with industry and retail funds, defined benefit and annuity funds would be able to transfer the tax benefits of imputation credits between different members of the fund. Instead of generating a cash refund as presently is the case, the imputation credits received on the investments of members in the tax-free pension phase would be used to reduce the contributions and earnings tax liabilities of other members in accumulation phase.

In the longer term, this creates a potential problem for defined benefit funds closed off to new members. As existing members subject to contributions and earnings tax retire and draw non-taxable pension income, the capacity of the funds to fully use franking credits against tax liabilities will decline.

When there's a separate pension or annuity fund with no members receiving employer contributions or paying earnings tax, unless specifically exempted in the legislation, these funds would join low-income taxpayers and many SMSF members in not being eligible for franking credit refunds.

Whatever decision is taken by a future government, providing exemption or special treatment of defined benefit and annuity fund members would be inconsistent with the proposed treatment of low-income and SMSF retirees relying on investment returns for their income. In today's low interest rate and volatile earnings situation, defined benefit and annuity income stream recipients are protected by employer or annuity provider guarantees, their retirement income streams in many cases indexed for inflation. To avoid the costs of providing these guarantees to new employees, employers have almost wholly stopped from offering defined retirement benefits.

Whatever changes are made to the imputation credit system, employer guarantees will protect the retirements of defined benefit fund members.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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