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What Labor’s backdown on franking credits means for your retirement income

It was an embarrassing back-down for the Labor leader Bill Shorten but one that we could see coming a mile off given the party’s flawed assumption that only the wealthy could feel the pinch from the removal of cash rebates from franking credits attached to company dividends.

Labor will now spare 300,000 low income retirees from the proposed change as all full and part-time pensioners, including those receiving benefits from a self-managed super fund (SMSF), will still be able to claim a cash refund from the tax office on any franking credits above their tax liability.

The bad news is that if you aren’t classified as a pensioner (it is means tested) or do not receive any income support from the government, you’d still be feeling the pain.

Labor’s estimate on the impact to their cost savings from protecting pensioners confirms this. The party believes the move will clawback $55.7 billion over a 10-year period compared to the original forecast of $59 billion if everyone was affected.

Don’t count on Bill Shorten backing down further on this either. He isn’t Donald Trump and polls show the policy won’t cost the party any votes as originally feared. The win in Batman and the recent News Poll has confirmed that most Labor supporters don’t really care about this issue.

But the impact on individual investors can be pretty significant. The Australia Financial Review reported that the after-tax returns for individuals with a $500,000 share portfolio will fall 132 basis points under the scheme (assuming the portfolio earns fully franked dividends and has a net yield of 4%).

SMSFs not in pension mode will take a bigger hit due to their lower tax liabilities. Their inability to collect a franking refund above their tax payment could shave 171 basis points off their annual returns under the same assumptions.

If Bill Shorten looks increasingly like the next Prime Minister of Australia (as the polls suggests), investors will start pricing this policy into the market and that will be an additional drag on some of our most generous income stocks that generate a franking credit.

These stocks have a poor profit growth outlook but use their big dividend yields to attract support from investors.

Talk about bad timing! Traditionally popular income stocks are already feeling the heat from rising bond yields and interest rates.

Labor has given me a new reason to avoid stocks like Telstra Corporation Ltd (ASX: TLS), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ).

I have also written about other unintended consequences of the policy, and Labor’s pensioner exemption hasn’t changed my views.

One other thing that the policy might influence is investors’ bias towards growth stocks. On this front, the experts at the Motley Fool have picked a sector that they believe are set to grow strongly over the coming years.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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