SMSFs and Companies – Lovers or Soul Mates?
I think most Australians are aware of what a company is, how it works and how they are owned by shareholders. Either through investing directly in shares or being employed by a company, companies are iconic business vehicles. And Australia has some pretty big ones. Not just here but up there in world terms – not as big as the big tech companies, but when it comes to resources and banking, well we punch above our weight. The top twenty Australian stocks top out at a $3 trillion market capitalisation and include names like BHP Billiton, Woolworths, Wesfarmers, Telstra, CBA, NAB, ANZ and other household names.
We all see them as big, strong and stable able to withstand shocks to the system plus for investors, some great capital gains over the long term. But, and this is the important but, not all investors choose them for capital gains, many older investors just love the income that flows from company dividends. And love for companies comes with some real emotion when fixed term deposits are less than 3% while dividends from banks are much higher. Look at one of Australia’s biggest banks, CBA which is currently paying a 7.26% fully franked dividend. That is pretty juicy income and the stock is priced accordingly. If only the market suffered a correction of 20%, what a bargain.
Plus dividends are fully franked while interest isn’t. For the average person on a 30% tax bracket or the non-resident shareholder this means that dividends paid are dividends kept. The franking credits wipe out the underlying shareholder tax liability. For those taxpayers with a lower tax rate the franking credits can be used to offset other tax payable and, here’s the kicker, if a taxpayer has excess credits they are refundable. This is why SMSF Trustees and members love companies. Shares held for SMSF accumulation members with the Trustee paying tax at 15%, the underlying 30% franking tax credit adds juice to the fire. Full refunds for excess franking credits. And that really hits home for pension accounts. No tax but full refundable credits, on top of great cash returns. Well that is too good to be true. It makes it so much easier for retiree members to live on their dividend cash flow and refundable franking credits.
Sure industry and retail super funds can get the same credits but really who knows what they do with them?
Currently SMSFs hold about $200 billion in Australian equities and for the most part that would be the top 20. ETFs, which also harness the power of franking credits give extension beyond the top 20 as do brokers and in command SMSF Trustees. In aggregate they are a powerful shareholding base and one which someone one day will be smart enough to harness through proxies.
If you ask me SMSFs give Australian dividend paying companies strength through their stable, long term investment profile. And that is why, this goes beyond love and if you ask me is true soul mate status. SMSF trustees stand behind these companies in the good times and bad times. And companies understand this and give their love back by focusing on dividends and other tax effective payments to shareholders.
But it does not just stop at the big companies. Look at listed investment companies (“LICs”). In the 1990’s financial planners could not give LICs away with pricing at a discount. The best investment vehicle for shares were unit trusts, a pass through vehicle for tax payers. But not today, the lure of the franked dividend has seen SMSF Trustees look for LICs.
But soul mate states with listed companies is only one part of the equation. Smart SMSF Strategists would be using some other SMSF strategies like:
- The obvious use of a corporate Trustee to enable the Trustee to pay a lump sum, make things easier for administration when members come or die in the fund as well as protection from legal suits. This one is really a two out of ten on the SMSF smart strategy status and in my mind, mandatory.
- Well you may wonder what that means? These are self-designated Early Stage Innovation companies with the criteria in extending beyond start ups with criteria laid out at www.innovation.gov.au For SMSFs and particularly accumulation members ESICs are tax strategy smart – even beyond franking credits. A full 20% tax offset for capital invested, no tax on dividends and CGT free on disposal within the first ten years. Sure, there is some rubbish around but remember these are risky investments and hence the need for the government to provide tax benefits to attract investment. This includes crowd funding money.
Smart SMSF strategists need to get involved in this area, not only from a tax point of view but also for business clients and start ups looking for capital. If you need help I have advised a few start ups so contact me at firstname.lastname@example.org By the way ESIC investment are a good lead-in strategy for other strategies like getting rid of contributions tax for under 50 year old members.
- SMSF purposed investment vehicles. I am currently advising a solar farm company on structuring investment solely for SMSF Trustees. With $220 billion in cash there is a big pot for strong SMSF purposed company investment vehicles.
- Buying into a business. Craig West from Succession Plus talks of the million Baby Boomer businesses to be put up for sale in the next decade as the owners cash out. Some will fade out but some will be sold to under 50 entrepreneurs or taken up in a business aggregation buy out. The company structure is a must with its franking credits and also, as long as it is not a related company for investing shareholders, whether directors or employees, they are suitable for super investments via a SMSF.
I could go on but I want to leave my best strategies for some trainings I have planned in 2018. These need to be explained, pulled apart and rebuilt in a face to face environment.
P.S If you have not read my book yet, “The Guru’s Guide to SMSFs” there is a lot of share investment and ESIC strategies in there. You can get copies of the book still at only $20 from www.ilovesmsf.com and for you SMSF strategists out there, start the year off by giving a copy to your clients. This includes posting, handling and shipping so it is “cost price” for us.
Marketing Tip: We have had more than ten Strategists buy multiple books for their clients and prospects. So get in first and make sure that your clients get a copy from your firm and not from someone else. The book is designed to show the absolute value and importance of a smart, professional adviser.