How dividends and franking credits are key to providing Australians with income for a comfortable retirement

Australia is facing a retirement income problem. Superannuation is designed to provide an income in retirement, but statistics show that more than half of all Australians have no super left by the time they reach age 70¹.

Retirees who have super left at that age are faced with investment options that are currently fairly low-yielding due to enduring low interest rates. For example, a term deposit may return as little as $2,000 for every $100,000 currently invested, and for some retirees that modest sum would fail to cover even their annual utilities bills.

For those receiving a part pension, the need for higher returns is particularly acute. The Age Pension asset test means that for every $1 of additional assets a retiree has over a certain threshold, they lose nearly eight cents in Age Pension payments. This means those assets need to generate an eight per cent return just for the retiree to break even, and such a return is really only possible to achieve in today’s environment with growth assets.

So, while individual circumstances will vary, for many people the cornerstone of any retirement income solution is growth assets, of which income-generating equities are typically a major part.

Why Australian equities?
If a retiree is focused on income, Australian equities can currently deliver a positive outcome in line with that strategy. The average male at retirement could potentially boost his retirement income by 70 per cent above the Age Pension by investing in Australian equities². For females, who today typically retire with a lower super balance than men, the boost is calculated to be 44 per cent³. Funds designed especially for retirement income may deliver an even bigger uplift, thanks to their heightened focus on dividend-producing equities.

Dividends are great for retirement income because they typically grow over time and are usually less volatile than capital gains. Australian equities are especially attractive because our current system of franking credits means that dividends are only taxed once, in the hand of investors. Franking credits encourage Australian companies to return cash to shareholders as a dividend, which means we are fortunate to have one of the highest dividend yields when compared to our global peers.

While alternative investments are available to help mitigate the potential impact of any changes, this is why changes to the franking credit system being proposed by the Labor party could make achieving a return adequate to provide for a comfortable retirement income more difficult.

We illustrate this in the chart below, which shows that if franking credit refunds are removed, the income of a self-funded retiree with $800,000 in Australian equities would basically drop to the same level as a retiree receiving the Age Pension with $250,000 in savings.

Income, including the Age Pension, earned by a single retiree invested 100 per cent in Australian equities before and after proposed policy change

Self-funded retirements at risk?
For some people, the removal of franking credits could create a disincentive to save for a self-funded retirement. 

If changes to the franking credit system do occur, investors need to be aware of how they may be impacted. There may be options to mitigate some of the impact. We encourage advisers to speak with their clients to explain what some of those options may be.

¹ ASFA, Superannuation account balances by age and gender, October 2017 (Table 2: Median balance by age and gender, 2015-16)
^2,3Assumes retiree has no other assets or income and is 100 per cent invested in Australian equities with a five per cent dividend yield, 75 per cent franked.