Confused about franking credits and interest rates? Find out how you can get the most from your dividends.
Many companies listed on the ASX pay dividends to shareholders that include imputation – or franking – credits. Investors need to hold shares for 45 full days to qualify for the franking credits.
Franking credits provide a tax benefit so the actual return from that share is “grossed up” to reflect its true value. Never assume an interest rate from a bank’s term deposit or at-call account is the same as a share’s dividend yield .
How does it work? The table below compares the true value of a 3.5% fully franked dividend yield against a 5.0% cash rate, assuming 30% and 45% tax rates (excl. Medicare levy).
If a 3.5% fully franked dividend yield is equivalent to a 5% cash rate after tax then clearly a 5% fully franked dividend yield offers better value than a 5% cash rate.
Table 2 highlights the grossed-up effect of various dividend yields, as well as the equivalent after tax yield based on 15%, 30% and 45% tax rates.
Where there is a surplus of franking credits (if the individual or entity’s tax rate is lower than the 30% company tax rate), they are refunded. Fully franked shares within a self managed super fund (SMSF), for example, provide a 15% tax credit which can be used to offset tax on other income within the fund.
If the SMSF is in pension phase, tax rate is 0%, the franking credits are fully refunded back into the account. Over time this ‘top up’ can add substantial value to the fund. Maintaining exposure in quality listed Australian shares that pay good dividends can be a very tax-effective income strategy, particularly if held within your SMSF.
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