Good news for franked dividend fans: not only is it attractive for retirement savers in Australia to lift their asset allocation to Australian dividend paying equities, as you would expect, but it’s actually sound practice, according to Dr Geoff Warren and colleagues at the Australian National University.

Dr Warren is no fusty academic: he spent years as a strategist with investment bank Ord Minnett in the days when it was an institutional broking house and before it was taken over by JP Morgan.

He and colleagues Drs Adam Butt and Gaurav Khemka at the College of Business and Economics at ANU have run some serious numbers, which indicate that imputation credits could add the equivalent of between 5% and 6% extra to holders’ spending power during retirement.

Their report is entitled What Dividend Imputation Means For Retirement Savers.

They also conclude that “Access to imputation credits has the equivalent effect of increasing balances at age 65 by around 8% or 9%, or lifting risk-free returns over the course of retirement to the order of 0.6% to 0.8% per annum.”

So, how much percentage allocation to Australian equities do they think the extra bang from imputation justifies?

For instance, they reckon that a theoretical retiree aged 65 with $500,000 socked away without the benefits of imputation should ideally be allocating 26% of their account to Australian equities, 33% to global equities and 41% to fixed income.

But imputation changes everything.

“When imputation credits are included in the analysis, the portfolio breakdown comes out at 46% in Australian equities, 15% in world equities and 39% in fixed income,” says their report.

In other words, imputation means it’s worth a near-doubling of domestic equity exposure from 26% to 46%.

The reason why this happens relates to the relatively high correlation between domestic and overseas equities, which is around 0.6. Domestic and overseas equities are really just two different forms of equity exposure. 

“Switching from world equities to Australian equities to capture imputation credits adds a meaningful amount to expected returns without increasing risk substantially,” they conclude as a result.

As a former colleague of Dr Warren, I felt able to bail him up on the knotty issue of whether Opposition Leader Bill Shorten is right or wrong to propose an end to the existing tax policy which currently allows retirees with no taxable earnings and a good franked dividend stream to get an actual cash refund from the ATO.

The research notes that the proposal will make a difference of between 1.3% and 1.4% a year from the Australian market overall for those retirees who can no longer claim the tax refund created by imputation.

“That is a significant number,” they state, putting it in context by comparing that with the expected long run equity market return of between 7% and 8%.

“It is no wonder this policy is the subject of heated discussion,” the researchers state, without jumping down strongly on either side of the fence.

So, what does Dr Warren really think?

Stating quickly that he’s providing a view of his own, he admits to being in two minds about the existing refund system.

“There is an equity issue in that most of the benefits of the refund system go to richer people,” he says.

“But at the same time it is just one of group of policies aimed at helping retirees become self-funded ,” he says.

He notes Treasury’s competing interests: one being to maximise the number of retirees who are not going to be dependent on the Age Pension, the other being not to give so much away in subsidies to the growing army of retirees that the government ends up significantly out of pocket.

“What is clear is that the early beneficiaries are the richer retirees, but as the time goes on, there will be many more less affluent but still self funded retirees looking to capture whatever benefits are available,” he says.

“Is the ALP proposal designed to “soak the rich” or is it a reasonable policy?” he asks rhetorically.

“The other point made by defenders of the status quo is that if you’re a zero tax-payer and the company paying the franked dividend has already paid tax, then a tax refund is just is a way of maintaining your tax status.”

The research he has done with his colleagues points up the fact, much stressed by the ALP, that self funded retirees do still end up costing the government money.

“After accounting for the offset of the Age Pension, we estimate that the total net cost per individual over their retirement phase is about $30,000 for retirees with a balance of $100,000, and around $80,000 for those with a $500,000 balance (in 2017-8 dollars.”

“While this may seem relatively ‘expensive’, it also offers social benefits,” they note. 

Like what?

Looking at the big picture of the Australian economy, the researchers highlight the fact that depending on the savers’ and retirees’ habits, the extra money thrown off by the imputation system during retirement reduces the need to save for retirement, and hence allows the saver to contribute less to super and hence spend more during the accumulation phase on the way to retirement.

“That helps to address the issue of adequacy and reduces the need for a higher superannuation guarantee levy,” they say, thus spearing two hot potatoes in one go.

“A further implication is that the home bias encouraged by imputation credits might make equity funding more readily available to Australian companies.”

“Removal of full access to imputation credits in retirement could unwind the benefits mentioned above and would undoubtedly solicit significant political backlash from retirees.”

My conclusion? This research proves that dividend franking will be hard for politicians to take away, and explains and even justifies the home bias towards Australian equities. But there’s a “two bob each way” debate looming over the political issue of refunds for low tax payers about which you will be hearing a lot more as we move to the next Federal election that must be held by mid-2019. 

Given that self funded retirees are getting very fed up indeed with the rules changing against them long after they have set up their plans for retirement, you can rely on the debate being a noisy one. 

Particularly since most of the pundits have the ALP winning the next federal election by a solid margin!