How would the proposed Labor policy changes affect me?

I wrote in my last post about the changes that Labor is proposing to make to the tax system, assuming of course that they get elected and get all their “policies” legislated.  Suffice it to say I wasn’t a fan of the changes as I think they will make it harder to reach FIRE, and policies is a bit of stretch given most of them are little more than soundbites at the moment.  So how will all of this affect my plans assuming it all goes through?

For those who haven’t read my previous posts on the proposed policies here is the one on the changes to franking credits and here is the one on the other proposed changes.

The main changes which would affect us would be the removal of cash refunds on franking credits, and the changes to taxation on distributions from trusts.  These would both affect how we held our investments, but probably not our investment allocation.

Currently the way our non retirement investments are held is basically all in my wife’s name.  She’s not in paid employment (although looking after two young kids is definitely hard work!) whereas I am so it makes sense for all of the income to go to her so we can use her tax free threshold instead of having some/all of the earnings go on top of my existing wage income. 

We, but mostly me (little Book of Mormon reference for you culture vultures out there) were however considering transferring or selling down our current investments held in her name (there would be some CGT to be paid but not a huge amount) and instead holding them in a discretionary trust. 

That way we’d still get to stream all the income to her for the moment, once she goes back to work we could either continue to stream it all to her if she’s on a lower tax bracket which seems likely, or divide it between us if not. Then once we retire we can share it between the two of us and potentially the kids.  There’s a bit more cost and complexity, but it would give us a LOT of flexibility and likely mean paying a lot less tax down the track.

A trust is almost certainly off the table if the proposed changes come through though, because we’d be paying 30% tax from the very first dollar of income so there’s no tax advantage to us in doing so.  Sure there is some asset protection which is nice, but I’ve pretty much got that covered by having the assets in my wife’s name anyway. 

We’re not aiming to have enough income that we’d have the equivalent of an average 30% tax rate anyway, and certainly not enough that we’d have that in both names.  So why add on cost and complexity if there’s nothing in it for us?

I’m conflicted on how I feel about the 30% tax rate on distributions from trusts.  On the one hand this would have been a great way for us to minimise tax, increase our flexibility, and would allow us to hold all our non superannuation/pension investments in one structure albeit at the cost of more complexity and expense.  Having spent much of my career looking at various arbitrage strategies trusts strike me as a great way of arbitraging the tax system.

On the other hand as I said in my previous article I don’t really see any real rationale for being able to stream income from discretionary trusts and in my discussion with various people since then nobody has come up with one. 

I’m certainly in favour of minimising tax as much as possible within the legal limits which is what the vast majority of people seem to do, but I can’t see why streaming is allowed and I can’t see a reason that it should be legal.  That wouldn’t stop me from using a trust because I deal with the world as it is not as I think it should be, but I wouldn’t be shedding too many tears if the proposed changes go through and we can’t utilise this strategy.

The next issue then is would we want to hold our investments in joint names rather than just in my wife’s name, and again the answer is probably no, for the moment at least.  The calculations on this depend to some extent on what income you’re receiving and from where. 

If you have it all in Aussie shares then under the proposed Labor changes to franking credits it’s fairly simple, unless you are aiming for more income in retirement than 95k after tax you can hold it all in one persons name in retirement and be no worse off than if you held it in both people’s names. 

Of course you have to get to retirement first so the journey there needs to be taken into account. 

Under the current tax system we would be worse off investing in joint names while she isn’t in paid employment because we’d be paying extra tax on the income I received compared to just holding it in her name and making the most of her lower tax status where she gets the cash refunds for excess franking credits. 

Along the way we’d also likely be slightly worse off because I’m likely to be in a higher tax bracket than her, although not by a huge margin.  We would however be better off once we’d actually retired though because we could make use of both of our tax free thresholds and reduce our overall tax bill. 

Under the proposed system we’d be either worse off or at best about break even at all times through the journey if we had our investments in joint names.  

We’d be worse off now because we would lose the cash refunds for franking credits in her name and be paying more tax in my name. Once she starts working again unless she’s in the same tax bracket as me we’d again be worse off because I’d be paying more tax on the income from our shares than we would if we held them just in her name. 

Then when we both retire because we lose the cash refund on the excess franking credits at our desired after tax income of $80,000 it doesn’t matter if we hold them in joint names or not.  So at no stage are we likely better off by holding our investments in joint names if we have all our investments in Aussie shares. 

The caveat to all of this is that we don’t in fact have all or even most of our investments in Aussie shares.

The way we’re currently invested (excluding our house) is roughly 35% in Aussie equities, about 40% in international equites, 20% in cash/fixed income and about 5% in property and alternatives.  The plan over time is to move some of that cash into shares because it’s way more than we should have sitting there not earning much, but we’ve been building up cash over the last 6 months while we waited to see what would happen with this election and legislation thereafter.

In any case because much of our current investment income doesn’t actually have any franking credits we have a lower breakeven point for the loss of the cash refund not to impact on us.  So at some point in the future it may make sense to start putting some of our investments into my name because we will be using up all the franking credits in my wife’s name and so would have to pay more tax. 

I haven’t actually done the numbers properly on when it would make sense to start putting money in my name at this point because currently we’ve still got a decent amount of excess franking credits so we’re not remotely close to it making more sense to be investing in my name yet. 

This will likely be when she is in paid employment again because we’ve still got a fair bit of excess franking credits that we would currently lose, and given she is likely to be at home bringing up our kids for a while there is no point in starting to do some investing in either joint names or my name just yet, although obviously we want to be planning ahead to make sure we’re setup for when she does get back into paid employment.

So for the moment at least if the changes came through we’d keep things simple and keep investing just in her name.

If the proposed changes do go through then we would lose the franking credits she is currently receiving, but the alternative would be to sell the shares, pay CGT, repurchase them in my name and then pay my marginal rate of tax which is higher than 30% anyway and it would essentially be cutting off our noses to spite our face.  So we’re going to have to suck it up.

What we may look at doing is investing our future savings in different asset allocations inside and outside super.  Inside super we would likely still be able to get a cash refund on the franking credits from Australian shares so they wouldn’t be wasted, and we could hold International shares and cash/FI in my wife’s name as we wouldn’t be losing franking credits there. 

International shares tend to have much lower dividends (hopefully with much higher capital growth to compensate) so there isn’t much extra income to worry about and the tax on this income can be offset by the excess franking credits she already has.  Cash/FI doesn’t tend to have any capital growth and is really more of a defensive play, but again the tax payable on income could be offset by the franking credits and it keeps it accessible in case of emergency.

Down the track though I still want to be living off the dividends from our investments so international shares aren’t as attractive, and if we do have to sell international shares then the reduction in CGT discount from 50% to 25% would hurt us. 

There is also the issue of accessibility, we want to be retiring a number of years before I can access my super and if most of the dividend generating assets are locked up inside super then we’re going to have to sell down assets outside of super which I would prefer to avoid. 

On top of this we have far more money invested in my wife’s name than we do in super and this is likely to remain the case, so there’s only so much we can do as far as changing asset allocations in each holding structure.

Basically it’s a complex situation and there’s no easy answer here and I’ll need to continue to think about how we will approach this issue.

Summary

All of the above was a fairly long winded way of saying that if the proposed changes do get legislated as described then we are unlikely to be making any major changes for quite some time.  Trusts are off the table, investing in joint names or having some assets just in my name isn’t going to make sense for a long time (and wasn’t anyway) and our overall investment allocation will remain the same. 

The main issue where it might make sense to make changes is how we are investing inside super vs outside super.  Sometime soon I will build a spreadsheet (because everything needs a spreadsheet!) and figure out what will likely be the most efficient way of doing this as well as the tradeoffs that would be involved in doing so.

What changes would the proposed Labor policies have on your FIRE strategy?  If you enjoyed this post and would like to read more like it then please subscribe!