The Importance of Franking Credits

A key benefit of investing in high quality shares is the dividend payment you receive as a shareholder. Looking back at over 100 years of investment history – dividends make up approx. 50% of your long-term returns as an investor. Dividends are often overlooked by people who only focus on share prices – but as the data demonstrates they play an incredibly important role in your overall returns.

An additional benefit you receive as an investor in Australian shares is the franking credit that is attached to the dividend payment. Franking credits were introduced in the 1980’s to avoid double taxation of company profits. Prior to this the Australian Tax Office would tax both the Company and the investor who received the dividend.

In essence, “franking’ means that you get a credit for the tax already paid by the company so that you are not taxed twice (once at the company level and again at your marginal tax rate). Importantly, franking credits can help reduce your income tax and are fully refundable.

Investors who receive a fully franked dividend will only be taxed the difference between 30% (company tax rate) and their own marginal tax rate.

But where franking credits become even more powerful is in Super and Pension accounts. Super funds are taxed at 15% while in accumulation phase and 0% for funds in pension phase. This means the excess credits can be refunded to your super or pension account effectively providing bonus income.

As demonstrated an investment strategy with a focus on improving after-tax returns can tap into the benefits of franking credits to boost overall earnings.