When markets are performing well and gross returns are impressive, clients are, in the main, happy.
However, it can be a very different story when markets are waning. Low or negative investment returns test the nerve of many investors, and clients perceive a real pinch when the cost of advice and administration and management further impact these returns.
It’s during these times that looking at net returns rather than gross returns becomes all the more important. When looking for ways to add value for your clients, identifying ways to improve the net return outcomes is paramount.
Most people invest their money to increase their after tax net earnings. What’s in their pocket at the end of the day is what really matters. Most investors don’t like paying fees and tax is likely to be the biggest ‘fee’ of all. So when we think about returns on investments we need to think more deeply than the simple reporting of returns after tax.
Concessional tax treatments are available to all superannuation investors to help encourage participation and maximise returns.
Reducing tax rates on superannuation contributions and tax on earnings from as high as 46.5 per cent to 15 per cent (in pre-pension phase) or even zero per cent (in pension phase) is very compelling.
However, there are often overlooked additional taxation benefits that can make significant differences to net returns.
To understand how a fund manager’s approach affects a client’s tax position, you need a detailed breakdown of the fund’s return.
When assessing the most tax-efficient funds, it’s important to consider five key criteria. Each can have a significant impact on net fund returns, and gross performance may be misleading when thinking about what will end up in a client’s pocket.
Five key criteria for assessing managed fund tax efficiency
1. Level of franking. Look beyond the ‘label’ to ensure funds are delivering the level of imputation credits they are targeting.
2. Stock turnover. Be mindful of the cost of excessive turnover of stocks within a portfolio.
3. Level of capital gains distributed and the applicable tax status.
4. Net unit movements.
5. Incidence of gearing.
Platforms can take tax efficiency tactics to the next level and are the ideal vehicle to deliver additional benefits to investors.
Key tax functions that platforms can and should deliver to investors for better net tax returns include:
n withholding and remitting contributions tax when it’s due, rather than at the time the contribution is made, leaving clients’ money invested for longer;
n ability to actively manage capital gains tax though a selection of investment unit parcels to sell rather than simply using a default ‘first in first out’ (FIFO) or ‘last in first out’ (LIFO) method;
n only applying capital gains tax when investments are realised, rather than building into the unit price;
n tax free transfer from super accumulation to pension phase — with no sell down and re-buy of underlying investments, unrealised capital gains can be carried from the superannuation phase into the tax free pension environment;
n direct allocation of imputation credits to the individual investor (pro-rated based on individual unit holdings) in both superannuation accumulation and pension phase, instead of pooling and sharing among all investors in a fund (averaged distribution disregarding individual unit holdings);
n automatic payment of superannuation anti-detriment refund (contributions tax) to eligible dependants; and
n easy facilitation of transition to retirement strategies.
All these facilities can increase net returns substantially and demonstrate one of the many benefits of investing in platforms. Looking at the treatment of imputation credits provides a good example. Platforms that can directly allocate imputation credits based on an investor’s individual unit holding can increase a 10 per cent yield by over 40 per cent (in pension phase) for a fully franked fund. Increasing the net effective return means more money for your clients’ pockets. The table below highlights the scenarios where the net return is increased above the 10 per cent yield.
Platform providers administer taxation processes in different ways, and these can have a significant impact on the net outcome for clients.
When reviewing platforms, substantial consideration should be given to the taxation treatment processes. Using platforms with sophisticated taxation management systems can make a real difference to your clients’ portfolio outcomes, especially when markets are rocky. A few extra per cent added via prudent taxation management may effectively keep net returns ahead of the market.
In the future, the development of separately managed accounts (SMAs) in the Australian platform market will add another dimension for actively managing clients’ tax positions.
Platforms offering SMAs will provide increased transparency, better active underlying share selection and new management and reporting technologies, which will ultimately revolutionise the ability to add value to net returns.
Bruce Hawkins is the group director of strategic development at Aviva Australia.
