What your kids should know about franking credits

Long term investment for retirees has suddenly become that much more difficult.

We have discussed at length the ALP’s policy on franking credits which will restrict cash franking credits to a large number of older people.

I will return to that issue in later commentaries. Today I want to talk about negative gearing and lower term deposit rates both of which require careful consideration. Even more importantly, those in retirement or approaching retirement who are not super rich will need to understand that they will not be able to help their children in the way they had hoped if the ALP wins, and they need to explain this to their children.

A lot of Australians have negatively geared a dwelling or dwellings and plan to pay off the mortgage with superannuation leaving them an income in retirement. Suddenly, assuming the ALP wins the election (and that is not a certainty) the rules are to be changed subject to the Senate.

Should a person holding a negatively geared dwelling sell out now?

Longer term dwelling prices will improve but there are dangers in the short to medium term particularly if you are very highly leveraged. Many people holding negatively geared property may wish to hold it because in 2020 property purchased (if the ALP wins) cannot be negatively geared. 

The chief executive of ANZ Bank in a press interview set out very clearly the dangers of holding for those who have financed their property with interest-only loans. It was rare for any CEO to be so honest with customers. Elliott confesses that there is no doubt that it is now very difficult to get an interest-only loan from a bank and warns that this will put pressure on many homeowners.

"What we have had is a bunch of people who took out totally legitimate responsible loans five years ago. They are coming up for their rollover which would automatically switch them to ‘principal and interest."

"In the old days the banks would have entertained keeping them on interest only but that has become almost impossible," he said. And then he warns that this can create a “terrible situation” where a bank applying responsible lending practices can only offer a borrower a principal and interest loan which could take more money out of their pocket than they can afford.

"The unintended consequences of that is the person that says: ‘Well I can’t afford it so my only option is to sell the property."

Elliott points out that this phenomenon created heavy selling in WA and adds considerable danger to the property market.

Basically, the ANZ Bank is saying that if you are overleveraged on a property, unless APRA changes the rules, you along with many others will be forced into higher repayments so you need to be able to afford them.

Any readers in that situation need to look very carefully at their finances and this current rally in the property market will be a good time to lower your leverage by selling. But there will be many others who are not as stretched who will say: "I will ride this out and enjoy the long term benefits of negative gearing." And of course, it is possible the ALP will be blocked in the Senate. 

If you want to buy a dwelling now and become a person who continues to enjoy negative gearing (which assumes the ALP wins) then be careful about your level of borrowing.

Longer term if the ALP policy is introduced then property investment must produce positive gearing where rents cover interest and other charges with a surplus to the owner.

That process will unfold via a soft real estate market, higher rents and/or lower interest rates. 

Right now, I can see a period coming when there will be great pressure on banks to lower their interest rates on loans for housing. The market is expecting the official interest rates to fall later this year but with term deposits, the banks are not waiting.

During the week, a 12 month deposit I had with a major bank triggered a notice of maturity. The bank is offering to roll over the deposit at 2.2 per cent compared to 2.6 per cent a year earlier – that is a big fall. I discovered that the 9-month rate is 2.45 per cent so the banks are now again playing silly games with depositors so you do need to look very carefully at what is on offer when your term deposit matures. 

Very clearly the banks expect interest rates to fall and they are giving depositors an early nasty taste at what is ahead. Do not simply accept that low one year rate at the bank and check to see if they offering better longer-term rates but I must warn you that they are not encouraging longer-term rates fearing they will be locked into higher rates. 

There is a bit of shopping to be done but it is not going to be a pleasant outcome for those with a large portion of their money in interest-bearing term deposits. And so, retirees are being attacked via franking credits, via negative gearing and via lower longer-term deposit interest rates. This is all designed to make it easier for younger people to buy houses.

The banks have heard the Shorten message in his budget reply speech: "We are going to stop intergenerational unfairness in the tax system" and added to his tax blows on older people a nasty sideswipe on term deposits.

At the moment there is a lot of apartment accommodation coming on to the market, but that will pass and over time rents will need to rise to create positive gearing so pushing younger people into buying houses and firming the market. But that’s down the track. 

Meanwhile, in the shorter term, this attack on retirees will not help the overall economy because they are large spenders. 

The very sad part about what is taking place is that the attacks will not affect the rich to any extent and of course the poor on government pensions are not affected apart from a nasty sideswipe at pensioners in self-managed funds. Those on the front line of the proposed ALP blows are people attempting to fund their own retirement.

A great many of those people — and I count a lot of InvestSMART and Eureka Report readers among them — plan to use their savings to help their children. That is a wonderful objective but right now the ALP’s proposed attacks on the retirement community plus the bank actions are so severe that you may need to rethink how much help you can give your children because you’ll need more savings to look after yourself. There is a very clear division between the political parties.

It is ironic that the ALP in aiming to gain the votes of the younger generation at the cost of the older generation may in fact adversely affect a great many young people because their parents and grandparents will no longer have the money to help them.

So this is my message: make sure your children understand what is happening to you. Do not keep it to yourself. Make sure your friends do likewise.

It's important that the younger generation understand that this our first intergenerational election where one party has devised policies to help younger people while reigning blows on the older generation.

Young people may not change their votes but they need to understand the consequences before May 18.