Franking credits are a great tool to minimise your tax payment while receiving passive income. In this article, we explore the definition and use of franking credits and why retirees in particular love them!

What are franking credits?

Franking credits involve the amount of imputed company tax. As defined by the ATO, it refers to a type of tax credit that companies need to pay along with the dividends to their shareholders.

A franking credit often proves beneficial to both the corporation and shareholder as it helps reduce the effects of double taxation. It does this by allowing companies to allocate the tax paid at a corporate level as a tax credit to its shareholders.

Depending on the company, some dividends fall under fully franked and thus the shareholder does not need to pay any tax on their end. In some cases, the dividend may only be partially taxed and the shareholder will need to report the remaining tax during their tax return.

Why are they so popular with retirees?

For retirees, franking credits can prove to be highly beneficial. This occurs due to the fact that the corporate tax rate stands higher than the investor’s personal tax rate. Commonly seen with retired investors as most superannuation and charity investors possess lower personal tax rates. Thus, the franking credits are refunded.

Example

To further illustrate this imagine Linda holds shares in a company called IUM Corporations. Annually, she receives a dividend of $6000 from a $120,000 share at IUM. From here dividends, Linda receives $2000 of franking credits from IUM. Other than that, Linda has been retired for the past four years. She has a tax-free, account-based pension in which she receives a part age pension of $10,000. Linda earns no other income.

When added altogether Linda’s income totals $18,000. This falls below the effective tax-free threshold, therefore allowing Linda to receive a complete refund of her $2000 imputation credits.