How to boost your franking credits

I have long been a big fan of the benefits of franked dividends but there are occasions when it would be handy to get a boost to how many franking credits you can get for a fixed amount invested.

That can be the case whether you are saving inside or outside superannuation and fortunately there are some innovative solutions available.

One solution would be to borrow money to buy more franked dividends using a margin loan through a broker.

That has some benefits including the ability to pay interest for a year ahead and claim that on a tax return earlier but it also comes with some disadvantages – usually the interest rates are a bit steep and there is always the chance of experiencing a margin call and having to come up with some more cash at an in-opportune time due to market volatility.

Admittedly the chance of a margin call can be greatly reduced by keeping the amount of leverage or gearing down to lower levels.

ETFs offer a fuss free gearing alternative

There is also another way with exchange traded funds (ETFs) that use internal gearing within the fund to add a modest boost to the amount of market exposure and dividends that you can get with a given amount of money.

Please note here that I am not referring to the heavily geared ETFs such as GEAR (ASX: GEAR) which have recently performed so well – they are more suitable for trading purposes due to the much higher amount of leverage used rather than for long term investment.

Rather than doubling exposure or more, the more modestly geared ETFs offer an extra 30% to 40% of exposure.

Naturally, all borrowing – whether internal in the fund or directly through a margin loan – adds to risk and volatility, with gearing magnifying the effect of market rises and falls.

Over the long term though, looking through the market ups and downs, having a modestly geared exposure to an index such as the ASX 200 can provide both extra returns and extra valuable franking credits.

That is particularly suitable in a structure like superannuation, which is inherently long term and there are a couple of particular strategies that make a geared ETF worth considering for self-managed super or self-directed super through an established fund.

Gearing on the cheap

As is common with the ETF structure, this geared exposure is provided more cheaply than with other geared exposures, due mainly to lower embedded borrowing interest rates and low fees available to larger, institutional investors.

Take the hypothetical example of a $100,000 investment in a moderately geared (35%) ASX 200 ETF which has a dividend yield of 4.5% with 70% franking.

That amount of leverage increases the exposure to around $154,000 of shares, bumping up the dividends from an ungeared amount of $4,500 to $6,923.

How useful those extra franking credits are depends a lot on your individual tax position but even in the low tax environment of super they are very useful for reducing tax bills.

There is an extra wrinkle to consider when using this strategy within super and that is buying extra exposure for a given amount of available concessional contribution cap.

How to beef up your investment above the contribution cap

So, if you are in the accumulation phase of super and can contribute $30,000, using a geared strategy could get you around $45,000 of exposure to the ASX 200.

Similarly, generating extra franking credits could be very useful for balances approaching or even exceeding the proposed new $3 million super threshold, with the extra franking credits used to offset part of any additional tax incurred.

Additionally, having the ability to liquidate geared holdings quickly to pay for tax or withdrawals is also helpful in the situation where an SMSF also holds large and more illiquid assets like property.

Giving your pension a boost without reducing market exposure

There is one final and probably relatively unknown way in which using a geared ETF within super can help to boost retirement income without reducing market exposure.

This strategy uses the concessional treatment of a lifetime annuity and the greater leverage available in a geared ETF to create a potential win/win for those whose assets are low enough or close to being able to qualify for a part pension.

Say, for example, that a hypothetical retired couple living in their own home live off a combination of the part age pension, an investment property worth $400,000 they want to keep and their superannuation account.

In their super they have enough cash to cover their mandatory super withdrawals for several years and also have $300,000 invested in the ASX 200 through an index fund.

Using an annuity to increase the pension

To ramp up their income, they take out a $100,000 lifetime annuity using some of their super cash.

Under the qualifying assets test rules for the age pension, only 60% of the lifetime pension is considered towards their eligibility for the pension, which increases their cash from the part pension.

At the same time, they add gearing by changing their vanilla exposure to the ASX 200 through an ETF to a mildly geared ETF over the same index.

This has the advantage of increasing their dividend income, potentially adding a double banger boost to what they get paid into their bank account to live on.

Naturally, the risk of the share part of their super investment will have risen but as long as they are prepared to look beyond some of that extra volatility, they may have pulled off the difficult act of increasing their retirement income without reducing their market exposure.

Individuals need to ensure changes will be beneficial

Naturally this sort of move requires a very thorough check against individual circumstances to ensure it achieves the desired income and is also suitable for the risk tolerance of the people involved – the “sleep soundly at night” test.

Potentially, though, the mildly geared ETF is yet another innovation that can achieve multiple aims for investors both inside and outside superannuation at various times in the investor’s life cycle.

Some of the more modestly geared Australian ETFs available include Betashares Wealth Builder Australia 200 Geared (30-40% LVR) Complex ETF (ASX: G200).

Another possibility is the VanEck Geared Australian Equal Weight Fund (Hedge Fund) (ASX: GMVW), which uses equal weighting across the ASX 200 rather than market weighting. This fund uses a higher amount of gearing up to 50%.

There are also some modestly geared international ETFs available, with a good example being Betashares Wealth Builder Diversified All Growth Geared (30-40% LVR) Complex ETF (ASX: GHHF) which obviously reduces the amount of franked income provided but can also be useful in getting more internationally diversified equity exposure.