What are Franking Credits?

If you’ve ever received a dividend from an Australian company, you may have encountered the term franking credits. While it might sound technical, understanding how franking credits work can have a meaningful impact on your after-tax investment income, especially if you’re retired or managing a self-managed super fund.

Franking credits are a feature of Australia’s tax system that helps investors avoid paying tax twice on the same income. For many, they offer a way to reduce tax or even receive a refund. Understanding how franking credits work and who benefits most can help you make more informed decisions about your investment and tax planning.

How Do Franking Credits Work?

When Australian companies earn a profit, they typically pay tax on those earnings at the company rate, which is usually 30 per cent. If the company chooses to distribute some of those profits to shareholders in the form of dividends, they may attach a franking credit that represents the tax already paid.

This means you’re not being taxed twice on the same income. Instead, you’re credited for the tax the company has already paid on your behalf. When you lodge your tax return, franking credits are added to your assessable income, but you also receive a tax offset of the same amount. Depending on your marginal tax rate, this can result in additional tax to pay, no change, or even a refund.

For example, if you receive a dividend of $700 that is fully franked, it may be accompanied by a franking credit of $300. Your total taxable income from that dividend is considered to be $1,000, but you get to claim the $300 as a credit against your overall tax bill.

This system, known as dividend imputation, allows the tax already paid by the company to flow through to you as the investor, helping to reduce the likelihood of double taxation.

Why Franking Credits Matter to Investors and Retirees

Franking credits can be particularly beneficial for investors who pay little or no income tax. Retirees drawing a pension from superannuation may be in a zero tax bracket, meaning they could receive a refund of the full franking credit amount. Similarly, self-managed super funds in the pension phase can often reclaim the credits in full, boosting the fund’s net income.

Even for higher-income investors, franking credits reduce the effective tax on dividend income. This makes shares in Australian companies that pay fully franked dividends attractive to those looking to build a more tax-efficient income stream.

It’s also helpful to understand the difference between fully franked, partially franked, and unfranked dividends. A fully franked dividend carries a full tax credit. A partially franked dividend carries only a portion of the available credit, and an unfranked dividend means no tax has been paid by the company, so there is no credit passed on to the investor.

Not all companies offer franking credits. Businesses that operate primarily overseas or those that aren’t yet profitable may distribute unfranked dividends. Understanding how and when franking credits apply helps investors better assess the overall value of an investment.

What to Consider in Your Investment Strategy

While franking credits are valuable, they should not be the sole driver of an investment decision. It is important to consider them within the broader context of your financial goals, your level of risk, and your diversification strategy.

Focusing too heavily on fully franked dividends can lead to an over concentration in Australian companies, potentially missing out on international growth opportunities. While tax efficiency is important, maintaining a well-balanced portfolio remains essential for long-term success.

The value of franking credits will also vary depending on your personal tax position. Investors in the accumulation phase within super may benefit differently compared to those in retirement. In other cases, your tax rate could mean the credits offset only part of your tax bill rather than resulting in a refund.

Speaking with a financial adviser can help you determine whether franking credits are aligned with your overall investment strategy and how to incorporate them effectively without compromising other priorities like growth, diversification, or liquidity.

Putting Franking Credits to Work

Franking credits can be a powerful tool for building tax-effective investment income. They allow investors to benefit from tax already paid by Australian companies and can offer meaningful advantages for retirees, SMSFs, and income-focused investors.

Understanding how franking credits work is one step toward making better-informed investment decisions. But like any financial strategy, the best outcomes are derived from applying the right tools in the right context.

At Annex Wealth, we work closely with clients to ensure their portfolios are structured to take full advantage of available tax benefits while aligning with their long-term goals. If you’re ready to explore how franking credits could fit into your investment plan, contact a member of our team today – we’re here to help.