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Margin loan for high dividend payment

Discussion in 'Other Asset Classes' started by inspiredbyprop, 18th Jun, 2016.

  1. inspiredbyprop

    inspiredbyprop Well-Known Member

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    Hi PCers,

    Need your help please. I'm stuck in calculating the pros and cons.

    Assume my personal tax rate is 25%.

    Now, if the variable rate of margin loan = 5.5%
    And I buy a stock which will return me 6.5%pa.

    Does it mean I receive a gain of only 1% in the invested money?
    i.e. if I borrowed 100k from the margin loan to buy the stock, total net return will be 1k.

    Does the tax rate even relevant in the scenario? if yes, how?

    Thanks heaps,
    IBP
     
  2. thatbum

    thatbum Well-Known Member

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    Your question doesn't seem to make sense to me. How about you try putting in some sample numbers.

    I can't see how your tax rate is relevant either.
     
  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    You borrow $100,000
    You pay $5500 in interest
    You receive $6500 in income
    $1000 net profit.

    Tax $250

    What about if the shares go down? Dividends may go down too.
     
  4. Casteller

    Casteller Well-Known Member

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    Yes profit $1000 but in Australia you will get franking credits also, so will pay less than $250 tax depending on what shares you buy. Could even get a refund on 25% rate. For 100K borrowed you would want to have at least 200K security to avoid margin calls. Capital gain is enhanced also though some leverage. I consider it less risky than property due to lower leverage, lower interest rate, diversification and higher net returns. You say "only 1%" gain but for many property investors this yield is not achieved and is often negative (negative gearing).

    I do this but on margin loan rate of 1.98%, shares return around 5%, so profit is 3%.
    I keep the LVR low though, usually under 35% (so 100K loan I would have 300K shares), so can withstand market shocks and still be able to pick up stock in slumps. Only invested in UK equities though (hence low margin rate), so no franking credits.
     
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  5. inspiredbyprop

    inspiredbyprop Well-Known Member

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    Thanks @Terry_w for clarifications.

    @Casteller, much appreciate your advice. It's perfect and exactly what I wanted to know.
    Now, I get the following formula.

    Assumption:
    Invested Capital = 100k
    Personal Tax Rate = 25%
    Margin Loan = 5.5%
    Dividend Payout = 6.5% (0% franked)

    Hence, Yearly Net Return ($) after personal tax
    = (dividend - loan) x capital x (100% - tax)
    = (6.5% - 5.5%) x 100k x 75%
    = $750
    NB: for 100% franked dividend, it will be readjusted after company tax of 30% and end result should be the same.

    Just a note to myself, for an ideal investment and quick calculation, I would probably consider using the calculation of (dividend-loan)*75%. In the example above, the net return would be 0.75% as opposed to the OP 1%.
    I will also consider the risk and LVR mentioned in your post.

    Could you please elaborate what do you mean by a refund of 25% rate? If possible, use the numbers mentioned above.

    I current have both margin and investment property loans established for stock investment.
    I found the rate for margin loan (high 5%) > investment loan (low 4%). It would be great if I could get the similar rate as you're getting, this means that my investment has lower return and higher risk :(

    Anyway, do you any ASX stocks with a reasonable dividend payout and no franking credits?
     
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  6. Hodor

    Hodor Well-Known Member

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    I believe it is a reference to company tax been 30% and your tax rate been 25%. If the dividends are fully franked you will get a refund as your tax rate is lower than the rate at which tax has already been paid.

    For example;

    You receive $700 in dividends that are fully franked (grossed up would be $1000 including the tax of $300 withheld)
    Your tax rate is 25%
    You receive an additional $50 come tax time as you only need to pay 25% tax on $1000 which is $250.


    I don't have a list.

    Why don't you want franking credits? They effectively improve your return.
     
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  7. inspiredbyprop

    inspiredbyprop Well-Known Member

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    thanks @Hodor, I've been reading your posts on the ETF thread and they're inspiring!

    0% franked dividend may work in my scenario where personal tax lower than company tax.
    Example: if 100% franked dividend = $100 and assume that payment is made before end of financial year. Instead of getting 100, I will get getting $130 hence $30 advantage in reducing non-tax deductible loan sooner.
    Although at the end of financial year, the end result would be the same. Just getting the money earlier is the advantage for lower income investor.
     
  8. kum yin lau

    kum yin lau Well-Known Member

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    Hi all, it is indeed the way to manage a much higher yield than any cash deposit. I personally rather do it when I'm on a stable income, and choose stocks that are ordinarily very reliable but have come off their highs [that's why I buy QBE under $12] . Just consider what we could have done at the height of the GFC in 2009.

    Remember Wylie buying shares and the big discussions w e had about shares back then? And just 2 months ago, we could have taken out a margin loan and bought BHP for $15?

    Coulda, woulda, shoulda!!

    KY
     
  9. willair

    willair Well-Known Member Premium Member

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    I would not be that worried about the ATO"s side of things ..
    100K as most will back depending on the ASX listing 80% margins,but once you tally up all the entry --exit costs and what sometimes happens in between ,for that small scale return..
     
  10. wogitalia

    wogitalia Well-Known Member

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    If your tax rate is lower than 30% then you want fully franked dividends, not unfranked. You will get a tax refund on the effective difference between your rate and the corporate rate.

    Unfranked dividends are not common because they're very undesirable for the Superannuation investors (a significant and influential sector of the investor market) and they tend to have negative connotations because franking credits are tax paid being returned and tax paid is generally a good sign a company is going alright. This actually extends further to most retirees and in fact most Australians (remember that the vast majority of Australians earn below the 30% tax threshold). The only people who don't really want franking credits are those in the highest brackets. Franking credits are basically the polar opposite of negative gearing, they're more the beneficial the lower your tax rate.

    An unfranked dividend isn't likely to be any larger than a franked one generally, I'm sure there are exceptions, but the company holding onto it's franking credits has very little purpose for the company itself and they've already paid the tax that translates into the franking credits so a company making a franked/unfranked dividend doesn't change the amount of cash leaving their account. A $1 dividend that is fully franked still costs them the same $1 as an unfranked $1 dividend.

    Again it's unusual for a company to be paying dividends without having paid tax and as a result having franking credits which makes getting unfranked dividends unusual.

    Also, make sure that capital growth is considered in the investment, just like property you shouldn't be buying solely for income (though just like property, it's a perfectly viable strategy). Also remember that margin calls can and do happen, they're always possible and you need to factor in what your actions will be should they happen.
     
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  11. thatbum

    thatbum Well-Known Member

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    Does your tax rate make a difference to the returns on franked vs unfranked dividends? You get credited tax paid on them either way.
     
  12. wogitalia

    wogitalia Well-Known Member

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    Yes and no. Yes in that it changes how favourable franked dividends are, no in that it doesn't change the "franked vs unfranked" equation being in the franked favour.

    The thing with the franking credit is that it is "taxable income".

    So using a very simply example.

    Net Dividend of $70 (that's what hits your bank account) that is fully franked will have $30 of franking credits attached and is a gross dividend of $100 with the gross being the "taxable income" amount.

    So using a few examples of that dividend and the equivalent unfranked of $70.

    Tax rate of 0% would be...

    Franked Dividend - $100 taxable income with $30 franking credits attached. Tax refund of $30. Total amount in bank = $100.

    Unfranked Dividend = $70 in bank.

    Tax rate of 15% would be...

    Franked - $85 in bank account (less 15$ in tax)

    Unfranked - $59.50 in bank ($10.50 of tax)

    Tax rate of 30%

    Franked - $70 in bank account, $30 of tax paid.

    Unfranked - $49 in bank account, $21 tax.

    Tax rate of 45%

    Franked - $55 in bank, $45 of tax paid.

    Unfranked - $38.50 in bank, 31.50 tax paid

    Hope this makes it clear? (Fact checkers fire away, this was some very quick workings!)
     
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  13. Marg4000

    Marg4000 Well-Known Member

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    No, you don't get the $130 during the year. You get $100. Then in your tax return you declare the $100 received and also declare the $30 franking credits as income, which adds $130 to your taxable income.

    If you are below the tax threshhold then you will receive a refund of the $30 after the end of the financial year. You will lodge either a tax return if applicable, or if you don't have taxable income you can lodge a form to receive a refund of franking credits.
    Marg
     
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  14. thatbum

    thatbum Well-Known Member

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    I just meant that a franked dividend of $70 is the same as an unfranked one of $100 in all marginal tax rate situations, from what I can tell.

    I could be wrong, I'm not really a shares person.
     
  15. wogitalia

    wogitalia Well-Known Member

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    Yeah, if you receive an unfranked dividend that is 42.857% larger than the equivalent franked dividend it will work out the same after tax. It's not comparing apples to apples by any means but the math is correct.
     
  16. ACMH16

    ACMH16 Member

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    Broadly though, franking credits are of exactly the same value to someone with an MTR of 0% as to someone on an MTR of 45%.

    It's calculated as paying your MTR on a distribution grossed up by 30%, and then refunding or charging you the difference between the amount owed on that calculation and the 30% the company paid.

    So what's truly happening is that you receive the grossed up value and then get charged your MTR off that, while having a 30% tax withheld similar to the withholding mechanisms of PAYG. The fact that 30% overshoots your eventual tax liability more when you're in a lower tax bracket doesn't somehow make franking credits more favourable at a lower tax bracket. You still receive exactly the same grossed up value and just have to pay less tax on it.
     
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  17. Bran

    Bran Well-Known Member

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    BHP for $15? I did. And sold at 19.50 I think. Toot toot.
     
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  18. The Falcon

    The Falcon Well-Known Member

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    Really the stocks not paying franked dividends on the ASX either ;

    - have Foreign earnings ; so income tax is not paid in Australia, or is only paid on part of their income, so do not have franking credits to pass on. An example of the first would be Amcor (AMC) which used all its franking credits years ago, and the second would be Coca Cola Amatil (CCL) which is franked to around 75% due to foreign earnings component (tax paid overseas)

    - Are limited by corporate structure whereby they must distribute all income for tax in the hands of unit holders (ie. REITs and Infrastructure companies).

    - Have depleted their franking credit balance and are paying out distributions above their earnings (ie. that they haven't paid tax on) this isn't very common. Most companies will have a handy franking credit balance available (companies pay tax on all earnings, receive franking credits for all the tax paid, and only distribute some of the earnings and franking credits, so they are left with surplus credits provided payout ratio is lower than earnings / retained franking balance).
     
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