When it comes to investing in the stock market, dividends can be a valuable source of income for investors. Dividends are payments made by companies to their shareholders and can come in two forms: fully franked and partially franked. Partially franked dividends, which only have a portion of the dividend subject to franking credits, can be an attractive option for investors looking for income with a potentially lower tax bill. However, investing in partially franked dividends also comes with certain risks that investors need to be aware of. In this article, we’ll explore what partially franked dividends are and provide a beginner’s guide to investing in them. Whether you’re a seasoned investor or just getting started, this guide will help you navigate the world of partially franked dividends and make informed decisions about your investments.
What Are Partially Franked Dividends?
Partially franked dividends refer to a type of dividend payment that contains both franked and unfranked portions. In Australia, franking refers to a system where companies can attach a tax credit to their dividends to reflect the tax that has already been paid on the company’s profits. The purpose of franking is to prevent double taxation on company profits, as these profits are already subject to corporate tax.
When a company distributes partially franked dividends, it means that not all of the dividend payment is eligible for franking. This can occur when a company has earned profits that are subject to different tax rates or when some of the profits have been earned overseas, and thus are not subject to Australian taxation. The franked portion of the dividend will be accompanied by a franking credit, which can be used to reduce the recipient’s tax liability.
Investors who receive partially franked dividends will need to account for both the franked and unfranked portions of the payment when calculating their taxable income. The franked portion is included as assessable income, while the unfranked portion is subject to withholding tax. The amount of tax payable on the unfranked portion will depend on the recipient’s personal tax rate.
Why Do Companies Pay Partially Franked Dividends?
There are several reasons why a company may choose to pay a partially franked dividend instead of a fully franked dividend. One reason is that the company may not have enough franking credits available to fully frank the dividend. Another reason may be that the company is trying to balance its tax obligations with the desire to distribute profits to shareholders. In some cases, a company may choose to pay a partially franked dividend to signal to shareholders that it expects future profits to be lower than in the past.
How to Invest in Partially Franked Dividends
When you invest in partially franked dividends, you are not receiving the full tax benefit that would normally come with franking credits, which means that you will have to pay more tax on your investment return than if you had invested in fully franked dividend shares. However, this extra tax is offset by the fact that the investment return itself is greater than it would be with fully franked dividends. This makes partially franked dividends a popular option for investors who want higher returns without paying too much tax at the same time.
When choosing between fully and partially franked dividend shares, it’s important to consider your personal circumstances as well as your investment goals before deciding which type of investment might be better suited for them when making an informed decision about how many shares should be held within each category over time – whether it’s one year or ten years from now!
Risks of Investing in Partially Franked Dividends
Investing in partially franked dividends can come with certain risks that investors need to be aware of. One of the primary risks is that the franking credit system can be subject to changes in government policy, which can impact the value of franking credits and the amount of tax benefit that investors receive from partially franked dividends. Changes to the franking credit system could result in reduced tax benefits for investors, which could impact the attractiveness of partially franked dividends as an investment.
The company’s financial performance may change
Another risk of investing in partially franked dividends is that the company’s financial performance may change, impacting the amount and nature of the dividend payments. For example, if a company experiences a decline in profits or faces financial difficulties, it may reduce or suspend its dividend payments. Similarly, if the company decides to invest heavily in growth opportunities or acquisitions, it may choose to retain more earnings instead of paying out dividends. In such cases, investors may not receive the expected level of dividend income, which could affect their investment returns.
Investing in partially franked dividends may also expose investors to risks associated with the specific industries or sectors in which the companies operate. For example, companies in industries such as mining, oil, and gas may be subject to fluctuations in commodity prices, which can impact their profitability and dividend payments. Similarly, companies in the financial sector may be subject to regulatory changes that can impact their ability to pay dividends.
Finally, investing in partially franked dividends may also expose investors to risks associated with individual companies, such as management issues or corporate scandals. For example, if a company experiences a significant management change or a public relations crisis, it could result in a decline in share prices and dividend payments.
All in all, investing in partially franked dividends can come with certain risks, including changes to government policy, changes in the company’s financial performance, sector-specific risks, and individual company risks. It is important for investors to understand these risks and to conduct thorough research before investing in partially franked dividends. Seeking professional advice and diversifying their investment portfolio can also help investors mitigate some of these risks.
Conclusion
Partially franked dividends can provide a valuable source of income for investors, but it’s important to understand the risks associated with this type of investment. By researching the companies that pay partially franked dividends, consulting with a tax professional, and understanding the potential risks, investors can make informed decisions about whether to include partially franked dividends in their investment portfolios. With a solid understanding of the benefits and risks of partially franked dividends, investors can make the most of this unique investment opportunity.
