Author Topic: Australian thinks about investing in Vanguard funds, head explodes  (Read 8456 times)

mustachebros

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Would appreciate some Australian assistance on the following two-parter. Basically I want to know whether I am thinking about these correctly.

1) Assume I go back to Australia after a several-year hiatus. I'm 35 years old. I wire 450K from overseas to Vanguard Australia, and purchase 225K worth of their ASX 300-tracker and 225K worth of their MSCI World ex-Australia-tracking fund.

Using the infallible 4% Rule, I withdraw $18,000 a year (keeping me within the zero tax bracket). I do this by submitting a withdrawl form to Vanguard every month for a tax-free $1500. Now, I mentioned this to a friend and he said "Oh but you'll pay Capital Gains Tax on every withdrawl!!1" Started looking into this, head exploded.

2) Assume I have just joined the work force in Australia, wide-eyed and 22 years old. Since I plan to retire long before I can touch my superannuation I don't care much about it, and instead put as much money as I can into a Vanguard fund. My goal is to get an inflation-adjusted 225K worth of their ASX 300-tracking fund, and 225K worth of their MSCI World ex-Australia-tracking fund, then retire on a cool $18,000/year, maybe when I'm about 35. I use my fee-free HSBC account and set up a recurring BPAY payment to transfer (initially) $1000/month into each of the two funds.

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Basically at the simplest level for someone who isn't interested in property in the slightest, and wants to retire at, say, 35 years of age, please help me understand the problems with the above two scenarios.

 


marty998

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #1 on: March 19, 2014, 05:06:39 AM »
Question 1

Your friend is not quite correct. But you are not going to get what you want either.

Here's the rub. You don't pay tax on withdrawals per se. You could withdraw all $450k the next day and not pay tax on that - if the fund has not earned any income and unit prices have not changed.

Your $450k buys x number of units in the fund. Changes in the fund's assets dictate changes in the unit price which change the value of your investment.

The fund earns an income (dividends and capital gains). Vanguard being the fund that it is, it is unlikely to generate significant realised capital gains, but it will generate dividends. The ASX 300 fund more so than the World fund.

At the end of every financial year Vanguard will send you a tax statement detailing the funds earnings with income and capital gains to be included in your tax return. You will also have to include in your income the gain on any units that have been redeemed where the exit price is higher than your entry price. (Again, vanguard will advise).

Be warned - with some non-income distributing managed funds, especially international funds, you can get into problems where the fund has not paid any cash distributions but you are still liable for tax on the earnings of the fund.

Question 2

Yes in theory that could work, I personally would not be comfortable with that amount, but each to their own.

mustachebros

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #2 on: March 19, 2014, 05:59:26 AM »
Awesome, thanks Marty. Sounds like I might be somewhat on the right track in putting together the simplest non-property, Australia-centric plan ever.

Regarding your answer to Question 2 first, sorry, which amount would you not be comfortable with? The monthly investment or the amount on which I would retire?

Back to Question 1, ok thanks wow I don't know how I missed that. Yes, I guess the first year's worth of withdrawals to the tune of $18,000 would theoretically be largely untaxed as it's just like withdrawing from a bank account (lots of assumptions here).

In year 2, assuming 4% capital gains, no inflation, untaxed portion would be around 96% of the $18,000 (assuming 4% withdrawal, simple calculations, no compounding).

So the untaxed portion would get smaller and smaller, year on year? Have I done the calculation wrong?

And does this even matter as aren't these gains included as my "income?"

Thanks again for your response.

Wildflame

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #3 on: March 19, 2014, 11:18:17 AM »
Would appreciate some Australian assistance on the following two-parter. Basically I want to know whether I am thinking about these correctly.

1) Assume I go back to Australia after a several-year hiatus. I'm 35 years old. I wire 450K from overseas to Vanguard Australia, and purchase 225K worth of their ASX 300-tracker and 225K worth of their MSCI World ex-Australia-tracking fund.

Using the infallible 4% Rule, I withdraw $18,000 a year (keeping me within the zero tax bracket). I do this by submitting a withdrawal form to Vanguard every month for a tax-free $1500. Now, I mentioned this to a friend and he said "Oh but you'll pay Capital Gains Tax on every withdrawal!!1" Started looking into this, head exploded.

I have not yet needed to perform a withdrawal from my Vanguard account, so I am unclear as to the precise details. However, there are two basic ways I can see Vanguard treating it (ignoring selling spread, which would occur either way):

1) Applying some withholding rate to your withdrawal. Similar to PAYG tax, and could occur one of two ways: (1a) they send you the $1500 net of any withholding tax and take out slightly more than $1500 from your account, or (1b) send you $1500 minus any withholding tax, so your account is decreased by exactly $1500 but you get slightly less in pocket.

I have heard of people working two jobs being under-taxed because their second job does not set the withholding rate high enough. This implies to me that companies are generally not informed as to an individual's correct withholding rate, and this is up to the individual to inform the company. Therefore I think situation 1 is unlikely. More likely is situation 2:

2) Vanguard takes $1500 from your account and sends you $1500. They send you the tax statement at the end of the year. You are liable to pay tax on any dividends you have received from the whole balance of the investment account, plus any capital gains on the amounts you have withdrawn ($18k). Given you bought the units in a lump sum, after the first year any capital gains should be subject to the 50% discount (assuming no further purchases of units).

The ATO can require a person whose investment income exceeds a certain threshold to report and pay instalments of tax quarterly or semi-annually. The threshold is $2,000 gross, subject to a number of exceptions (less than $500 tax payable, notional tax less than $250, and the third is irrelevant for a 35-year-old). However, as I understand it the ATO will tell you that you need to pay instalments only after the first tax return you lodge in Australia that exceeds that $2,000 gross income from investments, and will tell you what instalment you should pay.

Because capital gains tax only becomes due when it is realised (you have sold the asset), CGT is only relevant on the total of $18k withdrawals. In theory, if your $450k of investments earns 3% in dividends and 1% in capital appreciation, and we are being lazy and allowing me to assume you make one $18k withdrawal on 30 June each year, the capital gains in the first year will be $4500 and the dividends will be $13,500 for a total of $18,000, so you will have zero tax payable as your income falls within the tax-free threshold. However, and even better, if the dividends are fully franked, their grossed-up value will be $19,286 (rounded) and you will have had the companies pay $5,786 in tax on your behalf -> which, in our shiny hypothetical, means that your actual income would be assessed at $23,786 (capital gains plus gross dividends), but having paid $5,786 in tax, you would be entitled to a notional refund of (5,786 less (19% of 5586 = 1061)) $4725, or thereabouts. It would actually be slightly less, because the Medicare levy would start phasing in at 10% from $20,542 up to a max of 1.5% of total income ($357) -> the difference is 23,786-20,542 = 3244, 10% on that is $324.40, so you would be due for $324 or so. But that comes off the refund you'd get from all those franking credits anyway, so in the worst case you'd only get a $4.4k refund.

Mmm, tax. Please note: I Am Not An Accountant, this is not professional advice, speak to a tax agent.

In short, however, you will be taxed each year on the dividends you receive (even if they are reinvested) and on any capital gains on the units that you sell within the year. However, thanks to the black magic of franking and your otherwise negligible income, you will probably get a tax refund every year.

TLDR: Vanguard will give you a nice statement at the end of every year that tells you the numbers you need to plug into your tax return. As long as your total income is low and you get dividends, you'll get a refund cheque. Worst case, hire an accountant for an hour or two a year to do your taxes.

PS: Lol, Capital Gains. Situation 2 coming up soon.

Wildflame

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #4 on: March 19, 2014, 12:06:07 PM »
2) Assume I have just joined the work force in Australia, wide-eyed and 22 years old. Since I plan to retire long before I can touch my superannuation I don't care much about it, and instead put as much money as I can into a Vanguard fund. My goal is to get an inflation-adjusted 225K worth of their ASX 300-tracking fund, and 225K worth of their MSCI World ex-Australia-tracking fund, then retire on a cool $18,000/year, maybe when I'm about 35. I use my fee-free HSBC account and set up a recurring BPAY payment to transfer (initially) $1000/month into each of the two funds.

Assuming you get roughly a consistent 5% real return per annum (compounding monthly for my spreadsheet's convenience) and maintain $2k per month real contributions (so increasing with inflation), you would end up with somewhere around $440k of today's purchasing power by the end of the year you turn 34, if you started your contributions the start of the year you turn 22 (13 years total). However, this discounts the effect of taxation (SARPRISE TAXATION). In real short, if you are earning more than $37,000 inclusive of the gross value of any dividends you earn through your Vanguard accounts, you will need to pay an extra 4% tax (2.5% for the bit over 30% that the franking credits won't cover, plus 1.5% for the Medicare levy). If you assume instead of 5% you get something like 5.3% real return pre-tax over that period, then you'll end up hitting your mark after-tax - and that's in the worst case, with all your return coming from dividends, and none from capital gains. If you break 80k you'll need to allow for an extra 8.5% tax instead. If you hit 180k, hire an accountant. =P

The downside to accumulating like this is that the extra bit of tax you'll need to pay will come out of your pocket. In the very last month, you're looking at return of $1800 in the month, and so a $70 extra tax liability or so. In the whole last year, in other words, you may need to be prepared to pay up to an extra $840 in tax if you're below the 80k income bracket.

I know this is a lot of detail, but marty's post covers the basics very well. You only get taxed on capital gains on units you sell, when you sell them. For example, sell 10 units for $1.10ea when you bought them for $1ea, your capital gain is $1 (10x$0.10) and your tax will be anywhere from 0% to 46.5% of that $1 depending on your total income.

And I reluctantly agree with Marty: $18k is a very low amount to live off in Oz. I could only see that happening if you had free or near-free rent, or had a partner and $18k was your contribution to the household budget (36k is a reasonably generous sum for a household of 2 imo).



Frankly, early retirement in Oz is a sinch (the place is a combination socialist heaven - look at all this health care! - and gold-raining-like-manna-from-heaven capitalist powerhouse) with the partial exception of grappling with the rent-or-buy problem, and dumping a mere $2k a month / $24k a year into Vanguard is easily doable - if you plan to live on $18k a year, you only need to be earning around $50k pre-tax a year on average to save that much, and if you're tolerant of risk and willing to chance having your 'year turning 35' be 2008 and need to work a couple years more until the stock market recovers, an index fund in stocks will get you there and probably with a bit to spare!

If it helps, this is pretty much exactly the strategy I am planning to use: while saving towards a house deposit (personal goal to buy a house), full Oz stocks (High-Yield). Pay off house, save 50% in High-Yield, 50% in International to $200k (plus adjustment for inflation). Estimated time until semi-retirement (my version of ER): <9 years.

kingma15

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #5 on: March 21, 2014, 08:42:46 PM »

Frankly, early retirement in Oz is a sinch (the place is a combination socialist heaven - look at all this health care! - and gold-raining-like-manna-from-heaven capitalist powerhouse) with the partial exception of grappling with the rent-or-buy problem, and dumping a mere $2k a month / $24k a year into Vanguard is easily doable - if you plan to live on $18k a year, you only need to be earning around $50k pre-tax a year on average to save that much, and if you're tolerant of risk and willing to chance having your 'year turning 35' be 2008 and need to work a couple years more until the stock market recovers, an index fund in stocks will get you there and probably with a bit to spare!

If it helps, this is pretty much exactly the strategy I am planning to use: while saving towards a house deposit (personal goal to buy a house), full Oz stocks (High-Yield). Pay off house, save 50% in High-Yield, 50% in International to $200k (plus adjustment for inflation). Estimated time until semi-retirement (my version of ER): <9 years.

I am a new Australian mustachian and found this comment super interesting.

My only concern was the living off 18k a year. I am not sure this is do-able in Sydney? The cost of living is super high here.

Would you be supplementing your income with other work?

steveo

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #6 on: March 21, 2014, 09:19:52 PM »
Sounds like I might be somewhat on the right track in putting together the simplest non-property, Australia-centric plan ever.

I'm interested in something pretty similar however I intend to own my house. Apart from that I will do something very similar to yourself.

My question to everyone on here though is it worth it to invest in anything outside of say the ASX300. To me the tax benefits are pretty good on the australian stock market.

My only concern was the living off 18k a year. I am not sure this is do-able in Sydney? The cost of living is super high here.

I live in Sydney and I don't agree with this comment. House prices are ridiculous however grocery staples are reasonable and there are so many free activities. 18k per person plus a mortgage free house is easy. 18k without a mortgage free house might be tough.
« Last Edit: March 21, 2014, 09:24:02 PM by steveo »

kingma15

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #7 on: March 21, 2014, 10:16:14 PM »
Ahhh Steve-O, 18k per person I get.

My wife and I would spend about 20k per year between us if we take out mortgage and day care for our 2 kids.

We could easily do 36K per yesr with no mortgage.

I agree there are heaps of awesome free things to do in Sydney.

My comment was more thinking how my family of 4 could live of 18k per year. (i am sure it is do-able, but I am not that much of a kick ass Mustachian yet...)

steveo

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #8 on: March 22, 2014, 12:39:41 AM »
My comment was more thinking how my family of 4 could live of 18k per year. (i am sure it is do-able, but I am not that much of a kick ass Mustachian yet...)

We are a family of 5 and excluding mortgage payments and day care fees we spend about 38k. There is no way we could make it on 18k. I think myself and my wife could live off 18k mortgage free easily.

happy

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #9 on: March 22, 2014, 02:35:30 AM »
If you are planning on living on 18k a year, since the tax free threshold is 18k approx, would not the capital gains tax from selling the Vanguard be 0%?

I'm not an accountant but from what I can see from the ATO website, once you work out what the capital gain amount is ( this seems very complex) , it just goes on your tax return as income and therefore is taxed at your marginal rate. You'd have to have more than 18k of capital gain each year for it to matter i.e. you'd have to sell a really big parcel of Vanguard since CGT  only applies to the gains. If you were only withdrawing 18k worth the CGT might only be a few hundred or thousands i.e. never likely to get to 18k.  Its worth spending a few bucks and asking an accountant, since this makes a difference to your plan. Once upon a time I think CGT rate was 25 or 30% but this seems to have changed.
 
I suspect that the usual problem is that almost no-one with investment income is trying to live off 18k since that is about the single rate for most bennies. Also most people think about capital gains on top of their working income, and so they pay tax agh sir marginal rate.

mustachebros

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #10 on: March 23, 2014, 05:54:38 AM »
Hi guys - thanks for the responses. I had been trying to make some time to come back to this thread and give it the reply it deserves. I'm planning on sticking around in these forums for a bit and hopefully contribute in some way or another over time.

First of all, the impression I'm getting is that I should not be worrying so much about taxes as it seems 1) they won't be massive, and 2) they won't be too complicated. I'm admittedly quite out of the loop with regard to taxes/superannuation/etc in Australia but it makes sense (to the government; not me) that there would be tax breaks given to people who were happy to have the same Vanguard investment tied up in their super for 40 years.

Regarding surviving on $18,000, let's assume it was 1) outside of the metropolitan areas, and 2) rent-free.

Ok, let's get a little crazy. Assume for a moment that 1) there was no bid/offer spread on Vanguard funds, and 2) withdrawals happen instantaneously.

Every month you calculate 4% of the value of your investment, divided by 12 and withdraw it. Then at the end of the month you deposit everything back into the Vanguard fund.

The benefits I see are:

1) You don't accumulate a massive capital gains tax liability
2) You have tested your system*
3) You are a lot more in touch with how close you are to your "number"

In the early stages you might be withdrawing just 40 bucks a month, and investing the same 40 plus say 2000 bucks from your salary. But that 40 would gradually go up to 400 and then maybe 4000 over time, and so on until you could... well, I'm still not sure about all the details.

Hm, I think we'd need one more killer benefit to make this idea worth investigating.  But I'm wondering whether if spreads came down a bit more people would prefer to structure things like this.

Spreads have come down in the last eight years since I looked at Vanguard initially, and this is just the tip of the iceberg as far as how far things have come.

Just to be complete, the disadvantages are:

1) It's not actually available yet
2) Arguably it's not technically "investing" in the true spirit - you're basically turning your investment account into a cash flow.

Anyway, let us know what you think.

* I have a friend (not the same friend as above) who contributes to an insurance wrapper investment scheme in an offshore location. Apparently in 20 years time it will be easy to get his hands on the money, but in the mean time there is no way to test this. Also, I don't want to be rushing to set up 5000 dollar trusts and offshore companies and whatnot while desperate some day. Testing your strategy is important, IMHO.

happy

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #11 on: March 23, 2014, 06:52:54 AM »
Quote
Hi guys - thanks for the responses. I had been trying to make some time to come back to this thread and give it the reply it deserves. I'm planning on sticking around in these forums for a bit and hopefully contribute in some way or another over time.

First of all, the impression I'm getting is that I should not be worrying so much about taxes as it seems 1) they won't be massive, and 2) they won't be too complicated. I'm admittedly quite out of the loop with regard to taxes/superannuation/etc in Australia but it makes sense (to the government; not me) that there would be tax breaks given to people who were happy to have the same Vanguard investment tied up in their super for 40 years.

Regarding surviving on $18,000, let's assume it was 1) outside of the metropolitan areas, and 2) rent-free.

I don't understand the second part of your post at all, but as for the above.

Super is Australia is currently highly tax attractive and since its compulsory, the govt is trying to make it somewhat easier to understand. Investing in shares outside of super with regard to tax  is not so simple. Tax law changes all the time. If you invest outside of super you will probably be more highly taxed at your marginal rate…this is a big difference here to US where its much easier to do well investing. The only simple exception is if you don't earn much, you won't be taxed much. Whatever plan you hatch please run it past a reputable accountant.

deborah

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #12 on: April 26, 2014, 05:17:23 PM »
Every month you calculate 4% of the value of your investment, divided by 12 and withdraw it. Then at the end of the month you deposit everything back into the Vanguard fund.

The benefits I see are:

1) You don't accumulate a massive capital gains tax liability
2) You have tested your system*
3) You are a lot more in touch with how close you are to your "number"
Along with others I give the caveat that I AM NOT AN ACCOUNTANT but I think you would be setting yourself up for a lot of capital gains tax. If you have a share investment , housing investment ... for more than 12 months, capital gains tax is halved, because you are considered an investor rather than making-your-income-from whatever it is. Your monthly deposits and withdrawals could be a red rag to the ATO - as well as incurring whatever withdrawal/deposit fees are associated with the investment.

You will need a tax file number, and this is quoted to the fund so they don't withhold tax whenever they are paying you - otherwise you are considered to be at the highest marginal rate.

agent_clone

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #13 on: April 27, 2014, 02:15:22 AM »
Hmm, I could be wrong, but I think income tax (i.e. tax from income generated by working) is treated differently from investment taxes (i.e. dividends and capital gains tax).  I thought the tax rate for dividends was a flat 30%, with the possibility of them being franked (i.e. the company you invested with has already paid the appropriate tax so you don't need to pay additional tax, some Listed Investment Companies tend to have 100% fully franked dividends).  And that is why they talk about high income people with lots of investments paying less tax because of the 30% versus the 45% or whatever it is.

Then again I just fill out my tax forms each year and get back/pay whatever I need to...

For number 1: The ATO may or may not consider you bringing in money from overseas as income, but I am not sure on this one.  You will also need to declare income earned overseas (assuming you have more investments oversease), but there may be tax credits if you pay tax on it overseas.

For both of them where are you going to live? Are you willing to live in share houses forever?

I would also not be withdrawing money triggering a capital gains event until you need it.  Rather I would have the dividends go into a high interest savings account, then dole it out bit by bit, if you run out get out a few grand.  For number 1 I would be keeping your 18k  (or at least some money) out of the 450k as there is a CGT discount of 50% after the first year.

marty998

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #14 on: April 27, 2014, 05:00:19 AM »
This suggestion of churning funds so as not to accumulate a high CGT liability is, to be blunt, ridiculous.

Instead of "never" generating a capital gain by not selling, you are going to give yourself realised gains every single month.

agent_clone

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #15 on: April 27, 2014, 06:11:04 AM »
This suggestion of churning funds so as not to accumulate a high CGT liability is, to be blunt, ridiculous.

Instead of "never" generating a capital gain by not selling, you are going to give yourself realised gains every single month.

And he's going to be paying brokerage fees each time he withdraws/places back in money.  Which has is minimum of $10-20 each time, more depending on the amount of money.  Much better to not get money out until you actually need it, and then to get a few grand out at that time, put it in a high interest savings account then dole it out to yourself over time.

HowMuchCanAKoalaBear

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #16 on: May 17, 2014, 03:34:11 AM »
If you had 450k in VAS only they pay about 4% as a dividend .Its paid quarterly. So no Capital gains to worry about and you don't need to withdraw or sell anything just collect the dividends. Also its actually $20500 that's tax free thanks to the $445 low income tax offset another credit you get back.  You will get a nice refund check every year.

Income = $18000 in dividends + credits at 75% franking(asx300 approx franking rate)=$5785 therefore taxable income= $23785
Tax payable would be $940 but wait you have $5785 credits they owe you/refund is  $4845  So your yearly income is actually $22845 to live on.

For the first year of retirement :)  just have $18000 in a cash account to spend out of in addition to the 450k shares and let the dividends roll in its perfectly doable if you can live on that amount.

Good luck...

deborah

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #17 on: May 17, 2014, 03:51:20 AM »
credits at 75% franking(asx300 approx franking rate)
75% franking rate - where can you get that???

HowMuchCanAKoalaBear

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #18 on: May 17, 2014, 04:12:50 AM »
Hi Deborah I mean they're not fully franked 100% at the 30% company rate  because you own all ASX300 stocks some have no franking I think Westfield WDC is 0% and AMP is 70% of the franking so overall the average is  around 75% If you select your own stocks like the banks and Telstra they are fully franked and higher yields too.

http://frankingcredits.com.au/franking-credit-calculator/

« Last Edit: May 17, 2014, 04:23:46 AM by HowMuchCanAKoalaBear »

deborah

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #19 on: May 17, 2014, 04:45:03 AM »
Hi Deborah I mean they're not fully franked 100% at the 30% company rate  because you own all ASX300 stocks some have no franking I think Westfield WDC is 0% and AMP is 70% of the franking so overall the average is  around 75% If you select your own stocks like the banks and Telstra they are fully franked and higher yields too.

http://frankingcredits.com.au/franking-credit-calculator/
Sorry, I misread - I knew the company tax rate, and that franking credits were 30% or less (depending on how much the company decides to frank from its tax), so 75% was a bit strange, but 75% of 30% is quite understandable (about what I would expect too).

marty998

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #20 on: May 17, 2014, 05:50:06 AM »
We're going to have to relearn the maths soon when the company tax rate goes down to 28.5%.

For an example $100 dividend:

Cash received:     $100
Franking credits:  $39.86 (being 100 x 28.5 / 71.5)
Taxable income:   $139.86

It's hard enough explaining 30/70 to most people!!

HowMuchCanAKoalaBear

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #21 on: May 17, 2014, 06:05:49 AM »
I read that it will be a year yet July 2015 before that may happen to (28.5%)  and that's if it gets through the senate. Already got it plugged in the spreadsheet though.

dungoofed

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Re: Australian thinks about investing in Vanguard funds, head explodes
« Reply #22 on: June 08, 2014, 03:29:19 AM »
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