Dividends

Dividends are an important source of income for investors, particularly in Australia with the benefits of the federal government’s dividend imputation system.

But they don’t come without risk because they are not guaranteed and companies can reduce dividend payouts, as demonstrated during the COVID pandemic.

Explaining Dividends

Dividends are payments to shareholders from a company’s after-tax earnings. They are a form of income from investing in ASX listed stocks. Not all companies pay a dividend, and it is not compulsory for profitable companies to pay dividends.

Having said that, Australian companies tend to pay out a high proportion of earnings as dividends, as measured by the dividend payout ratio. Listed companies have, on average, paid out 65% of their earnings in the form of dividends from 1917 to pre-COVID¹.

Dividends declared at the half year accounts, normally February for companies with a June 30 balance date, are known as “interim” dividends. Those in the end of the year accounts are “final” dividends and are usually declared in August. Together, interim and final dividends make up the “full year” dividend of a stock.  

Dividends are considered income for taxation purposes – you will need to include them in your annual tax return.

Dividends for income generation

Australian investors have become accustomed to using shares as income-generating investments, making use of the attractive attributes of the dividend imputation system.

Because dividends are paid from after-tax income of a company, taxing shareholders on dividends would amount to double taxation. So, shareholders receive a rebate for the tax paid by the company on profits distributed as dividends.

These dividends are described as being 'franked', because they have a franking credit attached to them which represents the amount of tax the company has already paid. Franking credits are also known as imputation credits.

It’s important to remember that dividends come out of company earnings and are not certain in any financial year. If a company has a bad year, it can reduce its dividend. For example, during the COVID pandemic, companies cut or suspended their dividends without warning. Equally, not all stocks on the ASX are dividend paying, with management preferring to reinvest the retained earnings into growing the business instead of distributing it to shareholders.

Even the stocks most used for income investment, the big four banks and Telstra, have had occasion to cut their dividends.

Dividends and SMSFs

A self-managed superannuation fund (SMSF) operating in accumulation phase, building a nest egg, pays a 15% tax rate on earnings. This applies to all income, not just to dividends but also includes interest, net capital gains, taxable managed fund distributions, as well as concessional contributions. The 15% tax rate on earnings is lower than the general 30% rate for companies, meaning the franking credits available can offset or reduce the tax payable within the SMSF. If the franking credits are greater than all of the tax payable by the SMSF it will receive a refund of this excess after it lodges its tax return.

An SMSF completely in retirement pension phase (paying regular income members after retirement) does not pay tax on earnings. As a result, it receives a full rebate of the value of the franking credits, because it has no tax to offset. The SMSF will receive a refund of the excess franking credits after it lodges its tax return.

For SMSFs, the dividend imputation system means that a dollar of fully franked income is effectively worth more than a dollar. SMSF investors have used these rebates to great effect to income.

Dividend yields

Dividend yield refers to the dividend payout as a ratio to the share price. The yield of a dividend rises as the share price falls and falls as the share price rises.

Changes in share prices, and dividends, can have a positive or negative effect on the investor’s outcome depending on the circumstances.

When you buy a stock, the price you pay will determine the yield that the dividend represents to you. Regardless of the yield quoted on the stock in the newspaper or online, whether it uses historical (last year’s paid dividend) or projected (analysts’ consensus estimates) dividends, your eventual yield on a stock is determined by your buying price and the actual dividend you ultimately receive in the future.