Gearing in Super: Strategies to enhance outcomes from accumulation through to pension stage

Superannuation is one of the most efficient ways to build wealth over the long term. Super encourages a longer-term investment horizon and the tax rate within super is lower than those faced by most individuals outside of super. However, it is a heavily regulated space with restrictions on how you can invest, contribution limits and balance caps.

In this article, we explore how Betashares Wealth Builder ETFs can be used in different ways to enhance superannuation outcomes for individuals at different stages of their investment journey – from early accumulation, to late-stage accumulation, through to pension stage.

Betashares Wealth Builder ETFs provide low cost, diversified exposure to Australian and global equities and employ a ‘moderate’ degree of leverage. Because these funds are internally geared, they are one of the few geared investment solutions available to SMSFs¹. They also offer a far more cost-effective solution than some of the other SMSF leveraged solutions.

Of course, it’s important to remember that geared investments involve higher risks than non-geared investments, as gearing magnifies both gains and losses, and as such may not be a suitable strategy for all investors.

How can gearing enhance after-tax income generation?

It’s often said the only thing Australian investors like more than a dividend is a fully franked dividend. Australia’s unique imputation system provides eligible investors an income bonus on top of cash dividends – being franking credits.

A geared exposure to Australian shares may entitle you to more franking credits as your investment exposure increases compared to an investment in an equivalent ungeared portfolio.

Below we use a hypothetical example to show the potential difference in total income (including franking credits) generated between an ungeared portfolio of Australian shares and a geared equivalent.

For this illustrative example, we assume the investor has $100,000 of investible capital, a cash dividend yield of 4.5% with 70% franking, and the geared portfolio has a loan to value ratio (LVR) of 35%.

Hypothetical example provided for illustrative purposes only. Not representative of actual fund performance. Actual outcomes may differ materially. This information is not a recommendation or offer to make any investment or adopt any particular investment strategy.

More than $700 in extra franking credits was generated as borrowing at an LVR of 35% increases your investment exposure by around 1.54x (or approximately $154,000 for a $100,000 investment) on a given day.

That means instead of the franking credits being applied to $4,500 of dividends for the ungeared portfolio, it instead applies to the $6,923 of dividends that the geared portfolio generated.

It is important to note that not all Australian investors will be able to receive the full value of franking credits. The amount received is subject to an investor’s eligibility.

Optimising outcomes for different use cases inside super

With the potential to generate additional franking credits from a geared portfolio of Australian shares, the Wealth Builder ETFs can be used for a number of different use cases within super.

Increasing your investment exposure beyond the concessional contribution cap

For super investors in the accumulation phase, the Wealth Builder ETFs can make your super contributions work harder by providing approximately $45,000 of exposure to equity markets for $30,000 of invested capital (being the concessional contributions cap effective from 1 July 2024) on a given day.

This additional amount of exposure would have the potential to generate higher returns compared to being invested outside of super where returns are taxed at a (generally) higher marginal income tax rate.

According to research by CFS carried out in late 2023, the average Australian believed they needed $1.6 million to save for a comfortable retirement². Increasing your exposure to the market beyond the concessional cap using the Wealth Builder ETFs could help Australians achieve their retirement goals sooner.

However, it would be quite difficult to achieve this figure based on the $30,000 concessional capped contributions alone, particularly if you took a career break.

Super fund balances at or near the proposed $3 million threshold

For super fund balances at or near the proposed $3 million threshold that the Australian Government has announced will come into effect from 1 July 2025, the Wealth Builder ETFs could also provide scope for a SMSF to enhance franking credits (subject to the investor’s eligibility) and the ability to buy or sell units on the ASX for more flexible cash flow management.

Those additional franking credits could be used to offset part of the additional tax incurred if the $3 million threshold is exceeded.

Additionally, having the ability to liquidate holdings to pay this tax is also helpful in the situation where an SMSF also holds more illiquid assets like property.

To illustrate, let’s take a look at a hypothetical example of an individual in accumulation phase with $4 million in superannuation, assuming no contributions or withdrawals. If the balance grew to $5 million the following year, the additional tax liability of 15% would be applied to 40%³ of the $1 million (which includes both income and unrealised gains).

This would equate to an additional tax liability of around $60,000.

As it may not be commercially viable to crystallise unrealised capital gains, the need for liquidity becomes important for a trustee to fund this tax liability.

For example, a SMSF may have a concentrated portfolio of commercial and residential property, which are generally illiquid in nature and difficult to readily convert to cash. Having an allocation to liquid assets like a Wealth Builder ETF can provide the flexibility and funding required to rebalance an investment portfolio or meet potential tax payments.

Boosting income in pension phase

As members enter pension phase, there is a minimum drawdown percentage of 5% which increases as an individual get older. It is therefore important for pensioners to consider how their portfolio’s asset allocation can generate the desired mix of income whilst preserving capital.

A Wealth Builder ETF in combination with a lifetime annuity could provide this mix of boosting pension income payments whilst retaining a specific level of investment exposure to the equity market.

In the example below, we compare two hypothetical portfolios held within super by way of illustration. We assume the members in this instance is a couple in pension phase who owns their home, receives the age pension and account based pension, and has no other sources of income. They do not wish to sell the investment property.

Hypothetical example provided for illustrative purposes only. This information is not a recommendation or offer to make any investment or adopt any investment strategy.

Portfolio A is invested $150,000 in cash, $300,000 in Australian equities (through an investment in Betashares A200 ETF) and $400,000 in property⁴.

Hypothetical example provided for illustrative purposes only. This information is not a recommendation or offer to make any investment or adopt any investment strategy.

Portfolio B maintains the total investment value of $850,000; however, $100,000 is taken out of the Australian equities portion and moved into a lifetime annuity with the initial $150,000 cash.

By combining a lifetime annuity with an allocation to a moderately geared portfolio of Australian shares (by way of an investment in Betashares G200 ETF), the couple shifting from Portfolio A to Portfolio B could potentially increase their annual pension payments by $7,795 – from $11,926 to $19,721.

This is because lifetime annuities are favourably treated by the pension asset test⁵, which increases a pensioner’s eligibility to receive the age pension.

Importantly, Portfolio B’s exposure to the equity market is also retained as the geared portfolio of shares increases the investor’s exposure.

In this example, although the amount invested in equities dropped by $100,000, the $200,000 invested in moderately geared Australian shares (via Betashares G200 ETF) effectively provides a leveraged exposure to the market of around 1.54x (assuming a loan to value ratio of 35%) on a given day⁶.

This equates to roughly $300,000 ($200,000 multiplied by 1.54) of exposure to Australian equities in Portfolio B on a given day, being the same amount of exposure held via Portfolio A.

In summary:

Using a geared investment strategy in super has the potential to enhance franking credits and allow for more flexible cash flow management with the ability to buy or sell units on the ASX, which can be used to enhance tax and lifestyle outcomes for accumulators and pensioners.

Betashares Wealth Builder ETFs provide accumulators and pensioners who are comfortable with the risks associated with gearing with a powerful building block that could help to enhance long term wealth and income creation. The Betashares Wealth Builder range currently comprises two ETFs.

Key benefits of the Betashares Wealth Builder ETFs include:

• accelerate wealth creation with a moderate level of gearing in a cost-effective structure
• no loan application process, and no possibility of margin calls for investors
• convenient access to low-cost funding as Wealth Builder ETFs borrow at institutional interest rates that are considerably lower than those typically available to individual investors
• entitlement to more franking credits than if you had invested in an equivalent ungeared portfolio⁷.

With one easy trade on the ASX, investors can unlock the power of gearing with exposure to a portfolio of Australian and global stocks without the hassle of complicated loan applications.

The gearing ratio (being the total amount borrowed expressed as a percentage of the total assets of each Fund) will generally vary between 30% and 40% on a given day. This means that each Fund’s geared exposure is anticipated to vary between ~143% and ~167% of the Fund’s Net Asset Value on a given day. Each Fund’s portfolio exposure is actively monitored and adjusted to stay within this range.

Each Fund’s returns will not necessarily be in this range over periods longer than a day, primarily due to the effects of rebalancing to maintain the Fund’s daily target geared exposure range and the compounding of investment returns over time, and the impact of fees and costs.

Each Fund’s returns over periods longer than one day may differ in amount and possibly direction from the daily target geared return range. This effect on returns over time can be expected to be more pronounced the more volatile the relevant sharemarket or portfolio and the longer an investor’s holding period.

Due to the effects of rebalancing and compounding of investment returns over time, investors should not expect each Fund’s Net Asset Value to be at a particular level for a given value of the relevant sharemarket or portfolio at any point in time.

Investors should monitor their investment regularly to ensure it continues to meet their investment objectives.

Gearing magnifies gains and losses and may not be a suitable strategy for all investors.

Investors in geared strategies should be willing to accept higher levels of investment volatility and potentially large moves (both up and down) in the value of their investment. Geared investments involve significantly higher risk than non-geared investments. An investment in the Fund is high risk in nature.

Sources:

1.Subject to eligibility under the relevant SMSF’s investment strategy. ↑
2. https://www.cfs.com.au/content/dam/cfs-winged/documents/about-us/media-release/the-rethinking-retirement-report.pdf ↑
3. Proportion of earnings corresponding to funds above $3 million. ($5 million – $3 million)/$5 million = 40%. This is based on the proposed taxation of super balances above $3 million that will come into effect from 1 July 2025. ↑
4. Median price for a one-bedroom apartment in Melbourne as at 27 May 2024. ↑
5. Lifetime annuities are generally entitled to more favourable treatment for the purposes of the Age Pension assets test. Click here for more information. ↑
6. The G200 ETF’s exposure (and associated returns) will not necessarily be in this range over periods longer than a day, primarily due to the effects of rebalancing and the compounding of investment returns over time, as well as the impact of fees and costs. ↑7. Not all Australian investors will be able to receive the full value of franking credits.