Australian ETF Investment Guide: Maximizing After-Tax Returns Across Tax Brackets - With my thoughts on allocation

Australian ETF Investment Guide: Maximizing After-Tax Returns Across Tax Brackets

When it comes to investing in dividend ETFs as an Australian, the tax implications can make or break your returns. While US markets offer compelling options like VIG and JEPI, the reality is that franking credits and withholding taxes significantly impact your net returns. Let's break down the optimal ETF allocation strategies for different Australian tax brackets.

The Tax Landscape for Australian ETF Investors

Australian ETFs: The Franking Advantage

Australian dividend-paying companies provide franking credits - essentially pre-paid tax credits that can reduce your tax bill or even result in refunds. This creates a significant advantage for domestic ETFs like:

• VHY (Vanguard Australian Shares High Yield ETF): 8.66% dividend yield with ~20% franking credits
• VAS (Vanguard Australian Shares Index ETF): Broader market exposure with ~78% franked dividends
• A200 (BetaShares Australia 200 ETF): Low-cost broad market exposure with franking benefits
• IVV (iShares S&P 500 ETF): US large-cap exposure, currency unhedged
• VTS (Vanguard US Total Market Shares ETF): Broader US market coverage including small caps
• SPYD (SPDR Portfolio S&P 500 High Dividend ETF): US high dividend focus
• JEPI (JPMorgan Equity Premium Income ETF): US covered call income strategy
• JEPQ (JPMorgan Nasdaq Equity Premium Income ETF): Nasdaq-focused covered calls
• VDHG (Vanguard Diversified High Growth Index ETF): Diversified growth portfolio
• IOZ (iShares Core S&P/ASX 200 ETF): Alternative broad Australian market exposure

International ETFs: The Tax Drag

US ETFs face several challenges for Australian investors:

• 15% US withholding tax (reduced from 30% due to tax treaties)
• Currency exchange risk
• No franking credits
• Complex tax reporting for covered call strategies

Currency Strategy: Timing Your US ETF Purchases

The AUD/USD Advantage

One of the most overlooked aspects of international investing for Australians is currency timing. In 2024, the AUD/USD ranged from a low of 0.6185 to a high of 0.6919, representing an 11.9% swing - that's free alpha if you time your purchases well!

When to Buy US ETFs

Optimal Purchase Times (Strong AUD):

• AUD/USD above 0.70: Excellent time to increase US ETF allocations
• AUD/USD 0.68-0.70: Good time for systematic investing
• AUD/USD 0.65-0.68: Average timing, stick to plan
• AUD/USD below 0.65: Consider reducing new US purchases, focus on Australian ETFs

Historical Context

2024 average: AUD/USD = 0.6598. When the AUD was at its 2024 high of 0.6919, Australian investors got 11.9% more US assets for their dollars compared to the year's low.

Currency-Adjusted Allocation Strategy

Strong AUD Periods (0.70+):

• Increase US ETF allocations by 5-10%
• Perfect time for: IVV, VTS, VIG, JEPI, SPYD, JEPQ
• Consider lump sum investments in US assets

Weak AUD Periods (0.65-):

• Increase Australian ETF allocations by 5-10%
• Focus on: VHY, VAS, A200, IOZ
• Wait for AUD strength before major US purchases

Example Currency-Adjusted Allocation (Middle Income, Strong AUD):

• 25% VHY (reduced from 35%)
• 20% VAS (reduced from 25%)
• 15% IVV (increased from 10%)
• 10% VIG (increased from 8%)
• 10% VTS (increased from 5%)
• 8% A200
• 5% JEPI (increased from 3%)
• 4% SPYD (increased from 2%)
• 2% JEPQ (increased from 1%)
• 1% VDHG

Currency Hedging Considerations

Over three years to June 2024, unhedged global equities returned 11.2% p.a. vs 7.0% p.a. hedged - the AUD weakness provided significant tailwinds for unhedged investments.

Hedged vs Unhedged Strategy:

• Unhedged (IVV, VTS): Better when AUD weakening long-term
• Hedged options: Better for risk-averse investors or when AUD strengthening
• Dollar Cost Averaging: Reduces currency timing risk over time

Practical Implementation

1. Monitor AUD/USD weekly - set alerts at 0.65, 0.70, 0.75 levels
2. Adjust new purchases based on currency strength
3. Don't try to perfectly time - use ranges, not exact levels
4. Consider currency as "free diversification" - sometimes it helps, sometimes hurts

ETF Analysis by Tax Bracket

Low Income Earners ($18,201 - $45,000) - 16% + 2% Medicare = 18% Marginal Rate

The Sweet Spot for Franking Credits

At this tax bracket, you're paying less tax than the 30% company rate, making franking credits extremely valuable. You'll receive cash refunds for excess franking credits.

Recommended 10-ETF Allocation:

• 40% VHY: Maximum franking benefit and high yield
• 20% VAS: Broad market with excellent franking (78%)
• 10% A200: Additional Australian exposure, ultra-low fees
• 10% IVV: US large-cap exposure
• 5% VTS: Broader US market including small caps
• 5% SPYD: US high dividend (but watch the tax drag)
• 5% JEPI: US covered call income
• 3% JEPQ: Nasdaq covered calls (small allocation due to newness)
• 2% VDHG: Diversified growth component

After-Tax Yield Examples:

• VHY: 8.66% + franking benefit = ~9-10% effective yield
• SPYD: 4.4% - 15% US tax = ~3.7% net yield
• JEPI: 8% - 15% US tax = 6.8% net yield

Middle Income ($45,001 - $135,000) - 30% + 2% Medicare = 32% Marginal Rate

The Balanced Approach

This bracket still benefits from franking credits, though less dramatically than lower brackets. The $130,000 income example falls here.

Recommended 10-ETF Allocation:

• 35% VHY: Strong franking benefits with high yield
• 25% VAS: Balanced market exposure with excellent franking
• 10% A200: Additional broad market exposure
• 10% IVV: US large-cap core holding
• 8% VIG: International dividend growth
• 5% VTS: Broader US exposure
• 3% JEPI: Income diversity despite tax drag
• 2% SPYD: US high dividend (limited due to tax)
• 1% JEPQ: Small speculative allocation
• 1% VDHG: Diversified component

After-Tax Yield Examples:

• VHY: 8.66% + franking benefit = ~10-11% effective yield
• VAS: 4.5% + 78% franking = ~5-6% effective yield
• SPYD: 4.4% - 15% US tax = ~3.7% net yield
• JEPI: 8% - 15% US tax = 6.8% net yield

High Income ($135,001 - $190,000) - 37% + 2% Medicare = 39% Marginal Rate

Franking Credits Become Even More Valuable

Contrary to common belief, high tax brackets should INCREASE allocation to franked dividends. Even with VHY's modest ~20% franking, you're still getting tax relief on a portion of dividends, while the unfranked portion is taxed at your full rate anyway.

Recommended 10-ETF Allocation:

• 45% VHY: Higher allocation - franking credits provide more absolute tax savings
• 20% VAS: Better franking (78%) provides significant tax relief
• 10% A200: Additional Australian market exposure
• 8% IVV: US large-cap exposure
• 5% VIG: International dividend growth
• 4% VTS: Broader US market
• 3% JEPI: Some income diversity
• 2% SPYD: Limited US high dividend
• 2% VDHG: Growth diversification
• 1% JEPQ: Minimal speculative allocation

Top Tax Bracket ($190,000+) - 45% + 2% Medicare = 47% Marginal Rate

Maximum Value from Franking Credits

At the highest bracket, every dollar of franking credit provides maximum tax relief. VHY becomes more attractive, not less.

Recommended 10-ETF Allocation:

• 50% VHY: Maximum allocation - even 20% franking provides substantial tax savings
• 20% VAS: High franking rate (78%) extremely valuable
• 8% A200: Additional Australian exposure
• 7% IVV: US large-cap exposure
• 5% VIG: International dividend growth
• 4% VTS: Broader US market coverage
• 3% JEPI: Income component
• 1% SPYD: Minimal US high dividend
• 1% VDHG: Growth diversification
• 1% JEPQ: Speculative tech income

Key Investment Strategies by Asset Class

Australian Core Holdings (Priority for Franking)

1. VHY: High dividend yield with franking credits - cornerstone holding
2. VAS: Broad market with excellent 78% franking rate
3. A200: Ultra-low cost alternative with strong franking
4. IOZ: Another broad market option for diversification

US Market Exposure (Accept Tax Drag for Diversification)

5. IVV: Australian-domiciled S&P 500 exposure
6. VTS: Direct US listing for broader market coverage
7. VIG: Focus on dividend growth companies

Income-Focused Strategies (Tax Considerations Critical)

8. JEPI: Monthly income but heavy tax drag for Australians
9. SPYD: High dividend yield reduced by withholding tax
10. JEPQ: Newest option, tech-focused covered calls

Diversified Solutions

11. VDHG: One-stop shop for growth-focused investors

Comprehensive 10-ETF Comparison

ETF	Type	Yield	Franking %	Expense Ratio	Domicile	Best For
VHY	Australian High Yield	8.66%	~20%	0.25%	Australia	All brackets - especially high earners
VAS	Australian Broad Market	~4.5%	~78%	0.10%	Australia	High franking benefit, all brackets
A200	Australian Broad Market	~4.2%	~75%	0.04%	Australia	Ultra-low cost broad exposure
IOZ	Australian Broad Market	~4.1%	~70%	0.09%	Australia	Alternative broad market option
IVV	US S&P 500	~1.5%	0%	0.04%	Australia	US large-cap core holding
VTS	US Total Market	~1.4%	0%	0.03%	US	Broader US market exposure
VIG	US Dividend Growth	1.7%	0%	0.06%	US	Growth focus, all brackets
SPYD	US High Dividend	4.4%	0%	0.07%	US	High yield but tax inefficient
JEPI	US Covered Calls	7-9%	0%	0.35%	US	Income focus, better for lower brackets
JEPQ	US Nasdaq Covered Calls	~10%	0%	0.35%	US	Tech income, very new ETF
VDHG	Diversified Growth	~3%	Mixed	0.27%	Australia	One-stop diversified solution

Tax Efficiency Tips

1. Maximize Franking Credits

Lower tax brackets should prioritize Australian dividend ETFs to maximize franking credit refunds.

2. Consider Timing

High tax bracket investors might consider:

• Holding growth-focused ETFs in taxable accounts
• Using superannuation for high-dividend investments
• Tax-loss harvesting with underperforming positions

3. Currency Hedging

For international exposure, consider currency-hedged ETFs to reduce AUD/USD volatility.

4. Rebalancing Strategy

• Lower brackets: Focus on maximizing current after-tax income
• Higher brackets: Prioritize long-term capital growth

Common Mistakes to Avoid

1. Ignoring Currency Timing: That attractive 8% US ETF yield becomes 6.8% after tax, and could be further reduced by adverse currency movements
2. Ignoring Withholding Tax: US ETFs lose 15% to withholding tax regardless of yield
3. Overlooking Currency Risk: AUD/USD movements can significantly impact returns - an 11.9% annual range in 2024 alone
4. Not Considering Your Tax Bracket: What works for a $50k earner doesn't work for a $200k earner
5. Chasing Yield Without Tax Efficiency: High yields mean nothing if they're heavily taxed
6. Perfect Currency Timing: Don't wait for the "perfect" exchange rate - use ranges and dollar cost averaging
7. Ignoring Franking Credits: The most valuable tax benefit available to Australian dividend investors

Conclusion

The optimal ETF allocation for Australian investors depends heavily on your tax bracket. Lower income earners should maximize franking credit benefits with Australian high-dividend ETFs like VHY, while higher earners should focus more on growth-oriented options like VIG.

Remember: it's not what you earn, it's what you keep after tax that matters. Before making any investment decisions, consider consulting with a qualified financial advisor who can assess your complete financial situation.

The key is finding the right balance between current income, capital growth, and tax efficiency for your specific circumstances. With Australian franking credits providing such significant benefits, domestic ETFs often outperform international options on an after-tax basis, particularly for lower and middle-income brackets.