In a monthly column to assist trustees, specialist Meg Heffron explores major issues on managing your SMSF.
When legislation for the proposed new tax on people with more than $3 million in super (known as “Division 296 tax”) was first introduced to Parliament, it was referred off to a Senate Committee. That Committee reported back last Friday (May 10) with a majority recommendation to pass it unaltered.
The Government made no mention of it in this week’s Federal Budget other than to set aside some money to help implement it for members of the Commonwealth defined benefit schemes – perhaps they felt there was nothing more to say.
The Greens are mounting a final effort to get the Government to take even more drastic action (their dissenting report from the Senate Committee) but it remains to be seen whether they would risk derailing the measure altogether to secure their extra changes.
To be honest, this all sounds to me like Division 296 tax is coming whether we like it or not.
So, what should those impacted be doing right now?
Don’t necessarily withdraw large amounts immediately
First, don’t overreact. There will be plenty of people impacted by this change who shouldn’t immediately pull large amounts out of super. (And remember, not everyone has that choice anyway. Anyone who’s not yet old enough to take money out of super doesn’t get a free pass to do so just because of this new tax. The current legislation only allows people to take money out prematurely to actually pay the tax, not to avoid it.)
Here are just some examples of people who should think on it before taking large amounts out now.
One group is members of funds where the assets have already built up very large capital gains. Remember Division 296 tax looks forward – it will tax future gains (after 1 July 2025), not capital gains that have built up already. In fact, the only thing that will trigger tax on capital gains built up already is actually selling the asset to transfer the money out of super!
Another is group is members whose funds generate most of their return as income rather than growth. Division 296 tax will certainly mean that income is taxed more. But not necessarily as much as if the same amount was invested outside super.
Even those who do decide to move wealth out of super should remember they have some time up their sleeve. If it’s legislated as planned, the measure won’t start until 1 July 2025. And in fact, someone planning to remove a lot of money from super to take their balance down to less than $3m actually has until 30 June 2026 to do so.
That’s because the tax is only paid on a proportion of the member’s super fund “earnings” each year (eg during 2025/26 for the first year). The proportion for 2025/26 is nil% for anyone with less than $3 million at 30 June 2026. It doesn’t matter how high their earnings were during the year or how much they had in super on 29 June 2026 – if they have less than $3 million in super on 30 June 2026 no Division 296 tax will be paid.
And finally remember that there are ways to manage capital gains tax within a super fund for people who have pension accounts. Sometimes, this will mean it’s more attractive to sell assets and withdraw large amounts in July rather than the previous June. This is all about focusing on a completely different tax – the normal capital gains tax paid by the fund itself when assets are sold to make large pay outs. I explained why in a previous article here.
Re-think long term withdrawal strategies
To date, the objective of many people with large balances and significant taxable income outside super has been to leave as much as possible in their SMSF for as long as possible. The ever-present risk for them has always been dying with a large balance remaining and triggering tax for the next generation (ie death benefits tax). It’s why a common decision for the survivor when one member of a couple dies is to move money out of super, particularly if they are already quite elderly.
Division 296 tax just changes the trade-off.
It means many people in this position will find investing inside vs outside super is far closer to being neutral than ever before. In that case, why take the risk with death taxes?
It’s likely that the best option for many people will be a progressive wind down of their super balance over $3 million rather than a “big bang” right now. As their SMSF sells assets, they will choose to transfer extra money out and buy anything new outside of super (in their own name, in a trust or some other structure). They’ll do that even while both members of a couple are alive and so their family unit is insulated from death benefit taxes (because spouses can inherit each other’s super tax free)
Reconsider the right structure for speculative investments
Sadly, Division 296 tax probably means super is no longer the place to hold “blue sky” investments.
It has been up until now.
The fact that these investments often produced no income for an extended period didn’t matter because super is by its very nature a long-term thing. Then, if the investment’s success meant a significant capital gain, there were opportunities to minimise the tax impact for those in pension phase. At worst, the tax rate was effectively only 10% in most cases anyway.
And volatility didn’t matter. Again, super is long term, and the actual size of a member’s super balance only became critical for those hovering around important thresholds (such as the ones that impact their ability to make contributions) or starting a pension (where the balance size impacted the amount of pension payments required during the year). That was something people going into these investments were prepared to live with.
But Division 296 tax will change all that. It will mean members might be taxed simply because these investments increase in value. They expose themselves to significant tax bills that they may not have the cash to pay based on movements in an asset that is by definition unpredictable.
I wonder how this will impact access to private equity funding? Or IPOs?
The same applies to assets we might not have thought of as being highly speculative, but which have three important features: they are long term, most of the return comes from capital growth and they can be volatile. This is why so many have focused on farms – it will be far less attractive to hold these in an SMSF than it has been in the past.
A move to defensive assets for SMSFs?
In fact, bringing all these points together, I wonder if we’re likely to see large SMSFs shift to a more defensive position over time.
The members themselves may still have growth assets but they’re more likely to hold these outside their SMSF because of the Division 296 complications with these assets (ie paying tax on the growth as it happens rather than only once the asset is sold). The liquid, income-rich, non-volatile investments will be more attractive for SMSFs. I don’t know what this means for investment markets generally, but this doesn’t feel like a great outcome.
Review legacy pensions urgently
It’s no surprise that many people with large balances have been building up their super over many years. This is also the group most likely to have what are called ‘legacy pensions’ (old style pensions that are much less flexible than modern ones). There are a lot of rules for these pensions that stop their recipients taking money out at will.
Some also come with ‘reserves’. Reserves are a tricky thing – you’ll know if you have them that you’re even more restricted. And Division 296 tax presents even more challenges. If you unwind a legacy pension with reserves in (say) 2025/26 and use that as a trigger to allocate an amount to a member’s super account, the reserves themselves will count as “earnings”. That means they’re potentially subject to Division 296 tax, despite the fact that this isn’t new growth - it’s just an allocation of money that’s already in the SMSF.
Division 296 will definitely present another strong driver to look at legacy pensions now particularly if there are reserves involved.
In fact, the two (legacy pensions and preparing for Division 296) should be considered together. Some people with legacy pensions can find they limit their options if they take large amounts out of super in anticipation of Division 296 tax. That’s because the few chances they do have to wind up their legacy pensions are usually optimised if they have a large amount in super overall. The worst outcome would be to take large amounts out of super and only discover afterwards that doing so limits your choices when it comes to your legacy pension.
It's a shame the Government has taken this particular approach to extracting more tax revenue from wealthier members of the community. I wonder if many would have parted with their hard-earned cash more willingly if they were only paying tax on income their super fund had actually locked in (ie realised capital gains). And I wonder if over the long term, the tax take might have been even higher if the Government had chosen a different path.
Meg Heffron is the Managing Director of Heffron SMSF Solutions, a sponsor of Firstlinks. This is general information only and it does not constitute any recommendation or advice. It does not consider any personal circumstances and is based on an understanding of relevant rules and legislation at the time of writing.
For more articles and papers from Heffron, please click here.