Australia’s superannuation system is excellent for ensuring financial security in retirement. However, changes are often made to the system to keep it sustainable and ensure equity for all individuals. The latest proposed change by the Government is Division 296, targeting high-income earners and their super balances. While the changes are framed as necessary to make the superannuation system fairer, there are concerns and potential issues with the proposed legislation. This article will explain how Div 296 works and the issues that are causing its introduction to be delayed.
The Div 296 changes primarily aim to introduce an additional tax for individuals with superannuation balances over $3 million. The change is due to start from 1 July 2025. The Government’s purpose is to address concerns over the tax advantages enjoyed by wealthy individuals through concessional tax on large super balances.
What Extra Tax will you pay under Div 296:
Div 296 will tax “earnings” from the portion of your balance over $3m at an extra 15%. This is in addition to the standard 15% tax on earnings (income less expenses) within the accumulation phase and the zero tax on balances in the retirement phase.
Earnings = Closing balance – Opening balance + Withdrawals – Contributions
Let’s work it out with an example:
- Opening super balance (start of the year): $4 million
- Closing super balance (end of the year): $4.4 million
- Withdrawals: $0
- Contributions: $100,000
Using the formula:
- Earnings = Closing balance – Opening balance + Withdrawals – Contributions
- Earnings = $4.4 million – $4 million + $0 – $100,000 = $300,000
Now, the earnings related to the portion above $3 million need to be calculated. In this case, $1 million is the excess balance. The earnings attributable to the excess portion are:
- ($1 million / $4.4 million) × $300,000 = $68,182
The additional 15% tax on these earnings will be:
- $68,182 × 15% = $10,227
So, in this example, the individual would owe $10,227 in extra tax under Division 296.
Issues and Concerns with the Proposed Legislation
While the intention behind these changes is to reduce the advantage that high-net-worth individuals gain from tax concessions on large super balances, there are several issues with the proposed legislation. There has been a lot of criticism of the proposed changes from tax and professional associations due to fairness and complexity. The following issues are of particular concern.
- Taxing Unrealised Capital Gains: The inclusion of unrealised gains in the calculation of taxable earnings would set an undesirable and inappropriate precedent in the tax system. By taxing unrealised gains, individuals will be required to pay tax on income that they haven’t actually received.
- Liquidity Concerns: Having to pay tax on unrealised gains could lead to liquidity issues for SMSF’s. Super funds may need to sell assets or take other measures to pay the tax, particularly as these assets grow in value but do not generate cash flow. This presents potential liquidity risks for SMSF trustees and could discourage holding long-term growth assets.
- No ability to carry back losses: While Div 296 taxes gains in investment values, losses are ignored. Volatility will have a magnified impact on investments if you pay tax on the unrealised gains but get no benefit from unrealised losses.
- No indexation of the $3m threshold: The fairness of the proposed reforms has been called into question. The $3m threshold is not indexed to inflation like other thresholds. While this will not affect the Baby Boomers approaching retirement now, it will have a big impact on future generations. The $3m threshold seems generous now, but if you assume 3% inflation for 20 years it would be $1.66m in today’s dollars. That balance will affect a lot more people in the future.
- Behavioural Impacts: Another concern is that the new tax measures could influence behaviour, leading individuals to explore alternative investment strategies outside the superannuation system. High-net-worth individuals may decide to invest in assets outside of super to avoid the tax.
- Administrative Burden & Costs: The complexity of these changes will lead to greater administration costs. Assets will need to be formally valued each year, easy for shares, not so easy for property.
What should you do?
We are talking to our clients about whether they should take balances over $3m out of super and invest it in in their own name or in trusts. Looking at modelling, there is no black and white answer for this. While you may be better off while you hold the assets outside super earning income, when you sell and realise gains, you are often worse off due to the much higher individual tax on the capital gains.
Our suggestion is to talk about the situation with your financial advisors and work out the possible impacts for your specific situation. The bottom line is you will be paying more tax. Growth assets will be taxed on unrealised gains in super funds. Will this cause you liquidity issues? Do you need to look at the mix of assets held inside and outside your super fund?
Modelling also shows that the impact of this tax accumulates over time. As super funds have long time frames, there is plenty of time to make decisions. While the proposed start date is 1 July 2025, take your time to consider the impact reducing super balances will have. Remember gains up until 30 June 2025 are not taxed under Div 296.
Conclusion
The Division 296 superannuation changes represent a significant shift in the taxation of large superannuation balances, aiming to increase fairness in the system and reduce the tax concessions available to high-income earners. However, the proposed legislation comes with challenges, particularly around the complexity of tax calculations, potential liquidity issues, and the risk of unintended consequences for SMSFs and individual behaviour.
The legislation has already passed the lower house but is held up in the senate. With less than a year to go before the start date of the Div 296 legislation, and an election due before then, we are in a state of flux. If you have a large super balance, stay informed and consult your financial advisers to navigate these changes effectively. Addressing the issues and finding a balance between fairness, simplicity, and the long-term goals of the super system will be critical for the successful implementation of Division 296.
Author
Alison Lacey
Chartered Accountant & Director
This article first appeared in the October 2024 issues of the News Bulletin, published by the Australian Dental Association https://www.ada.org.au/Dental-Professionals/Publications/News-Bulletin