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Meg on SMSFs: Indexation of Division 296 tax isn't enough

Only a few months ago, it seemed this new tax was almost certain to become law (“this new tax” being the highly controversial extra 15% tax on super earnings for those with more than $3 million in super – aka Division 296 tax). At the time, a newly re-elected and confident government was firmly sticking with its intention to reintroduce the bill and get it passed. It seems amazing that we’re now speculating about changes. But here we are.

In recent weeks it seems even the Treasurer’s resolve has wobbled and there is a quiet murmuring of potential change. If the rumours are to be believed, the two aspects of this legislation being reviewed are the two most contentious: the lack of indexation of the $3 million threshold and the taxation of unrealised capital gains.

It’s likely the Treasurer hopes throwing a bone like indexation will take our eyes off the bigger issue of taxing unrealised gains.

It shouldn’t.

Indexation would be nice – and definitely better than nothing - but nowhere near as powerful as we might like to think.

Firstly, indexation would largely benefit those not yet caught by Division 296 tax. For example, if the threshold is indexed to inflation and this is around 3% pa, the threshold would reach $4 million in around 10 years, $5 million in around 18 years and $6 million in around 24 years. This is excellent for someone starting with $1 million today and maximising their super over the next 20 years. Whereas they might be likely to exceed $3 million, the chance of exceeding $5 million - $6 million in that timeframe is far lower. This is because the contribution caps we already have will quickly limit their ability to boost their super with their own money.

For those already in Division 296 tax territory, indexation would definitely result in less tax but is unlikely to have the enormous impact many would assume.

Consider the following example:

  • Bob has $7 million in super initially (including a $2 million pension) – minimum pension payments are drawn each year
  • The $3 million Division 296 tax threshold increases in line with inflation (and let’s say that’s 3% pa)
  • The Fund’s investment return is 8% pa before tax (5% growth, 3% income)

After 10 years, Bob would be around $40,000 wealthier if the $3 million threshold is indexed vs if it remains fixed at $3 million (this has been adjusted for inflation – so it’s $40,000 in “today’s dollars”).

That is certainly a valuable saving. But over that time, how much Division 296 tax has he paid? In this example, he’s paid around $670,000 in Division 296 tax in total even if the threshold has been indexed.

Repeating the same exercise with someone who started with $10 million in super, the saving thanks to indexation is roughly the same (around $40,000). But this time, the Division 296 tax paid during that time is over $1.1 million even if the threshold is indexed.

Why is it having so little impact?

This isn’t the right maths but conceptually, a $100,000 increase in the threshold means the member avoids 15% tax on earnings on an extra $100,000. If earnings (both income and growth) equate to 8% pa (for example), all this person is really saving is 15% x 8% x $100,000 (around $1,200). Of course this compounds over several years and the difference grows each year (ie, the gap between the indexed threshold and $3 million gets bigger) – so after 10 years, it’s a meaningful amount. But it’s around the same saving for everyone (no matter how big their starting balance) and it’s therefore dwarfed by the amount of Division 296 tax the member has actually paid for larger balances.

What does this mean?

Those fighting for change when it comes to Division 296 shouldn’t settle for indexation of the threshold. It’s better than nothing but doesn’t really change the equation for larger balances. And it doesn’t solve the fundamental issue of taxing unrealised gains.

That problem has been well articulated by many people in this debate in that the current structure results in:

  • highly unpredictable tax bills for those with volatile assets – and therefore a tax cost that simply cannot be planned for,
  • tax being imposed at a time when there is no guarantee there will be money available to pay it, and
  • tax being paid on asset growth that subsequently disappears.

Interestingly, my modelling suggests that if the Government found a way to tax actual capital gains when realised (ie the usual approach when it comes to taxing things), they might even raise more revenue.

In particular, without some form of grandfathering, this approach would effectively result in an additional tax being applied to gains that have already accrued (before the introduction of the new tax).

For example, let’s imagine Bob’s $7 million super fund has already built up $2 million in accrued (so far unrealised) capital gains at 30 June 2025.

Under the current approach, the ‘earnings’ taken into account for Division 296 tax would be his fund’s income (3% less tax) plus its growth (5%). Let’s say that amounts to around $540,000. So if Division 296 tax was introduced exactly as planned, he would pay 15% tax on a proportion of this amount (in his case, the proportion happens to be around 60%).

But what if the method switched to a proportion of ‘actual taxable income’ (rather than the earnings amount above). If Bob’s SMSF didn’t sell any assets during the year, his earnings would only be around $210,000 (3% of $7 million).

However, if his fund sold some of its assets and realised (say) $900,000 in capital gains, the Division 296 earnings (on an ‘actual taxable income’ method) might be more like $810,000. This is the fund’s income of $210,000 plus his fund’s capital gains, discounted by one-third (this is the discount super funds normally get for assets held for more than 12 months) - ie $600,000. Again, we can assume Bob would only pay Division 296 tax on a proportion of this amount (to reflect the fact that not all of his super is over $3 million).

This is because if the method was changed and no grandfathering was provided, even the gains Bob’s SMSF has built up before Division 296 tax would be caught. In contrast, Division 296 tax as it stands right now only looks forward – only growth post its introduction is taxed.

Of course, any change in method would need to consider:

  • whether it’s appropriate to consider grandfathering to avoid retrospectively taxing gains that have already built up over many years,
  • how to allow for discounting of capital gains (Division 296 tax as it stands effectively ignores discounting – it simply captures ‘growth’),
  • how to deal with pension accounts (in my examples above I’ve assumed the tax would be applied to a proportion of income ignoring any reduction due to the fact that some of the fund’s normal taxable income is entirely tax exempt because of its pension).

The key, however, is that the government probably could find a way of capturing just as much tax revenue even if it changed the tax. The problem is it would have to wait longer for it to arrive. If Division 296 tax is aligned to actual taxable income, the big tax bills would only really emerge when capital gains were realised.

But at least the people subject to the tax could be guaranteed to have the cash when it happened.

 

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.

New: The Heffron SMSF 2025/26 Facts and Figures document has been finalised and is available as a free download. Keep it on-hand to access the most recent information to stay up to date.

For more articles and papers from Heffron, please click here.

 

  •   8 October 2025
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26 Comments
JohnS
October 09, 2025

If I were given the choice between indexation of the $3m or not taxing unrealised gains, I would take the latter.

No doubt the $3m will increase just before an election, just like the income tax marginal tax rate figures change just before an election

3
GeorgeB
October 12, 2025

"the $3m will increase just before an election, just like the income tax marginal tax rate figures change just before an election"

It's another lever available to an incumbant government or opposition to corrupt voting intentions and goes a long way to explain why crafty politicians like Chalmers will resist indexation of both with unwavering tenacity.

3
David
October 10, 2025

We are putting layer after layer of added on complexity into the tax system. This div 296 is yet another layer which will soak up the time and effort of a whole bunch of Australians and the financial industry at a time when Australia is searching for reasons why productivity is declining!! Seriously......

2
davidy
October 10, 2025

I can accept the $3m cap but will never understand/accept the tax on 'unrealised' earnings. This is just so wrong and the so called Treasury boffins clearly don't understand how it works.

2
shawn burns
October 09, 2025

Yes, way too complicated. It should have a hard $3m cap, with relief to move any excess each year to a trust or wherever, in fact, where it should have been in the first place. the super regime is overly generous for allowing uncapped investments. Savings of course, should be allowed, and are, in a company, trust, personally etc, anywhere else that pays fair tax imo. And believe me i am not talking my own book here

1
John N
October 09, 2025

Fully Agree. Too much noise and wasted focus for a small element of the population.

2
billy
October 10, 2025

If only Costello hadn't made all super pension payments tax free, all of the "complications" of the super system would not be needed.

We would not have to have the pension transfer limit

We would not need Div 296

Just repeal the Costello changes and things would be fine

Dudley
October 10, 2025


Repeal tax on imaginary (inflationary) returns and could repeal 'Super'.

GeorgeB
October 11, 2025

Countries generally choose between two main approaches:

EET (Exempt–Exempt–Taxed): Contributions and investment earnings are exempt from tax, but withdrawals are taxed — the tax applies “on the way out.”

TEE (Taxed–Exempt–Exempt): Contributions are taxed when made, but earnings and withdrawals are tax-free — tax applies “on the way in.”

Australia, for reference, uses a “TTE” model (Taxed–Taxed–Exempt), where both contributions and earnings are taxed, but withdrawals in retirement are largely tax-free.

Changing from TTE to another model mid stream would significntly disadvantage savers whose balances were built up on another model and would require complex grandfathering to avoid some savers paying tax on all 3 counts namely on contributions, earnings and withdrawals.

2
Johns
October 12, 2025

Actually it would become T T T-

Taxed going in Tax on earnings and in retirement taxed on withdrawal pension paid would taxed and tax already paid would be refunded. It worked before costello wanted to buy votes. It will mean that big super balances would pay big pensions which would be taxed. If the big balances were due to return of your after tax contributions that part would be tax free.

Removal of the enforced payment of super goes against the while idea of super being a source of retirement income. There needs to be reintroduction of compulsory pension payments (be that at 65 or aged pension age)

The aim of super isn't to have most of it remaining still in super when you die. Super is not an estate planning tool. There needs to be a minimum annual draw down. And allowing super contributions until you are 75 without a work test needs to stop. That just makes super more of an estate planning tool

Dudley
October 12, 2025


"it would become T T T-":

It already is.
Homeowner couple having assets $1 more than $1,074,000 results in a 100% tax of Age Pension.

OldbutSane
October 10, 2025

I honestly don't see why it would be so hard to quarantine the $3m as a hard cap like they did for pensions and treat the excess as a separate "excess" accumulation account and tax the earnings at 30%.

Gen Y
October 10, 2025

Even easier would just to combine this with the Transfer balance cap and increase the tax payable on accumulation funds when held in Accum after preservation age. Very simple solution that solves a lot of problems.

Dauf
October 11, 2025

Its so simple, set a hard limit (currently say $3.0 million) and the rest has to get out of super...Index it in line with the TBC (currently $2.0m) and get rid of the immoral unrealism capital tax

simple and fair as no-one (absolutely no-one) needs more than $3.0 m tax free, which is typically then $6.0 m for a couple. Seriously?

1
Jack
October 10, 2025

The purpose of super has been legislated “to preserve savings to deliver income for a dignified retirement….”

A super fund of more than $3 million, by definition, cannot be in pension mode because it exceeds the Transfer Balance Cap (TBC) Note that a pension fund, while tax exempt, has mandated cash withdrawals that increase with age. Pension funds produce income in retirement.

A large super fund, in excess of the TBC, must be in accumulation phase which at present is still only taxed at 15%. But an accumulation fund in retirement has no mandated requirement to make any withdrawals, ever. As such, the fund may grow undisturbed until death. That makes it an ideal concessionally taxed estate planning investment vehicle.

If accumulation funds are not required to produce any retirement income, why are they allowed in retirement, if they do not satisfy the legislated purpose of superannuation?

Dudley
October 10, 2025


"A super fund of more than $3 million, by definition, cannot be in pension mode because it exceeds the Transfer Balance Cap (TBC)":

TBC is fixed at first transfer from Accumulation to Disbursement ('pension').
Disbursement account can grow to more than TBC when returns exceed withdrawals.

"accumulation funds are not required to produce any retirement income":
Nor are Disbursement accounts.
Withdrawals from Accumulation are not mandatory but withdrawals from Disbursement are mandatory.

Goronwy
October 12, 2025

No. If you have converted just under the TBC into pension mode and then have good returns you very much can, particularly as for four years from 2020-24 you only had to pay 50% of the scheduled required pension.

Tim
October 10, 2025

Jack,
A super fund of more than $3 million can be fully in pension mode.
In 2018, my SMSF was placed in pension mode with a balance just under the TBC of $1.6M. It has grown since then to be $3.4M at COB today. I'm a gold (and silver) bug. I do feel like I should be paying some tax when the gain is realised, but under the current rules, I won't.

1
Jack
October 10, 2025

Tim,
If your super is in pension phase, regardless of its size, it is required to pay you a pension each year in cash, which is set as a percentage of the fund balance at 30 June and increases with your age. That mandated pension itself is an interesting problem if the assets are gold or silver. At least the fund is producing income in retirement.

If your super is in accumulation phase, and most large funds exceed the TBC, then there is no requirement to provide income in retirement. My question still stands. Why do we allow people to hold assets in accumulation phase beyond the age of, say 70, when those tax-advantaged assets are not required to produce income in retirement.

Dudley
October 10, 2025


"Why do we allow people to hold assets in accumulation phase beyond the age of, say 70, when those tax-advantaged assets are not required to produce income in retirement.":

'Because we had not thought that far, yet. Thanks for the suggestion. We'll get Treasury to suggest ways to tax it more. It'll only affect about 3 million and we can buy more votes than that.'

Disgruntled
October 11, 2025

That's different.

You can't start a pension fund above the TBC at the time of commencement however it can grow in value after that date.

Warren Bird
October 13, 2025

Looks like the criticisms have been heard and accepted.

https://www.abc.net.au/news/2025-10-13/treasurer-announces-rework-of-stalled-super-tax-increase/105884568?utm_source=abc_news_app&utm_medium=content_shared&utm_campaign=abc_news_app&utm_content=other

Mart
October 14, 2025

Criticisms heard and accepted or humiliating climb down ? Wonder how much the fact that the Industry funds told Jim they can't actually calculate his planned changes had in the changes ....

SteveC
October 14, 2025

It was set up to satisfy Industry funds as they use unit price not individual asset prices to calculate member balances so it was easy for them to apply. The issue, as correctly highlighted here, was that SMSF contain assets not units which made it inequitable. Thing is that it was flawed from the start due to this and no indexation which has been corrected so kudos to the Treasurer for listening and making sensible changes.

Dudley
October 14, 2025


"kudos to the Treasurer for listening and making sensible changes":

Condemnation to the Treasury boffins for not pointing out the problems. "Yes, Minister. Very Brave Minister."

 

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