Normally, we’d say “don’t act now” – at least until the legislation has actually been passed by Parliament. Despite the government’s strong majority, who knows whether this measure will be upstaged by more important legislative priorities, deferred to start from 1 July 2026, or even adjusted to secure passage through the Senate?
But one group of SMSF members facing a difficult choice in the final few weeks of 2024–25 are those fitting into one of these categories:
- Currently receiving a complying lifetime, complying life expectancy, or flexi pension that might be commuted (i.e. stopped) in the future.
- Anyone likely to receive a reserve allocation that won’t count towards their contribution cap.
(Since commuting these pensions often results in reserve allocations being made without counting towards the contribution cap, some people might be in both groups.)
Why? Let’s use a complying lifetime pension being paid from an SMSF as an example.
Division 296 tax depends heavily on how a member’s “total super balance” changes from year to year.
Currently, a member who has a complying lifetime pension has a strange amount included in their total super balance for this pension – it’s not the amount of their “pension account” or even the “actuarial value” of their pension. It’s whatever was reported back in 2017 for their transfer balance cap. (At the time, this was just 16 times the annual pension payment – so for someone receiving $150,000 pa, it was $2.4 million). Ever since, the same amount has been recorded for that pension in their total super balance. Conceptually, this doesn’t make sense – the pension has actually become less valuable over time as it will stop when the member dies, and obviously, this becomes more likely as the member ages.
Since this number will influence the member’s Division 296 tax (assuming they have other super), it’s important it’s calculated more realistically. So, the Division 296 tax rules include a change that will involve a more accurate value being placed on this pension each year in the future. It will be based on the member’s age, whether or not the pension is reversionary, the rate at which it increases each year, etc. Let’s say its value is $2 million on 30 June 2025. It will be a different number on 30 June 2026 (the pension payment amount may well be higher but the member will be another year older).
All is fine until the member decides to commute the pension. At that point, perhaps the trustee will take advantage of the new reserve rules and allocate the entire amount previously supporting the complying lifetime pension to the member’s accumulation account. This amount might be way higher – in fact, it often is – than the $2 million value placed on the pension. What if it is much higher – say $3.5 million? (Which wouldn’t be uncommon.)
At the moment, we don’t know for absolute certainty how this “bonus” of $1.5 million (i.e. $3.5 million less $2 million) would be treated because the Division 296 tax legislation was written before the reserve rules were changed in December 2024. But under the original drafting, any reserve allocation that doesn’t count towards a contribution cap is part of the member’s “earnings” for Division 296 tax – i.e. subject to the tax in exactly the same way as if the member’s account had grown by that much because of its investment returns.
(This section of the Division 296 tax will require a change whatever happens as it refers to a section of the tax legislation that was removed as part of the reserve changes. But a significant change in philosophy would be needed to avoid having these big increases in a member’s account balance included in “earnings”.)
The same applies to anyone contemplating any other reserve allocation (for example, from their flexi pension that ended years ago). If the same philosophy applies – where only reserve allocations that count towards a contribution cap avoid Division 296 tax – they are definitely incentivised to make the allocation before 30 June 2025. Alternatively, we may find ourselves in the unusual situation of those with large balances:
- Deferring their allocation until their balance is much smaller (less than $3 million), or even
- Deliberately taking particular steps to ensure the allocation does count towards their non-concessional contributions cap (even though it doesn’t need to) because at least that allows them to escape Division 296 tax.
Winding up legacy pensions and dealing with reserve allocations should be handled carefully, but there is an element of urgency now for those who are also caught in the crosshairs of Division 296 tax. The most unenviable part of that urgency is that people may need to act even before we know for sure how the Division 296 tax rules will deal with reserve allocations like these.
