Understanding the new $3 million super tax

Back in early 2023, the Albanese government announced the introduction of its 'Better Targeted Superannuation Tax Concessions Bill'.

The Bill itself flip-flopped through parliament, failing to pass the first time around, and is once again on the political agenda following the federal election.

In a nutshell, it sets out the so-called Division 296 tax changes (named for the section of tax legislation it relates to).

If it's passed by parliament in its current form, the Bill will see investment earnings - including unrealised gains - on super balances above $3 million, face an additional 15% tax, taking the total tax rate to 30%.

This is a key change to super, which has long enjoyed low tax rates to encourage saving for retirement.

Who will be affected by the $3 million super tax? 

Rest assured, the vast majority of Australians will not be impacted by the proposed additional super tax.

It will only apply to people who have at least $3 million in total super savings - be it in one account or spread across multiple balances.

As the average balance across professionally managed (APRA-regulated) super funds is less than $342,000, the bulk of those likely to be affected are members of self-managed super funds (SMSFs).

Frankly, we are talking about a very small group of people. The Grattan Institute estimates that fewer than 0.5% of all Australians - about 80,000 individuals - will be affected, 85% of whom are aged over 60.

How the $3 million super tax will work

Let's clear some confusion. The proposed new 15% tax is not levied on super balances above $3 million. Rather, it applies to the fund's investment earnings that apply to super savings in excess of $3 million.

This may sound complicated, but it's reasonably straightforward. Here's an example from the industry body ASFA showing how the $3 million super tax will work:

Example: Jill, not currently working, aged 55 

On 30 June 2025, Jill has a total super balance of $3.0 million. By 30 June 2026, this increases to $3.1 million. Jill made no contributions or withdrawals during the year. The increase reflects investment returns.

Under the proposed Bill, Jill's super earnings for the year are $100,000 ($3.1 million less $3.0 million). Remember, only the portion of her fund's earnings over $3 million will be taxed the extra 15%. 

This portion is calculated by subtracting $3 million from $3.1 million ($100,000) and dividing this figure by $3.1 million to find a percentage. (The maths is $100,000 ÷ $3.1 million x 100.)

In this example, 3.23% of Jill's super fund earnings, equal to $3,230, will be subject to the higher tax rate. This will see her pay $485 in additional tax ($3,230 x 15%).

It's hardly a king's ransom, but it can be significant for funds with extremely large balances. And they do exist. One report I came across said Australia's 10 largest SMSFs each have an average of $423 million in assets.

Again though, we are talking about the thin end of the wedge. This brings us to the motive behind the proposed tax. 

The 'why' behind the $3 million super tax

Tax breaks in super are an incentive for us to save for our own retirement. However, those same tax breaks have seen some wealthy Australians tuck more money in super than they will ever need in retirement.

As a result, the Grattan Institute says super has become a taxpayer-subsidised inheritance scheme - one that benefits older, extremely wealthy Australians, while leaving a higher tax burden on younger taxpayers.

From this perspective, the new super tax makes sense. It's not without problems, though.

Key issues with the $3 million super tax

While no legislation is perfect, there are noteworthy weak spots in the proposed new super tax:

• Taxing unrealised gains

An obvious drawback is that unrealised gains will be taxed. While losses can be carried forward to offset future tax liabilities, taxing 'paper' gains is a radical departure from existing tax policy - and one that brings practical challenges.

Among SMSFs with more than $3 million in assets, listed shares typically represent a large chunk (about 29%) of fund portfolios.

Yet, as we saw earlier this year, shares can experience high levels of volatility, soaring in value one year, only to dip the next.  

At the other end of the spectrum, funds with highly illiquid assets such as property, may struggle to pay the extra tax when a real estate investment rises in value.

• Lack of indexation

The $3 million threshold is not being indexed. It's easy to brush off the new tax as a 'tax on the rich' (which it fundamentally is at present). However, this may not always be the case.

Unless the threshold is indexed for inflation, more people will be captured over time. The Financial Services Council has crunched the numbers, finding that without indexation more than 500,000 Australians currently in the workforce could be impacted by the tax by the time they reach retirement.

• Confusion around defined benefit funds

Around 1 million Australians have a defined benefit super fund, and these are a bit trickier when it comes to the proposed Division 296 tax.

In a defined benefit fund, members receive a retirement pension set out by a formula rather than being based on the balance of their accumulated super savings.  

It's estimated that only around 10,000 defined benefit fund members will be impacted by the proposed tax. 

Where to from here?

With the Better Targeted Superannuation Tax Concessions Bill expected to be reintroduced to parliament in July, there have been plenty of calls for the proposed $3 million super tax to be finetuned. To date, the federal government has shown little interest in making any changes.

Originally, the new super tax was flagged to start from 1 July 2025. There's been no word on whether that start date might shift, and the government may stick with the original timeline.

This makes it important to get professional financial advice if your total super savings are above the $3 million threshold - or look like they will be by 30 June 2026.

More broadly, any changes to super can be both frustrating and stressful. Despite the seemingly constant fiddling with the rules, I continue to be a big fan of superannuation.

Even with the proposed new tax, super remains a very tax-friendly way for the overwhelming majority of Australians to save for their senior years.

And, as we live longer lives, and in better health, it is super that will provide the income for many of us to enjoy a decent lifestyle once we exit the workforce.

That said, the proposed Division 296 tax is a reminder of the need to grow investments outside of super.

It's easy to overlook regulatory risk, but as we are seeing right now, it has the potential to impact personal wealth. Spreading your money across multiple asset classes, in and out of super, is a great way to diversify and reduce risk.