Earlier this year, the Federal Government announced plans to introduce legislation that would change the way superannuation is taxed.
The proposed tax changes target superannuation balances over $3 million. If passed, they could have a significant impact on self-managed super funds (SMSFs) and broader retirement planning.
Central to this is the introduction of a tax on unrealised gains. If implemented, experts say this could have a major impact on super in Australia.
Strap in as we explain how the proposed tax on unrealised gains might impact your super.
What is the unrealised gains tax, and how does it work?
Last year, the government introduced legislation called The Treasury Laws Amendment (Better Targeted Superannuation Concessions and Other Measures) Bill 2023.
The bill introduces a tax on unrealised gains for super balances over $3 million.
Essentially, this means you could face a tax bill on appreciated asset values — even if you haven't sold those assets.
This is not typically the case. We pay capital gains tax (CGT) on profit earned only on the sale of an asset, such as stocks in the S&P/ASX 200 index (ASX: XJO).
For SMSFs, in particular, this could mean paying tax on 'paper gains'. Naturally, the concept has drawn criticism.
As Geoff Wilson of Wilson Asset Management pointed out in The Australian, "If you want to destroy self-managed super funds, then this is how to do it".
Wilson argues that the change could push investors towards less volatile, cash-based investments that aren't affected by the $3 million threshold.
Given long-term growth rates in property and the stock market, many SMSF trustees with well-diversified portfolios could find themselves exceeding this threshold in the coming years, leading to higher tax liabilities.
Wilson says that, according to the Financial Services Council, while 80,000 Australians might be affected initially, this figure could rise to 500,000 superannuation accounts in the future.
The decision to tax unrealised capital gains sets a dangerous precedent for tax change in this country, overturning nearly 40 years of a tax practice that delineated between income and capital gains tax, with the latter only payable on the realisation of an asset.
And indexing tax thresholds is a long-established principle.
How might this impact superannuation?
It's important to reinforce that the proposed changes will impact superannuation accounts of $3 million or more.
All those beneath this threshold aren't impacted.
But for those who are, taxing unrealised gains introduces a cash flow challenge, particularly for SMSFs holding illiquid assets like property.
TAMIM Asset Management says that trustees could be forced to sell assets to cover tax bills, disrupting long-term investment plans.
Unlike CGT, which is typically payable upon sale, this new tax could apply based on annual asset valuations. As a reminder, stocks and bonds are valued on a mark-to-market, that is, a daily basis. Says the asset manager:
This change could create significant cash flow issues for SMSFs holding illiquid assets, such as property, since the tax liability would arise without the corresponding liquidity to pay it.
TAMIM says the impacts on super, particularly SMSFs, could be "profound," as selling assets prematurely to meet tax requirements "could also result in lower long-term returns".
Additionally, trustees could face increased administrative complexity, as they would need to accurately calculate and report unrealised gains, a process that may not be straightforward for SMSFs that are not set up to differentiate between realised and unrealised gains in the same manner as larger, APRA-regulated superannuation funds.
The Bill has already passed the House of Representatives. All eyes are now on the Senate.
The government needs the support of all Greens senators and at least three other members to pass the legislation. If it gets over the line, it would likely be imposed by July next year.
Irrespective of what happens, the general view among opponents of the Bill is that it stinks for superannuation.
TAMIM says that, while well-intentioned, "it could inadvertently impose substantial burdens on SMSF trustees, forcing them to rethink their investment strategies and compliance processes".
Geoff Wilson meanwhile called the notion "grossly inequitable and unfair".
Foolish takeaway
With these potential changes on the horizon, it's crucial for investors to understand how the tax could affect their superannuation.
If passed, the bill would impact accounts worth north of $3 million. Currently, this is a fraction of the population.
But if you're investing for the long-term, you're ideally looking to maximise your retirement nest egg. Should you be penalised for doing so? Besides, the $3 million is in today's dollars. What about the impacts of inflation?
The debate continues, precisely why it's important for investors to stay on top of the latest developments.
