Written by:
Melanie Dunn
Principal
Accurium
This article/resource was written prior to the Federal Treasurer’s announced changes to the Division 296 tax measure on 13 October 2025.
Legacy pensions highlight need for deferral of Division 296 commencement
As SMSF trustees and advisers grapple with the expected start of Division 296, a technical storm is brewing for clients holding legacy pensions. The introduction of new regulations from December 2024 has made the commutation of legacy income streams more attractive, however members may face significant costs due to how Division 296 tax assesses the total superannuation balance of these pensions.
Artificial inflation of Division 296 ‘earnings’
The core issue? The methodology for calculating Division 296’s earnings, based on the total superannuation balance (TSB) before and after commutation could leave members facing a surprisingly high Division 296 tax bill.
When a member commutes a defined benefit pension, the difference in the TSB valuation just prior to, and after, commutation can artificially inflate Division 296 ‘earnings,’. This artificial inflation occurs when the reserve supporting the pension is allocated to the member, but the TSB calculation doesn’t adjust for this reserve allocation.
For example, take a 70-year-old SMSF member being paid a lifetime defined benefit pension, backed by a $2 million reserve in the SMSF, and he also has a $2 million accumulation balance. Under current Division 296 rules, his TSB on 30 June 2025 would combine the accumulation balance and the family law value of the pension – TSB around $3.09 million. If we assume there was no change in Fund balances over the year except for making a $100k pension payment, Division 296 ‘earnings’ would be about $69,000 in this scenario.
However, if the member takes advantage of the new five-year exit rules for legacy pensions and commutes his lifetime pension in full in 2025–26, allocating the reserve to his accumulation balance, the year-end TSB would change to $3.9 million based on market value of assets. The member’s adjusted TSB (taking into account withdrawals) would be $4 million, ‘earnings’ for Division 296 purposes are then calculated as $4.0 million minus $3.09 million – a staggering $910,000. Artificial inflation in Division 296 earnings is clear.
Why is this happening?
The problem lies in how legacy pension liabilities are valued versus the reality of the value of reserves held to support them. The method for calculating TSB for legacy pensions is not tied to the market value of assets supporting the pension liability. In most cases, both the family law valuation is lower than the amount held in reserve to support the pension liability. When a reserve is allocated to the member on commutation, the full value hits their TSB, creating a Division 296 tax liability that is not matched by genuine earnings.
Worryingly, these Division 296 inflation effects are not limited to pension commutation. They also arise from other reserve allocations that are not assessed as contributions, including fair and reasonable reserve allocations, or allocations to members from previously expired or ceased pension reserves.
The legislative gap and a pathway forward
The legislation’s definition of contributions excludes reserve allocations not counted against a member’s concessional cap. This oversight means ‘cap free’ reserve allocations directly inflate Division 296 earnings in the year of commutation.
Division 296 legislation was drafted prior to the new Regulations for commutation of legacy pensions. That a fix is required, is both clear and urgent: Amend the Division 296 TSB adjustment rules to include in the definition of ‘contributions’ allocations from a reserve to a member, less the TSB immediately prior to commutation value of any defined benefit pensions which ceased or were commuted in the year.
This would ensure reserve reallocations are not assessed as earnings when determining the new tax, providing members with a fairer outcome.
Urgent clarity and a call for deferral
Without prompt action, trustees and members with large balances could face significant, unintended tax consequences upon commutation of their defined benefit pensions. They may incur material Division 296 tax on what is effectively capital of the fund, not earnings.
The situation calls for more than just a legislative technical fix, it requires more time for clients to make clear, informed decisions. The introduction of Division 296 should be deferred to 1 July 2026. Time is needed for a legislative framework that deals fairly with the unique nuances of legacy pensions, so trustees and advisers can act with confidence.
Read our full article on this topic Legacy pensioners need deferral of Division 296 commencement on Accurium Education.
If you need expert guidance on legacy pension commutations or navigating Division 296, the Accurium technical team is here to help.