Division 296 and defined benefits

02 Apr 2024
Meg Heffron

Meg Heffron

Managing Director

It seems the Government was true to its word – Division 296 really will apply to defined benefits and recent regulations released for consultation explain how.

While we might dislike the method of calculating the proposed extra tax for members with more than $3m in super (Division 296 tax), there’s no arguing that it’s deceptively simple.

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To calculate it, the ATO only needs to know three things about a member:

  • Their total super balance (TSB) at the start and end of the year,
  • The “contributions” added to their balance during the year, and
  • The “withdrawals” removed from it.

In a defined benefit fund, this is tricky for two reasons.

Firstly, a defined benefit doesn’t have a “balance” associated with it. When a member has a defined benefit pension, for example, the trustee has promised to pay a particular income stream for a pre-determined period (often for life) and the pension will stop when the period comes to an end. Even though we might show account balances for members with these pensions in their SMSF, that balance is technically irrelevant to them. Their benefit is purely based on the promise made by their fund.

So their “balance” isn’t what’s used for their total super balance (and in fact in APRA funds providing defined benefits, the member wouldn’t even have a specific balance reported to the ATO for them). Historically, the amount used for their total super balance (TSB) has been particularly ridiculous – it’s been the value for transfer balance cap purposes that was reported when their pension first started (or 1 July 2017). You might remember that at the time, this was simply 16 x the next year’s annual pension payment for lifetime pensions.

So a 90 year old, receiving $100,000 pa for life at 1 July 2017 would have had an amount of $1.6m recognised for their transfer balance cap at that time. A 60 year old, receiving exactly the same pension for their (likely to be much longer) life would also have had $1.6m recognised for their transfer balance cap. And since exactly the same number is currently used for their TSB, they are both still considered to have a “balance” in super of $1.6m despite the fact that – at least the 90 year old (now 97) – can’t possibly get $1.6m worth of value out of the pension anymore.

So the new regulations needed to come up with a method to place a more realistic value on the pension for total super balance purposes. I’ll talk more about that in a moment.

Secondly, when a defined benefit is still building up (ie, it’s in accumulation phase), there might not be any contributions going in that are specifically related to that member. That’s because if the benefit is being funded by, say, an employer or the Government, they essentially promise to make sure there’s enough to pay the benefit when it becomes due. They might put in a lot of money (ie contributions) in some years, and not much the next. It’s quite different to the more common style of super where an amount clearly gets added to a member’s super balance. So again, the Government needed to come up with a way of calculating that for Division 296 purposes.

(There are also parts of the regulations that deal with recognising sometimes a member with a defined benefit won’t actually get all the money – because it’s subject to a family law split etc).

In short, the key impact of the regulations for defined benefit pensions is to start with the family law value – in other words, how would the pension be valued if the member’s relationship had broken down and a value was needed for their super.

(Some interests don’t have a family law value – they would be treated separately. In particular, their value for this purpose might end up being “whatever the member could take out today” if they terminated the super interest.)

Alternatively, instead of using the default family law value, the trustee of the fund can get an actuary to value the pension and provide a certificate (albeit a different type of certificate to what is used for tax exempt investment income purposes (ECPI) or solvency valuation purposes). But there are restrictions here. In particular, the actuarial value would need to be 90% - 110% of the family law value anyway.

The family law value for a defined benefit interest is calculated using regulations to the Family Law Act which set out both a methodology and a range of factors. For pensions, the concept is the same as the method used for transfer balance account purposes (annual payment x a factor). However, the factor is much more nuanced – it’s not 16 for everyone regardless of age and the features of the pension. Instead:

  • Younger people have higher factors and older people have lower ones – recognising the fact that a defined benefit pension really declines in value as a member gets older (and has fewer years left to receive it),
  • Males have shorter life expectancies than females so there are different factors for each,
  • There are “add ons” to the factor if the pension is reversionary to someone else (ie, will continue to a spouse when the original pensioner dies) – which also makes sense, that pension is “worth more”, and
  • Different factors apply depending on the extent to which the pension is indexed in the future – for example, a pension that goes up with CPI is worth much more than a pension that doesn’t change.

For example, an 80 year old male receiving $100,000 pa for life (no reversion), that is indexed in line with inflation would have a value of around $685,000 placed on their pension for this purpose. The value the following year would be based on a higher pension payment (indexation) but a lower factor (shorter life expectancy). It might be higher or lower than $685,000 depending on inflation. And of course, withdrawals would still be added back to determine earnings over the year – so this member might well have some earnings. But at least the pension would be valued more appropriately than simply using the value used back in 2017 for the transfer balance cap.

For defined benefit super interests that are still accumulating, there may well be regulations in place to value these already. (The law has always needed to value these for contribution cap purposes as it wasn’t possible to rely on the transfer balance cap amount – by definition they’re not in pension phase yet). In cases where there are no regulations in place already, larger interests will also default to the family law value (again, using factors that reflect the nature of the benefit, actual ages of the member etc).

However, there is an extra test to weed out accumulating interests that aren’t worth much yet – essentially if the “vested benefit” is less than $1m, the vested benefit can be used instead of the family law value. The vested benefit is the amount the member would receive if they terminated their interest. Often, in a defined benefit fund, the vested benefit at a point in time is less than the “underlying” value of the ultimate benefit (ie, the value built up so far of the benefit they’ll get if they stay in the fund).

There are still some people who won’t be subject to Division 296 because they’re protected by the constitution (primarily State Parliamentarians, senior State Public Servants, State judges etc). But other members of defined benefit schemes will be subject to Division 296 just like everyone else.

We’ll cover a lot more on Division 296 in our Super Intensive Day in August / September. For early access to tickets, register your interest here.


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