Explained: What is the unrealised capital gains tax and how to protect your superannuation

A proposed change means you could be taxed on money you haven’t even made yet. Here’s what you need to know and how to protect your nest egg.

Superannuation changes can be unsettling.

Proposed changes to the way superannuation is taxed means you could be slugged for money you haven’t even made yet, in a move finance experts have described as “poorly conceived”.

Treasurer Jim Chalmers unveiled the unrealised capital gains tax – on superannuation balances above $3 million – in an effort to reduce tax concessions for the wealthy.

It will mean people would be taxed for assets in their super which gain value but haven’t been sold – but because it is not indexed to inflation, it is likely to rope in many more people than the 0.5 per cent of Australians currently in scope.

For eligible super members, the reform would impose an additional 15 per cent tax on their super account’s earnings over $3m, on top of existing super taxes.

The earnings taxed would include unrealised gains, or rises in the value of assets like stocks or property which haven’t been sold yet.

Tax and finance experts have criticised the policy as unfair.

“It’s the principle of making people pay tax on a gain they have never got and they never get,” personal finance expert Noel Whittaker said.

Griffith University professor of finance Robert Bianchi said it was a “poorly conceived idea” and it would place an increased burden on superannuation funds, accounting firms and financial planners.

Griffith Business School Associate Professor Robert Bianchi. Photo: Supplied

“It’s completely inconsistent with the way tax is applied outside of superannuation,” he said.

“There are great concerns within the business community and in academia because what that means is if you were to approve this and you were to think this is a great idea, the same principle can be applied to real estate and it can be applied to share portfolios.

“You’re being taxed on something that you currently own, you haven’t converted it to cash, but then you need a cash flow to pay for your tax liability.”

Here’s some advice from tax and financial planning experts on how the tax could work and what you can do about it:

How would the tax work?

Earnings would be calculated by looking at the change in a total balance from the start to end of a financial year, adjusting for withdrawals and contributions to the fund.

The earnings would include all unrealised gains and losses – or the rise and fall in value of an asset like stocks.

For assets like property, this would require a new valuation and a comparison to previous valuations.

The final tax would factor in the proportion of earnings regarding the remainder of the total balance, minus $3 million.

For example, if a person’s superannuation balance was $4 million, the tax would apply to $1 million.

Negative earnings could be offset against the tax in future years.

Individuals would have the choice of either paying the tax out of pocket or from their super.

The bill has proposed to apply the tax from the 2026 financial year.

Who is the tax expected to impact?

The tax would be applied to anyone with a super balance above $3 million.

Doctors, business professionals, senior managers, farmers and engineers are the most likely to pay the new tax, a recent study from the Australian National University found.

Self-managed super funds (SMSFs) which often hold higher balances and volatile and illiquid assets like property are also expected to be affected more.

Personal finance expert Noel Whittaker said many SMSFs were invested in start-ups, which could suddenly surge or plummet in value.

He also noted some stocks could rise and fall by as much as 150 per cent, in sectors like minerals and resources.

“The big danger is a people with speculative shares or start-ups where they may make a big spectacular capital gain before 30 June and are thus liable for a large sum of unrealised capital gains,” he said.

“The company may tank in the next year and you’re stuck with a massive loss and you need to bankrupt your fund to pay the tax on it.”

He also warned that it could be a “widow’s tax”.

“If you and I are a couple and we had $6 million in super between us and I die, you’ve suddenly got $6 million, you’re over.”

Finance columnist Noel Whittaker.

I don’t have $3 million in my super – how would this affect me?

Currently about 80,000 people (0.5 per cent of Australians) have more than $3 million in superannuation, according to a Treasury estimate – but experts have warned more people will exceed the threshold in coming years.

The government’s proposal does not have plans to change the $3 million minimum over time.

“[It’s] the lack of indexation, which means you’ll be paying it eventually,” Mr Whittaker said.

“The fact that it’s not indexed means that every year, more and more people will be caught.”

Hudson Financial Planning managing director Juanita Wrenn added there could be broader indirect effects to super fund members.

She warned super funds could be forced to liquidate assets and hold more cash to pay for the potential tax, which would earn less returns for members overall.

They could also increase fees to cover the administrative burden, she said.

“Large redemptions from pooled super funds to manage tax may increase transaction costs or reduce returns for all members, not just those above the threshold.

“That means lower performance and higher fees for everyday Australians who did nothing wrong – simply because of how the fund manages its pool.”

There also be indirect effects to consumers’ super balances if there were other members selling assets on a wide scale, she explained.

“Broad liquidations or shifting of capital could affect market pricing, particularly in niche asset classes held in SMSFs.”

How could this affect my super over the long run?

Paying a tax on unrealised gains would eat away at potential future earnings, Scott Girdlestone from William Buck said.

“[The] issue with taking the tax upfront on unrealised gains is that the tax you’ve paid, you don’t get to keep in the fund to actually generate more and more earnings.

“So bringing it forward actually reduces the future earnings and wealth accumulation of funds in general.”

Scott Girdlestone, partner, wealth advisory at William Buck.

If you have an unrealised loss one year that would be offset against tax on earnings in future years, would it all come out in the wash eventually?

Ms Wrenn said in theory, yes – but this would assume there would be consistent future gains to offset your loss against.

“It does not help with cash flow in the short term and SMSFs could be stuck with losses now but no relief until years later, if at all.

“The concern is that this adds uncertainty and administrative burden to long-term planning.”

Could I invest my money somewhere else?

Mr Girdlestone from William Buck has said there could be a balance achieved in an alternative structure between super funds, trusts and other investments, but it would be best for individuals to seek advice from a financial adviser or accountant.

For example, he said different assets which may be more volatile, like private equity, could be placed in a trust where unrealised gains wouldn’t be taxed, instead of a self-managed super fund.

Trusts distribute funds to beneficiaries, which are taxed at the individual’s marginal tax rate – ranging up to 45 per cent.

“It’s not as simple as saying hey this is a blanket strategy for everyone, but (you should be) looking at it and saying okay what if I used a trust and company combination outside of superannuation,” Mr Girdlestone said.

“Is that a better place to hold that share portfolio, as opposed to within my super fund?

“I think the answer is ultimately going to differ depending on what the individual’s marginal tax rate is.”

Hudson Financial Planning managing director Juanita Wrenn. Image: LinkedIn

Ms Wrenn said her practice had already started to see a wave of “strategic rebalancing, not panic selling, but targeted shifts away from volatile or hard-to-value assets”.

Investors could move towards income-producing, franked Australian shares and liquid assets like bonds and listed property, which could be sold quickly, she said.

She added there were alternative investment products to super, whether it was an investment bond for long-term savings, a family trust, or contributing to a spouse’s or child’s super.

“For high-net-worth individuals, it may be preferable to invest in family trusts, bucket companies or investment bonds.

“These offer tax rates up to 30 per cent and more flexibility in managing timing, distribution and estate planning.

“They also avoid the punitive layering of tax under [the proposed law].”

Strategies differ between individual circumstances, and experts recommend obtaining professional advice.

However, liquidating and taking assets out of super could generate further costs and could mean giving up the tax concessions available – even if further taxes are applied on higher balances.

Selling property for example would incur stamp duty and capital gains tax, Mr Whittaker said.

He also warned investing elsewhere would “not be as tax effective in most cases as leaving your money in super”.

“There is no other option I can think of, apart from giving it away to your kids or your church or anybody else, where you would be as well-off tax-wise as leaving your money in super.”

How could I take an asset out of my self-managed super?

There are also two ways to move an asset out of a self-managed super fund, Mr Girdlestone said.

The fund may transfer an asset out into a trust or elsewhere, if the person has met one of the conditions of release – mainly reaching preservation age and retiring, he said.

For younger people who maybe wouldn’t meet the conditions of release, their SMSF could sell the asset, potentially to the member’s trust or an individual, at market value.

This would transfer the asset out of the fund, but still leave its value in cash, which wouldn’t help reduce the super balance, Mr Girdlestone said.

“It might allow you to choose an asset that is less volatile in terms of returns,” he said.

“Let’s say if you’re at $3.5 million and your private equity position is $1 million, it could fluctuate quite a bit in value, they’re quite volatile assets when they’re actually valued.”

However, there could still be taxes incurred from selling assets – like stamp duty and capital gains tax.

What happens if I have an illiquid asset, like property?

An illiquid asset like farmland, infrastructure or art, can’t be sold quickly and easily and this is where it was most complex, Ms Wrenn said.

If it was valued at the end of a financial year and its value rose, the individual would have to pay the corresponding unrealised capital gains tax.

“Trustees might face forced sales of other assets to cover tax on gains in these illiquid holdings,” she said.

“This raises serious equity and valuation concerns, especially if asset prices drop after being taxed at peak valuations.”

Mr Girdlestone said this would mean the person would have to hold cash either within their super or outside to pay for the potential unrealised capital gains.

“So then you start to think well what’s the most appropriate place for that illiquid asset to be held – is it outside super or inside super?

“I think it’s more than just the tax minimisation, it’s also the funding of the tax itself and how a member may choose to actually meet the tax obligation.”

It can be hard to know what to do with your super.

Is it still worth making voluntary contributions to super?

Super is still “one of the most tax effective structures that you can have,” Mr Girdlestone said.

“It’s more a question again of running the numbers and looking at the tax deduction.

“If you’re in a situation whereby you still have enough income to warrant it, then if you look at the tax deduction benefit to you … you just have to work out whether or not that’s worth it relative to the tax on the earnings – if indeed that contribution is going to put you over the $3 million.”

Should you consider timing your retirement with market movements?

Ms Wrenn said market movements were more relevant under the proposed rules as a surge could create a tax spike.

“Timing withdrawals or retirement might become a strategic lever.

“But it’s risky, trying to time markets rarely works well.

“Better to structure portfolios for stability and liquidity and plan well in advance.”

DISCLAIMER: Information and opinions provided in this article are general in nature and have been prepared for educational purposes only. Always seek personal financial advice tailored to your specific needs before making financial and investment decisions.

Originally published as Explained: What is the unrealised capital gains tax and how to protect your superannuation