Australia’s upcoming Division 296 tax reform will affect more than just high-income earners. While life insurance payouts for death, total and permanent disablement (TPD) or terminal illness remain excluded from annual superannuation earnings, they will still be counted toward the $3 million superannuation threshold used to calculate the new tax.
This means that individuals who received insurance payouts inside superannuation, even many years ago, may find themselves subject to additional tax despite no further income or asset growth outside of their fund. The Australian Taxation Office (ATO) will apply this rule regardless of the individual’s circumstances at the time of receiving the payout.
Past Payouts From Insurance Increase Today’s Super Balance
Life insurance payouts made in previous years—for instance, as a result of retirement forced by illness—are no longer distinguishable from the rest of a member’s superannuation balance, according to David Busoli, principal at SMSF Alliance. As a result, they now contribute to the Division 296 cap.
While TPD benefits are excluded from taxable earnings in the year they are received, they form part of the total super balance thereafter.
For example, a $4 million payout received 10 years ago, now grown to $6 million, would leave the member $3 million above the tax threshold and subject to Division 296 calculations, even though the original source of the funds was an insurance payout rather than investment returns or salary sacrifice contributions.
The only exception is when the payment qualifies as a structured settlement for personal injury compensation. Structured settlements are exempt from Division 296 calculations entirely, provided strict conditions and timely ATO notifications are met.
Tax Calculations May Still Penalise Despite Exclusions
Although insurance proceeds are excluded from the earnings formula, their inclusion in the year-end super balance affects the proportion of income taxed. Busoli illustrates this with an example where a member ends the year with a $4.2 million balance, including a $1 million insurance payout.
While only $200,000 would count as earnings, the taxable portion of that income would be calculated as 28.6%, leading to a final tax bill of $8,571.
In contrast, without the insurance payout, the same $200,000 gain would attract a lower taxable portion of 6.3%, resulting in a tax bill of just $1,875. According to Busoli, this demonstrates how insurance payouts, though not counted as earnings, increase tax liability by inflating the overall super balance.
For members nearing or above the $3 million threshold, withdrawing part of the super balance to purchase non-super assets such as a home may be one option to remain below the taxable cap by the 30 June 2026 deadline.
