The current financial year will see SMSF trustees having to manage their situation with regard to the Division 296 tax and other changes announced in the 2026 federal budget. Josh Persky analyses the situation and identifies an investment approach that might provide an optimal solution.

The 2026/27 federal budget was framed as a targeted rewrite of the rules for large superannuation balances, but its real consequence is broader than the headline measure. Division 296 is now law and it commenced on 1 July 2026. Alongside it, the budget also legislated a separate, significant change to how capital gains are taxed outside super and the interaction between the two is reshaping how advisers think about portfolio structure for large retirement savings balances.

This is already evident in the conversations unfolding between advisers and their clients. There is increasing focus on after-tax outcomes alongside pre-tax performance. Investors are no longer asking simply what they own, but how those exposures and overall portfolios will behave under the new tax settings. And advisers, in turn, are being forced to confront a more difficult question: whether traditional portfolio structures are fit for purpose in an environment where tax is no longer a second-order consideration, but a defining driver of outcomes.

This moment should not be mistaken for disruption alone. It is, more importantly, a moment of asymmetry.

Because while Division 296 introduces complexity for conventional investment structures, particularly pooled vehicles like managed funds and exchange-traded funds (ETF), where tax outcomes are shared, opaque and largely uncontrollable, it may create additional opportunities for investors who can actively manage tax outcomes within their fund. The ability to control realisation events, tailor exposures and actively manage after-tax outcomes is becoming an increasingly important consideration for investors seeking to optimise portfolio outcomes under the evolving tax environment.

That is why direct indexing is becoming more relevant for some investors.

Division 296 targets realised earnings

The Treasury Laws Amendment (Building a Stronger and Fairer Super System) Bill 2026 and its companion imposition bill have passed through parliament. Division 296 tax commenced from 1 July, with a transitional rule for the first year where only an individual’s total superannuation balance (TSB) at 30 June 2027 will be tested against the $3 million and $10 million thresholds, which are themselves indexed in $150,000 and $500,000 steps respectively.

Importantly, following extensive industry consultation, the government dropped the original proposal to tax unrealised gains. Division 296 now applies only to a proportion of realised superannuation earnings interest, dividends, rent and realised capital gains attributable to the portion of a member’s balance above $3 million. That redesign matters. It means the tax is directly geared to when and how much a fund realises, which puts renewed focus on trustees’ and their underlying investment vehicles’ control over realisation timing.

Why managed funds leave trustees exposed

One limitation of holding equity exposure through pooled vehicles whether actively managed funds or passive ETFs is trustees surrender control over the timing and quantum of capital gains distributions.

A managed fund realises gains when it rebalances, when the underlying benchmark is reconstituted or when it is forced to respond to other investors’ redemptions. Those capital gains are distributed to all unitholders as a taxable event, regardless of when an individual became an investor or what their broader tax position looks like.

The trustee of an SMSF holding managed funds and, by extension, ETFs has limited control over the timing of realised gains distributed by the fund. Under the old regime, that was a manageable trade-off: the simplicity of a pooled structure outweighed the modest tax disadvantage.

However, under Division 296, because the tax is calculated directly from realised earnings, the timing of those distributed gains may have a greater impact for some trustees, depending on their circumstances. It is not a hypothetical concern. It is a structural mismatch between the investment vehicle and the tax environment in which it now operates.

Direct indexing in a changing tax environment

Direct indexing inside an SMSF addresses this problem at the structural level. Rather than owning units in a pooled vehicle, the super fund holds individual listed securities directly with full beneficial ownership at the holder identification number level, where the SMSF holds the securities in its own brokerage account. That single change in ownership structure changes almost everything that follows.

With individual security ownership, a rules-based tax-efficient portfolio monitoring and rebalancing engine can identify positions sitting at a loss, sell them to crystallise a capital loss and reinvest in similar securities to maintain the model portfolio’s intended market exposure. Importantly, the portfolio’s investment outcome is preserved, maintaining the integrity of benchmark tracking. The after-tax outcome is actively managed, because the losses generated are real, usable tax assets that can be deployed across the fund’s broader tax position, including to offset realised gains and reduce the net realised earnings that feed into the Division 296 calculation.

A rigorously disciplined portfolio optimisation approach, delivered through a systematic, technology-driven execution framework, can pursue this outcome in a way that pooled, passive structures simply cannot replicate for individual members.

Cost-base management remains a strategic discipline

Even without a change to how capital gains tax (CGT) is taxed inside super, cost-base management stays central to good SMSF portfolio administration and it takes on added weight for trustees managing the cost-base adjustment election described below.

In a direct indexing portfolio, every position has its own acquisition date and cost base, tracked individually at each lot level. That granularity makes it possible to sequence disposals, thoughtfully prioritising higher cost-base positions to minimise realised gains when managing exposure while maintaining the integrity of index tracking.

A managed fund or ETF cannot replicate this kind of lot-level management on behalf of individual members. None of that is possible when a client is a unitholder.

The cost-base adjustment requires careful review

Parliament provided a transition mechanism for SMSFs affected by Division 296: a cost-base adjustment election. Eligible small superannuation funds, including SMSFs, can elect to adjust the cost base of CGT assets held on 30 June 2026 to their market value on that date. This crystallises a deemed CGT event at today’s rates and establishes a higher cost base from which future gains are measured.

The election is not straightforward and two features raise the stakes. First, it triggers an immediate CGT event on embedded gains, so trustees must weigh the current tax liability against future savings, accounting for holding period assumptions, projected asset growth and the fund’s liquidity position.

Second, the election operates as an all or nothing choice: it cannot be applied selectively to individual assets within the fund and once made cannot be revoked.

The broader point is the adjustment analysis requires every trustee to inventory their holdings, model their future earnings profile under the new Division 296 tiers and assess their exposure across asset classes.

For many trustees with a TSB above $3 million holding equities in pooled structures, that exercise will reveal a gap between the tools currently available and the tax environment in which they now operate. Trustees may choose to consider a range of approaches, including direct indexing, depending on their circumstances.

Outside-super tax settings for equities have also changed

Separately from Division 296, the same budget legislated a significant change to CGT for individuals, trusts and partnerships holding assets outside superannuation. Here, from 1 July 2027, the 50 per cent CGT discount will be replaced with cost-base indexation and a 30 per cent minimum tax rate on capital gains, applying only to gains that accrue after that date.

It’s worth being precise here. Superannuation funds, including SMSFs, are explicitly carved out of this reform. Complying super funds retain their existing CGT treatment, effectively a 33 per cent discount on gains from assets held for more than 12 months, taxed within the concessional superannuation environment. Division 296 remains the mechanism through which large balances face a materially different tax outcome, not the new indexation/30 per cent floor regime, which does not touch fund earnings at all.

That distinction actually sharpens rather than weakens the case for reviewing SMSF structures. With the CGT discount disappearing for gains realised outside super from 1 July 2027, the relative tax advantage of holding growth assets inside a well-structured super fund becomes more pronounced for many investors, even as Division 296 introduces a new realised-earnings tax for balances above $3 million.

For large SMSFs, that means the quality of in-fund tax management now matters on both sides of the ledger: minimising unnecessary realised gains to manage Division 296 exposure, while making the most of the CGT concessions super still retains relative to the new outside-super regime.

The transition period warrants review of positions outside super

For assets held outside superannuation, any gains realised before 1 July 2027 continue to be assessed under the existing 50 per cent CGT discount. That gives investors and their advisers a genuine, time-limited window to review non-super portfolios, assess existing positions and think carefully about disposal timing before the indexation model and its 30 per cent minimum tax floor take effect for gains accruing thereafter.

For SMSF trustees, the more immediate deadline is the Division 296 cost-base adjustment election tied to 30 June 2026 values. For clients who have been considering direct indexing inside their fund, establishing a portfolio now with individually owned securities, individually tracked cost bases and an optimisation engine working from day one puts them in the strongest possible position as Division 296 begins to bite from 1 July 2026. The longer that establishment is deferred, the shorter the runway for the optimisation engine to generate usable tax assets before the first transitional test date of 30 June 2027.

These changes highlight the importance of understanding after-tax outcomes and reviewing portfolio structures where appropriate both inside and outside superannuation. The advisers who serve SMSF clients best over the coming years will be those who help trustees understand not just what has changed, but what is now possible. That is exactly what direct indexing is built to do.

In a regime where tax efficiency must be engineered at the individual portfolio level, owning the underlying exposures can change how tax outcomes are managed, but involves trade-offs that should be carefully considered. It transforms portfolio management from a static allocation exercise into a dynamic process, where tax positioning, real-time optimisation and client-specific customisation are not optional enhancements, but core capabilities.

The federal budget didn’t invent this shift, but it has accelerated it sharply and, for large SMSFs now inside the Division 296 regime, irreversibly.