Segregate Assets in a SMSF for Pension and Accumulation Purposes

Segregate Assets in a SMSF for Pension and Accumulation Purposes

It is a myth that segregation of assets is only relevant when a member is being provided with a pension to claim exempt current pension income (ECPI (tax exempt income).

SMSF assets can be segregated for investment purposes or for tax purposes or a mix of both. A segregation strategy in relation to investments can be applied to pension assets or accumulation assets but it is predominantly used when a fund is providing pensions. An investment segregation strategy is often known as member investment choice. However, any strategy used only for tax purposes may be a red flag to the Australian Taxation Office (ATO). So, it is crucial to maintain records explaining why assets are being segregated to show how it supports the pension or accumulation account and why it has been adopted.

A self managed superannuation fund (SMSF) may have members who are at different life stages and have different risk profiles.  Segregating certain assets to a member account or groups of members may be a strategy which is useful to satisfy the members retirement objectives.

The fund’s trust deed and the investment strategy must allow for segregation of assets and the overarching requirement is that any investments undertaken by a SMSF’s trustee is for the sole purpose of providing retirement benefits for the members.

Defined benefit pensions are not discussed as it is beyond the scope of this article but please note that when the fund provides one of these types of pensions the assets cannot use the segregation method for the purpose of claiming ECPI. This article relates to account-based pensions in retirement phase.

What is Segregation of Assets in a SMSF?

Assets are considered to be segregated current pension assets when segregated to a specific member account or a member pool rather than assets from the general investment pool shared by all members. The income from those assets supporting retirement-phase income streams is exclusively added to the member account or to a pool of members which can include a common group of members with common goals i.e. pension members vs accumulation members.

No tax is payable by a SMSF in relation to the income earned from assets which are segregated to a pension account which is in retirement phase and the SMSF is entitled to use the segregated method. Typically, an account-based pension is a retirement phase pension. It is noted that segregated income identified as non arms length (NALI) will not be tax exempt but this would be relatively unusual. (Refer to the ATO website for details on NALI and our resources page)

During accumulation phase when members are building wealth for retirement purposes assets are generally not segregated but are pooled for the general benefit of all members. The income generated from those assets is allocated to each member in a fair and reasonable manner.

Segregated Vs Unsegregated SMSFs Accounts

As discussed above segregated assets are specifically set aside from the general unsegregated pooled assets and the income is allocated directly to the member or pool of members.  Unsegregated assets are those assets which form part of the general pool and the income from those assets are spread across all member accounts on a proportionate basis which is usually based on the members balances.

The key benefit of using unsegregated assets is simplicity and lower costs.

The benefits of segregation include:

• meeting the investment objectives of members with different risk profiles and life stages
• when the fund has high- and low-income producing assets it can be beneficial to allocate the high-income producing assets directly to the pension members where they can obtain a tax exemption and the higher cashflow is used to fund the pension payments
• funding member investment choice (refer to discussion below in relation to investment segregation)

What is Investment Segregation Vs Segregation for Tax Purposes?

It is important to separate tax at the fund level and the member level.

Tax on income from pension assets is taxed at the fund level. Either the segregated method is used, or the proportionate method is used to calculate the tax exemption. Generally, no tax liability is allocated to a member in pension phase (except for a transition to retirement pension (TRIS)) regardless of the ECPI method used.  The fund’s tax liability is spread proportionally to fund members in accumulation phase or members taking a TRIS.

A SMSF can segregate an asset to a member’s pension account as part of the member’s investment choice and all of the income arising from that asset is allocated directly to the member’s pension account.  As no tax is allocated to pension members the way in which the ECPI is calculated is not relevant but can make a significant difference at fund level.

Similarly, an asset can be segregated to a member’s accumulation account.  There is no ECPI tax exemption, but the principle is the same in that all of the income from the segregated asset is allocated directly to the member.

Please obtain advice from your SMSF Specialist when considering any of the above as each person’s circumstances are different and it is important to avoid any legal or compliance issues.

How does my SMSF Segregate Assets?

The key to segregate assets is to identify and separate assets from the general pool.  Consider the following when

• a decision is made in advance as to which specific assets are to be segregated and to which member account
• document the specific segregated assets set aside to support the pension
• document why the SMSF segregates its assets
• review and update changes to the assets being segregated which is particularly important if income such as dividends are received as part of a dividend reinvestment scheme which keeps increasing the segregated assets
• open a separate bank account (best practice) to receive income but it is possible to use sub accounts under the one universal bank account to separate the cash in relation to segregated assets
• if segregating shares or managed funds operate different shareholder or managed accounts to separate the segregated assets from the general pool
• rental income should be separately managed to other rental properties which form part of the general pool
• expenses in relation to the segregated assets should be paid from the segregated bank account which also include pension payments when the pension assets are segregated

Some tips include:

• a property cannot be partly segregated
• a SMSF can segregate assets to support a member pool including 100% of a property
• ensure any disposal of segregated assets which have been supporting pensions are banked into the segregated bank account
• any expenses paid to improve a segregated property or maintain it should come from the related segregated bank account
• whilst best practice is to have a separate broker account or shareholder/unitholder account the separation of income from dividends or trust distributions can be done using accounting processes by splitting the income into sub accounts to identify the segregated and unsegregated income and the cash being transferred to the segregated bank account

Using the Segregated Method for Exempt current pension income (ECPI) purposes

Generally, this involves calculating the fund’s ECPI for assets which have been segregated to provide retirement phase pensions which is typically an account-based pension. A SMSF is not required to obtain an actuarial certificate in relation to income arising from segregated assets. There are some exceptions (please refer to our resources page in relation to “understanding actuarial certificate for a SMSF“).

No tax is payable on a fund’s ECPI from segregated assets supporting retirement phase pension accounts.  The income. including, capital gains and losses, are simply disregarded and not included in the fund’s tax return.

Using the Unsegregated Method (Proportionate Method) for ECPI Purposes

Generally, a SMSF is eligible to use this method for calculating ECPI when the fund has unsegregated assets supporting income streams which are retirement phase pensions. Assets are pooled and not specifically set aside to support the pension. An actuary determines what the exempt proportion is which is then applied to the fund’s total assessable income for the appropriate period. A proportionate amount of the fund’s total income is tax free.

The major exception is when a fund is 100% in pension mode for all of the year when the SMSF must use the segregated method.

The SMSF needs to obtain an actuarial certificate when the SMSF applies the proportionate method.

What Method can your SMSF use if it has Disregarded Small Fund Assets?

A fund MUST use the proportionate method for calculating ECPI when the fund’s assets are deemed to be disregarded small fund assets when meeting the following criteria:

• any member of the SMSF had “total superannuation balances” of more than $1.6mil (this is not indexed)- this includes the balance in the SMSF plus any other superannuation funds where the member has a balance including pensions and accumulation accounts which is measured at the previous 30th June
• that same member was in receipt of a retirement phase pension from the SMSF OR any other superannuation fund which is measured at the previous 30th June -even if the member is not receiving a retirement phase pension from the SMSF but is receiving one from a different SMSF or a retail or industry superannuation fund
• the SMSF was not in 100% pension phase in the entire income year (current financial year)

Frequently Asked Questions About Segregated Assets in SMSFs

What is deemed segregation?

When the SMSF is in 100% pension mode (retirement phase pensions) for all of the financial year the fund’s assets are considered or deemed to be segregated current pension assets the super fund is required to use the segregation method to calculate the tax exempt pension income.  The income is 100% exempt from tax and an actuarial certificate is not required. 

I am the sole member of my SMSF and do not have any other superannuation member accounts. Can my SMSF segregate assets to my pension account if my total super balance was over $1.6million at the 30th June in the prior year?

Yes and No.  For tax purposes the fund is unable to use the segregation method to calculate the tax-free exemption as the fund has disregarded small fund assets unless the fund is in 100% pension mode for all of the financial year and then it must use the segregation method.  However, for investment purposes the SMSF can segregate the asset to your pension account.

What if it is the same circumstances as the prior question but it is my first year when I start my pension does this change anything?

Yes. The disregarded small fund assets are measured at the prior 30th June when the fund did not have any members with pension accounts and thus it does not apply to the year the pension is started.  The fund may be eligible to use the segregation method to calculate the tax free exemption and will not require an actuary certificate.  

Can my SMSF use one bank account when it receives income from segregated assets and unsegregated assets?

Yes it can but the bank account has to be divided into sub accounts to reflect the cashflow of the income and expenses relating to the segregated assets.  Any segregated income received must be transferred relatively quickly to the sub account, General expenses such as accounting fees and audit fees should be allocated on a fair and reasonable basis.

Can my SMSF segregate a property to more than one member account?

Yes a property can be segregated to a group of members usually with similar investment objectives as an investment pool. However, a property cannot be partly segregated.

Can pension payments be made from the fund’s general pooled bank account?

It depends.  If the pension is not supported by segregated assets but with the general pool of assets pension payments can be made from the general bank account. 

Key Takeaways

• member investment choice can include segregating assets to a pension or an accumulation account for the benefit of a member or a pool of members
• segregation for investment purposes is different to segregation for tax purposes
• tax applies at the fund level
• tax is apportioned between accumulation members (or TRIS members) but not to pension members
• the fund needs to use the segregated method or the proportionate method, or a mix, to calculate the ECPI
• a SMSF is eligible to use the segregated method to claim ECPI when the fund is in 100% pension mode for all of the entire year
•  segregation means an asset is set aside and must be identified in the records of the SMSF

Do you need help with understanding Segregated Assets?

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