Should I segregate my pension assets?

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When an SMSF buys and holds assets on behalf of its members, the trustees need to decide how to structure and invest these assets. Effectively, you need to decide between either ‘segregating’ assets, or keeping the assets ‘pooled’ (or unsegregated).

Segregating fund assets generally involves the identification and physical separation of certain assets. On the other hand, the pooled approach is the opposite; that is, all assets are held and invested together as the name suggests.

Segregated vs pooled

While there could be a number of reasons why one approach may be more attractive than another, when dealing with pension assets, the approach you choose can lead to vastly different outcomes for the fund.

Given our ageing population, coupled with the advent of Transition to Retirement strategies (TtR), it is growing increasingly common to see SMSFs paying pensions. Also, the prevalence of these funds having both a pension and an accumulation (or savings) account within the same fund (indeed for the same member) has also increased.

This is in part because one of the benefits of commencing a pension within an SMSF is the tax exemption (regardless of the member’s age) given to pension asset investment earnings.

Where the fund is entirely in pension mode, the identification of these pension assets is rather simple – all of the fund’s investment earnings will be exempt from tax.

However, where the fund has pension and accumulation assets, like in a TtR, the assets must be segregated to obtain the pension income exemption.

Segregated approach

As noted earlier, the segregated approach requires a physical separation of assets. That is, pension assets will need to be identified, invested, and accounted for separately from assets that are in the accumulation mode.

Under this approach, for example, separate bank accounts would be maintained for the pension and for accumulation assets. Similarly, separate term deposits and share holdings would be held.

The ATO has also indicated its discomfort with only partially segregating an asset. This can be particularly troublesome if a bulky asset such as a property is held inside the fund and a pension is to be commenced.

The benefits:

  • All income and capital gains derived by the pension assets will be automatically exempt from tax – including capital gains triggered in pension phase but accrued in accumulation phase;
  • No actuarial certificate is required – reducing associated costs/delays;
  • Individual investment strategies are more easily catered for – e.g. income-producing assets can be specifically identified and held in pension phase.

The disadvantages:

  • Capital losses are disregarded, that is, they can’t be used nor carried forward;
  • Bulky assets such as property can’t be partially segregated;
  • Separate bank accounts and investment holdings are required;
  • Two or more separate sets of accounts will need to be produced each year, potentially increasing costs and complexity.

Pooled approach

The pooled (or unsegregated) approach is quite the opposite. Effectively, all assets are invested and accounted for together, regardless of whether they are pension or accumulation assets.

However, because the pension assets haven’t been specifically identified under this approach, in order to determine the level of exempt income the fund is entitled to, the trustees will need to obtain an actuarial certificate each year.

The benefits:

  • Capital losses can be applied and/or carried forward;
  • Easily caters for bulky assets such as property;
  • As assets are not held separately, only one set of annual accounts is required – making the administration of the fund simpler.

The disadvantages:

  • Only a proportion of income and capital gains are exempt from tax – creating a potential trap if selling an asset which has accrued capital gains, even if sold in pension phase;
  • An actuarial certificate is required each year, which may result in additional costs and/or time delays;
  • Difficult to cater for differing individual investment strategies.

Selecting your approach

Deciding on a method of asset segregation will have a number of impacts, from simple differences in costs and the way that assets are invested, to the creation of a potential tax trap when selling certain assets. However, the method used is also one that can be changed from year to year.

So, as both approaches have a range of benefits, it is a case of selecting which one is best suited to your fund and its assets at a particular point in time – a case of horses for courses!

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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