How SMSFs segregate assets in retirement

As the name suggests, segregation refers to the separation and allocation of specific fund assets to specific fund members or class of fund membership.

Whether it be for investment or tax purposes, asset segregation can provide significant benefits for SMSFs.

What is asset segregation?

Put simply, asset segregation refers to the process where the SMSF trustees identify a particular fund asset as being held solely and separately for a particular fund member or class of members.

Asset segregation is most commonly used where an SMSF has fund members in both the accumulation and retirement phase of superannuation.

For instance, trustees could resolve that all the shares their SMSF holds in BHP are being held solely for one member of the fund, or that they are being held for all members who are in pension/retirement phase.

The reason that segregation is used more often for retirement phase members relates to the tax treatment of fund earnings in retirement phase when all fund earnings become tax-free.

If an asset is identified as being segregated and held solely for retirement phase members, then all income generated by that asset is allocated to the members in retirement phase, making the income entirely tax-free to the fund.

Asset segregation can also be used in the accumulation phase for investment purposes. For instance, where different SMSF members have different investment objectives or preferences. One member may want to invest their retirement savings in direct property, while another member may want to invest entirely in listed shares.

This can be achieved within the one SMSF by segregating specific assets to specific members.

Pooled vs segregated approach

Where SMSF trustees take a pooled investment approach, all fund assets are held in a pool for the benefit of all fund members. All income and expenses that relate to the pooled assets are shared by all fund members in proportion to their member balances within the fund.

Whereas under a segregated approach, income and expenses that relate to assets identified as being segregated are allocated only to the member or class of members identified by the fund trustees.

Partial asset segregation

It is not possible to partially segregate an asset. The asset either needs to be fully segregated or held in the general asset pool of the SMSF.

Therefore, trustees will need to have up-to-date member balances before implementing a segregation strategy to ensure that the member’s balance is sufficient for an asset to be segregated for their benefit.

Do the fund rules allow segregation?

It is always important to check your SMSF trust deed for any fund-specific rules that may apply.

When it comes to asset segregation, it would be prudent for the trust deed to explicitly allow this to take place, rather than being silent or for the deed to ‘not disallow’ it. A positive statement in the trust deed wording allowing the use of segregation would be preferred.

You will also need to review your fund’s investment strategy and make sure that any segregation implemented and used by the trustees is in line with that strategy.

If changes or updates are required to your investment strategy, carry these out before you do anything else.

How do you segregate assets?

There needs to be a formal approach and process followed to achieve effective segregation of a fund asset and this would usually be carried out using a trustee resolution or within the minutes of a trustee meeting where the decision was made.

The paperwork would usually include:

• The identification of a specific asset that is to be segregated and for which member or class of members the asset is to be held
• The reason or reasons for using segregation (e.g. ease of fund administration, different stages of fund membership, different investment objectives)
• That the fund’s investment strategy has been reviewed, and the proposed asset segregation is in line with the strategy
• That the fund’s trust deed has been reviewed and allows segregation to take place.

Changing the status of an asset

A question that often arises is whether an asset that has been identified as being a segregated asset can later be changed to being a pooled asset, or vice versa. Put simply, can the segregation status of an asset change at a later date?

The short answer is yes, so long as there is a reason for the change to be made and that it’s not being done solely to obtain a better tax outcome.

For instance, where the rent received on a segregated rental property is no longer sufficient to meet the fund’s ongoing pension obligations, the trustees may need to revert to a pooled approach where all the fund’s income can be used to make the required pension payments.

The bottom line

If you are considering asset segregation in your fund, it would be prudent to discuss this with your fund administrator first. They will need to be aware of what is taking place in order to correctly administer your fund. They may also be able to assist in the process or provide you with standard paperwork or procedures that can be used or followed.