PORTFOLIO POINT: These assets stay here. Those assets go there. Segregation within SMSF can lead to better tax outcomes.
The word “segregation” might have some unsavoury connotations in other aspects of life, but not when it comes to running your SMSF. Given that tax is a major element of getting any investment right, particularly super, you need to understand that segregation is a tax play.
In simple terms, segregation means splitting the assets into definable piles for each member. That is, some of the assets belong to this member and some to that member: this member owns all the BHP shares; that member owns all the high-yielding term deposits.
Should one member own all the dud assets that haven’t performed well in a decade? Possibly. If your partnership/marriage is secure and you know that it will all be shared in the end, then one partner should potentially consider taking one for the team?
It can make sense under a multitude of scenarios.
Okay. The benefits?
Segregation, in SMSF terms, can be a wondrous thing from the tax gods. It is another real benefit of SMSFs, as most managed-fund super accounts don’t allow for individually owned super assets.
There are two main ways that SMSF assets are taxed: on the income derived from them; and on capital gains. Having individually owned assets with an SMSF can mean that, potentially, big capital gains tax bills are avoided, or income tax can be minimised.
While any accumulation super fund might wish to use segregated assets for different investment strategies within its super fund, or to invest differently on behalf of members with differing needs, the real value comes when different tax strategies are at play, including pension strategies.
That is, there can be considerable benefits to segregation if one member of the fund is in pension phase while the other is in accumulation phase.
I’ve often written about the benefits of super funds in pension phase. For a refresher, read Retire your tax bill, but those benefits can be summarised as a pension fund being tax-free on income and capital gains and the income drawn from the fund being either tax-free, or tax-friendly (for the over-55s on Transition to Retirement pensions).
Each super fund, its members and its assets need to be looked at on a case-by-case basis. If there’s an asset that has a big capital gain attached, on which you’d like to avoid paying tax at sale, then putting it in the pension fund could make sense. If you’re unlikely to sell it for a longer period (an investment property, for example), then it could potentially be left in the name of the fund member in accumulation.
Similarly, if there’s an asset that is yielding a high income, on which tax needs to be paid annually, it might be better segregated into the pensioner’s name.
Sounds great. Do I just announce it?
No. You need to make the decision before the beginning or at the start of the financial year in which it’s going to apply. And if using this to support a pension, an actuarial certificate will be required.
And be aware that trying to segregate assets for the express purpose of trying to avoid tax is still considered tax evasion and significant penalties can apply.
Am I segregating already?
Quite possibly, you’re not. And this could be for a number of reasons.
It’s possible there would be no benefit to your SMSF. Assuming a two-member fund, if you’re both finished making contributions and are both in pension phase, then the benefits are probably negligible. If you’re both in accumulation phase, there might also be little point.
Also, many trustees, accountants and advisers don’t understand the concept well enough to implement it with the SMSFs they help control.
Unsegregated super funds
The alternative is unsegregated funds, which would be for most SMSFs where both members share the same tax position from the point of view of super.
That is, where both members are in accumulation phase, or both are in pension phase and all assets are in pension phase, there would usually be little benefit to segregation. The cash and assets are pooled and each member effectively owns their rightful portion of the assets, depending on their balances.
If one member is in pension and one in accumulation, segregation is also often used for simplicity. Assuming one member’s entitlements are 70% of the fund, then 70% of capital gains and income would be attributed to that member.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.