Segregation of SMSF assets

Segregation of SMSF assets

Each SMSF can either be run as a segregated or unsegregated fund. Segregated funds hold separate asset pools that are specific to different members or specific to pension versus accumulation balances. Unsegregated funds have one large asset pool, and all members share in the combined investment returns.

Unsegregated funds

With unsegregated funds, one pool of assets is held, corresponding to all member balances.  The investment returns on those assets are spread across all members in proportion to their member balances.

Segregated funds

With segregated funds, 2 or more asset pools are established.  Each asset pool either corresponds to a member, pension balance, accumulation balance or combination of these.  Some examples might be:

• All pension balances correspond to one pool of assets, and all accumulation balances correspond to another pool of assets
• John's member balance corresponds to one member pool, and Mary's member balance corresponds to another asset pool

The key requirement is that separate pools of asets are held.

The benefits of unsegregated funds

There is one key benefit of unsegregated funds.  Simplicity.  This is such an important benefit that it usually outweighs the benefits of segregation.  In my experience, only a few per cent of funds are segregated and there is a good reason for this.  To put it another way - if you want to run a segregated fund then you should have a very clear rationale for doing so.

The fund accountant or administrator is likely to charge more to run a segregated fund due to the additional complexity it creates.  Segregated funds are also more likely to incur a penalty from the ATO for breaching the SMSF rules.  

The benefits of segregated funds

Here are some situations where segregated funds might be warranted:

• Where the members have very different investment objectives, and keep their finances separate.  Examples might be parents (who want more income and less risk) and children (who want higher growth) in the same fund; or a husband and wife in their second marriages.
• Where one member is in accumulation and the other is in pension, and the fund owns some assets producing high income and others producing low income.  In this situation it might make sense for the higher income assets to be allocatd to the pension member.  Not only will this create cash flow to pay the pension benefit, it may also produce some tax savings.  This situation can make sense if there is a large age gap between the spouses.  If there is only a small gap (eg a few years) then it may not be worth the effort to segregate the assets because once both spouses are in pension phase then the benefit will cease.

Segregated funds don't need to obtain an Actuarial Certificate.  Depending which actuary you use, this could be a large cost saving.  If you use Lime Actuarial then you won't save as much because our Certificates represent such good value at only $110 plus GST.  In other words, Actuarial Certificates are now so affordable that they should no longer be a reason to segregate.

Recent Developments

In late 2013, the ATO released TD 2013/D7 which dealt with segregated assets.  This Determination was withdrawn in December 2013 because it didn't adequately address bank accounts.  More recently, TD 2014/7 was released which deals specifically with bank accounts, however doesn't cover many other topics that were originally included in TD 2013/D7.

The key point is that the regulators are imposing tighter restrictions on segregated funds, making them more difficult to operate and narrowing the situations where they are warranted.

Conclusion

While both segregated and unsegregated funds have their place, unsegregated funds are far easier to operate and are therefore more common.  Caution should be exercised in operating segregated funds to ensure they are being run correctly. 

THIS ARTICLE WAS CORRECT AT THE TIME OF WRITING. SMSF RULES CHANGE OVER TIME AND THE ARTICLE MAY BE LESS RELEVANT IN THE FUTURE.