Accurium said that experience has shown that most SMSFs that have both retirement and non-retirement phase member accounts use the proportionate method when claiming ECPI. However, he noted an important issue that trustees need to be aware of when they are looking to implement segregation as part of their investment strategy is that segregated assets cannot exceed the value of the account balance. 

“We know that part of an asset cannot be segregated. This makes large indivisible assets, like property, difficult to segregate,” Accurium said in a recent blog.

“Where a fund is looking to segregate an asset to a retirement phase income stream, it must ensure that the market value of the asset does not exceed the account balance of the income stream.”

In an example provided, on 1 July 2019 a fund had assets totalling $900,000. This was composed of a bank account with $50,000, $350,000 in shares and a property valued at $500,000. 

The fund had two members, with member one (M1) having an account balance of $125,000 in accumulation phase and had $275,000 supporting a transition to retirement income stream which was in retirement phase. Member two (M2) had an accumulation account balance of $500,000. 

On 1 July 2019, M2 decided to commence an account-based pension with their entire accumulation balance and the fund’s trustees are considering whether to segregate assets to support the retirement phase income streams in the fund.

Proportionate and hybrid segregation 

In this scenario, if the trustees do not segregate assets, the fund’s assets will remain unsegregated where all of the fund’s assets are pooled to support each member’s account balances. The fund will require an actuarial certificate after 30 June 2020 to claim ECPI for the 2019–20 year.

“If we consider that M2 wishes to segregate some fund assets to support their new retirement phase pension. Their retirement phase pension account balance at 1 July 2019 is $500,000; therefore, the total value of the assets allocated to support the income stream cannot exceed $500,000,” Accurium said.

“The property held by the fund is valued at $500,000 at 1 July 2019. M2 decides to segregate this property to support their retirement phase pension of $500,000. 

“They complete appropriate trustee minutes to reflect this decision and update the fund’s investment strategy to reflect the differing investment strategy of M1 and M2. This asset is now a segregated current pension asset. M2 also sets up a new separate bank account to receive any income from the segregated asset and to make pension payments.”

With the fund now partially segregated, Accurium noted the fund will use the proportionate method to claim ECPI in relation to income earned on the pool of assets supporting M1’s retirement phase income stream and accumulation liabilities. 

This means income earned on the property and bank account supporting M2’s retirement phase income stream will be entirely tax-exempt using the segregated method. 

Full segregation 

When undertaking full segregation, there needs to be greater focus around where the fund’s trustees decide to segregate assets to support all of its retirement phase accounts on 1 July 2019.

“Consider the members decide to allocate the $500,000 property, the $50,000 bank account and $225,000 of the shares (note that this should equate to an exact number of shares as we can’t segregate part of a share),” he explained.

“They complete appropriate trustee minutes to reflect this decision and update the fund’s investment strategy to reflect the differing investment strategy of the accumulation and retirement phase interests.

“The fund also sets up a new separate bank account to receive any income from the unsegregated shares, which are currently solely supporting accumulation, and to receive any future contributions.”

Accurium said the fund will now claim ECPI using the segregated method and will not require an actuarial certificate. 

“All income earned on the unsegregated shares and bank account which were supporting the accumulation interest will be taxable. Income earned on the property, shares and bank account segregated to retirement phase pension will be exempt income."

“Again, the members must draw their minimum pensions from the segregated retirement phase pension bank account to ensure they are eligible for the income tax exemption and to ensure the assets remain segregated.”