Pension income and segregation in an SMSF


[This article is a response to comments on my previous article requesting clarification on the treatment of segregated assets in superannuation.]

Prior to the 1 July 2017 amendments, any superannuation fund, including an SMSF, had a choice of two methods for calculating the amount of its income that was exempt from tax based on which assets of the fund supported a pension.

Briefly, previously the trustee could use:

  1. the proportionate method, generally calculated as fund income from assets supporting a pension divided by total fund income. More technically, a formula called a liabilities calculation used the ratio of pension liabilities of the fund to total benefit liabilities.
  2. the segregating of assets supporting a pension. The anti avoidance rules around this second method meant that the value of the asset segregated for pension payments cannot exceed the value of the member’s account. For example, say a fund has an apartment in the Gold Coast with a market value of $600,000 but the value of the pension member’s account was only $500,000, the anti avoidance rule prevented the fund segregating that asset.

Other comments about these two methods

Surprisingly the majority of SMSFs used the proportionate method. The reason we found that surprising (and we have had the benefit of talking, under Chatham House rules, to over 600 experienced SMSF practitioners who have attended our SMSF Specialisation Programme over the last four years) is that fund trustees who use that method are ‘giving up’ some valuable tax planning functionality.

For example, and subject to general anti-avoidance rules, segregating an asset with a large unrealised gain and then disposing of it means that 100% of the gain is exempt, whereas only a proportion would have been exempt had they used the proportion method.

Specialists tell us the reasons most SMSFs don’t use segregation are administration hassle and costs. The income of a segregated asset has to be accounted for separately, say, in a separate bank account. Also, the cost of managing segregation, compared to the ease of getting an actuarial certificate for the proportionate method, cannot be justified.

What is the change after 1 July?

In effect, an SMSF that has at least one member who has a superannuation accumulation of $1.6 million cannot use the segregated asset method.

It is not a blanket ban on SMSFs using this method. It is where at least one member in pension mode has a superannuation accumulation of at least $1.6 million.

Note it’s not $1.6 million in pension mode, as in the Transfer Balance Cap, it’s $1.6 million in superannuation. The rules use the Total Superannuation Balance measure and not the Transfer Balance Cap measure in calculating the $1.6 million. That means in that it will be all superannuation accounts of a member, either in accumulation or pension, plus the value of any deferred pensions, which are included in the Total Superannuation Balance calculation. And it’s not just the members’ balance in the SMSF that is included, it’s all their superannuation accounts.

What that also means is that an SMSF where no member has more than $1.6 million Total Superannuation Balance can still use this segregated method when paying a pension.

Blanket ban, anyone?

Go figure! It’ supposed to be an anti-tax avoidance measure but it only applies, among other reasons, if at least one member has at least a $1.6 million Total Superannuation Balance, but you can still use it if they don’t.

OK, the rule only affects SMSFs and the reason they haven’t removed it for all funds is that, while most non-SMSFs will also use the proportionate method if they pool all members’ funds, some very large funds have separate pools for accumulation members and for pension members. The income from the pension pool can use the segregated asset method.

For the record, here is the legislation

The exempting rule for segregated assets (section 295-385) now excludes assets from using the segregated asset method called ‘disregarded small fund assets”. The Amending Act says:

4  At the end of section 295‑385

Add: (7)  Also, *disregarded small fund assets are not segregated current pension assets.

9  At the end of section 295‑395

Add: (3)  However, *disregarded small fund assets are not segregated non‑current assets.

Here is the definition of disregarded small fund assets in the Amending Act, and note ‘2(c)(i)’ which is the Total Superannuation Balance condition.

5  After section 295‑385

Insert: 295‑387  Disregarded small fund assets.

(1)  The assets of a *complying superannuation fund are disregarded small fund assets at all times in an income year if the fund is covered by subsection (2) for the income year.

(2)  A *complying superannuation fund is covered by this subsection for an income year if:

(a)  any of these requirements are satisfied:

(i)  the fund is a *self managed superannuation fund at a time during the income year;

(ii)  there are less than 5 *members of the fund at a time during the income year; and

(b)  at a time during the income year, there is at least one *superannuation interest in the fund that is in the *retirement phase; and

(c)  just before the start of the income year:

(i)  a person has a *total superannuation balance that exceeds $1.6 million; and

(ii)  the person is the *retirement phase recipient of a *superannuation income stream (whether or not the fund is the *superannuation income stream provider for the superannuation income stream); and

(d)  at a time during the income year, the person has a superannuation interest in the fund (whether or not the superannuation interest is the superannuation interest mentioned in paragraph (b)).


Gordon Mackenzie is a Senior Lecturer in taxation and superannuation law at the Australian School of Business, University of New South Wales. This article summarises the major points as understood by the author, it does not consider the needs of any individual and does not consider all aspects of the legislation.

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