Segregated vs. unsegregated funds – what’s the difference?
The super changes starting on 1 July this year introduce new words to our superannuation vocabulary such as ‘transfer balance cap’, ‘personal transfer balance’ and ‘notional capital gain’.
However, there are some words and phrases that have been around for many years like ‘segregated’ and ‘unsegregated’ superannuation fund that we also need to understand. Many of us may need to refresh our memory on the meaning of those words and how the superannuation changes impact on segregated or unsegregated funds.
Whether a fund is segregated or unsegregated determines how much of its net income is taxable and tax exempt. In addition, depending on the category of fund, certain fund investments will be eligible to have their CGT cost base reset during the pre-commencement period of 9 November 2016 to 30 June 2017. The resetting of the CGT cost base links to the introduction of the $1.6 million transfer balance cap, which commences on 1 July this year and limits the amount a person is able to transfer to retirement phase. The transfer balance cap applies to account-based and defined benefit pensions, which are in existence on 30 June 2017 and those commencing from 1 July 2017.
As the name suggests, a segregated fund has its investments specifically allocated to those member accounts which are in retirement phase and those in accumulation phase. The income and taxable capital gains earned on investments supporting retirement phase are tax exempt and income on investments supporting accumulation balances in the fund are taxable. It should be noted that a fund which is solely in accumulation phase or solely in retirement phase is treated as a segregated fund.
In contrast, a fund that is unsegregated has all of its investments pooled so that no particular asset is specifically allocated to those supporting retirement and accumulation phase. In other words, a small portion of all the fund’s investments, in theory, is devoted to both the retirement and accumulation phase. In an unsegregated fund, the amount of tax exempt and taxable income of the fund is based on a proportion based on the average balance of the fund in retirement and accumulation phase during the financial year.
In the case of an unsegregated fund, the superannuation legislation requires a certificate from an actuary to certify the proportion of the fund in retirement and accumulation phase for the relevant year. These proportions are applied against the fund’s taxable income and determine the taxable and tax exempt income of the fund. From 1 July 2017, there will be no requirement for a fund to obtain an actuarial certificate where the fund is paying only account-based pensions and transition to retirement income streams (TRIS).
The changes that take place from 1 July 2017 permit a superannuation fund to reset the CGT cost base on its investments where a member has a balance in retirement phase of more than $1.6 million or is drawing down a TRIS. The resetting of the cost base is optional for each investment or parcel of investments owned by the fund. The reason for the reset is due to the requirement that the member must have no more than $1.6 million in retirement phase by 1 July 2017 and that the income earned on investments supporting a TRIS will be excluded from retirement phase and taxed at 15%.
The investments that qualify to reset the cost base are different for segregated funds and unsegregated funds. In a segregated fund, it is the value of the investments transferred from retirement phase to accumulation phase to reduce a member’s pension balances to $1.6 million by 30 June 2017 that can have their CGT cost base reset. The value used for the reset can be any value of the investment between 9 November 2016 and 30 June 2017, providing the investment has been owned by the fund during that time. In an unsegregated fund, the trustee can choose any investment to have the cost base reset to its market value on 30 June 2017, providing the investment has been owned by the fund throughout the period from 9 November 2016 to 30 June 2017.
Let’s look at a case study to illustrate the difference between resetting the cost base for the investments in a segregated fund compared to an unsegregated fund.
Greg and Michelle are members of the G&M Superannuation Fund. Greg has a pension balance of $2 million and Michelle has an accumulation balance of $1 million as at 30 June 2017. The fund has the following investments:
Let’s assume Greg and Michelle decide to have the fund administered for tax purposes as a segregated fund. They have decided to ‘segregate’ the fund’s investments between the retirement phase and accumulation phase as follows:
As Greg’s pension balance is required to be reduced to $1.6 million by 1 July 2017, it will be necessary for him to partially commute his pension balance to $1.6 million and transfer $400,000 to an accumulation account that will be established for him. In these circumstances, the fund is able to reset the CGT cost base on those investments that are being transferred to Greg’s accumulation account, provided they have been owned by the fund throughout the period commencing on 9 November 2016 until 30 June 2017. Let’s assume the shares in XYZ Pty Ltd are transferred to accumulation phase and the cost base of the shares will be $400,000 on 1 July 2017. The fund could choose the value of the shares at any time between 9 November 2016 and 30 June 2017. However, in this case the value of the shares at 30 June 2017 has been used.
After the adjustment has been made, the amounts in accumulation and retirement phase would be as follows:
Rather than having the fund treated as a segregated fund, let’s assume Greg and Michelle decided to have the fund taxed as an unsegregated fund. The investments would be pooled so that no investment was allocated to either the pension or accumulation phase. The fund’s investments would be pooled as follows:
Where the fund operates on an unsegregated basis, it is possible to reset the cost base for any investment the fund has owned throughout the period 9 November 2016 until 30 June 2017. However, the value of the investment as at 30 June 2017 is required to be used to determine the notional capital gain.
In this case, Greg and Michelle’s fund may reset the cost base of the shares in DEF Limited, Limited, XYZ Limited and the property, as the value of those investments on 30 June 2017 would result in a notional capital gain. It would not be worthwhile resetting the cost base of the cash, fixed deposit or the shares in DEF Limited as there are no notional capital gains arising on 30 June 2017.
Understanding the difference between a segregated and unsegregated superannuation fund in the past has been important to determine the taxable and tax exempt income of the fund. However, for this financial year, understanding the difference becomes more important for members who have pension amounts in excess of $1.6 million that are counted against their Transfer Balance Cap or for anyone in receipt of a TRIS.
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