Don’t set up an SMSF just because you can.
A lot of people have got the idea that an SMSF is a great way to increase their borrowing power.
Set up an SMSF. Use the fund to borrow money. Buy an investment property. Make money.
4 simple steps to wealth creation.
Except it’s not simple and there are severe financial penalties if you go about this the wrong way.
If you are thinking about setting up an SMSF there are 2 things you should bear in mind.
Having said that, when you do things right, it is possible to leverage your SMSF by borrowing to invest.
Before 2007, when you wanted to buy an asset within your super, you had to have sufficient funds to pay in full. Now it is possible to pay a deposit on an asset and fund the balance through lending.
You can use the funds in your super to buy what is termed a ‘single acquirable asset’, which can be such things as a property, shares or a managed fund. As with any portfolio, it makes sense to diversify so, if you don’t have enough capital in your super to buy the assets you want, borrowing is an option. If you keep the assets inside the fund until you retire you can avoid thousands of dollars in capital gains tax.
You can’t borrow a lump sum and use that to buy different assets. Each asset must have a separate loan, what is called an LRBA (limited recourse borrowing arrangement), and then held in a specific holding trust until the loan is repaid.
What this means is that each loan is compartmentalized and, if one of them is in default, the lender only has access to the specific asset that loan is based on. The rest of your assets are safe.
Make sure that you have enough liquidity in your fund to repay the loan, taking into account any ongoing administration fees for your SMSF or pension pay-outs. If you are depending on future member contributions, ensure they will continue at the same level for the lifetime of the loan.
What you choose to invest in of course depends on your fund’s strategy, but you need to be aware of the restrictions that come with a loan. It’s about the ‘single acquirable asset’ stipulation. If you buy a block of shares, for example, you are stuck with them until you cash out. If the shares are underperforming, you can’t sell a portion of them and buy different shares.
In the case of a property or land, you are not allowed to develop it to increase its value. You cannot let out a residential property to trustees of the SMSF or their family, but you can buy a commercial property to use for your business, which would pay rent to your SMSF. For residential property you can borrow up to 80% of the value and for commercial property up to 65% of the value.
There is a tendency among lenders to give loans on assets with a regular return, like a rental property.
The ATO have tweaked the regulations regarding SMSFs several times since 2007 so, if you want to set up your own SMSF, or use an existing one to borrow funds, talk to a qualified financial adviser.
Always keep in mind that the advice on this blog is general advice because everyone’s situation is different. To receive more specific advice tailored to your particular circumstances, reach out to us via our contact form and we will get in touch with you shortly.