Benefits and Risks of borrowing in your super fund

Some benefits

Control

Because an SMSF trustee has complete control and discretion regarding the investment strategy for their SMSF, they can determine the type of investment property they want to purchase in the SMSF. Retails and industry funds are currently unable to borrow to purchase direct property as they make investment decisions for the entire fund membership, not on what individual fund members want in an investment.

Leverage

An SMSF Super Fund Loan allows your SMSF to borrow for investment purposes. Borrowing in your SMSF enables your fund to acquire a beneficial interest in an investment property that it may not otherwise be able to afford to purchase. This allows your super fund to diversity into direct property.

Increased flexibility of cashflow

Using a Super Fund Loan may help the cashflow of your SMSF when a property is purchased. For instance, if the fund has a balance of $500,000, it may be able to purchase a property for $470,000 [plus purchase costs of $30,000] using its existing cash resources. However, the fund may face potential liquidity issues if you don’t have a cash buffer in your SMSF. In this case a Super Fund Loan could help ease the cashflow issues of your fund by taking out a Super Fund Loan, so allowing the SMSF to retain some of its cash to continue to operate and pay its ongoing liabilities.

Tax advantages

Investment income received by your SMSF, including income your fund receives because it holds a beneficial interest in a property acquired with a Super Fund Loan, is taxed at the concessional superannuation rate.

If your fund is in the accumulation phase, the income received from the property will not be taxed at more than 15%. This means that your SMSF fund may pay considerably lower rates of tax on the income received in your SMSF, than if you owned the property outside your SMSF.

Currently, if you sell the property when you’re in pension phase, over 60 years of age, the sale proceeds are capital gains tax free.

Asset protection

Generally, all assets in your super fund are protected against creditors in the event of bankruptcy, even if the SMSF does not actually hold the property but has a beneficial interest in it. The Bare/Property trust shields the property which has the Super Fund Loan from creditors, therefore limiting any claim of the creditors to the property held in the Bare/Property trust.

Some risks

Structuring

If you don’t structure your SMSF correctly right from the start, you may not be able to simply restructure or rectify the problem within that structure at a later date. You may have to unwind the arrangement which may involve a forced sale of the asset which could cause a substantial loss to your SMSF.

Liquidity

Maintaining liquidity is vital for a successful Super Fund Loan. Loan repayments will be deducted from your fund so it has to be liquid at all times. You need to plan carefully to ensure contributions and SMSF income is sufficient to meet the loan repayments and other existing and potential liabilities when they fall due. You need to factor in events such as the possibility of the property not being leased for some time, a major repair that needs to be made or if one or more members are in the pension phase.

If you’re in the accumulation phase, contribution caps impose limits on the contributions you can make on a tax concessional basis. This may limit the tax effectiveness of the Super Fund Loan if non-concessional contributions are needed to fund the loan repayments because the member’s concessional contribution cap has already been utilised.

As a trustee you now have to consider the need for insurance should you or another fund member die or incur an accident/illness that limits your income earning capacity and hence your ability to maintain your contributions to super. The trust deed needs to be worded to allow the proceeds of any life insurance policy to be used by the SMSF trustee to repay the loan so that the trustee is not forced to sell the property.

Trustees must continue to meet their loan obligations and the SMSF must have sufficient cash flow to meet the repayments when they fall due. If your ability to make super contributions is at risk because of an accident or illness, the SMSF may have liquidity issues. You should consider mitigating this type of risk by considering insurance cover including total and permanent disability and/or temporary disability cover.

If the SMSF defaults on the loan the lender may take possession and sell the property. You’ll receive the sale proceeds less the outstanding loan amount. If there’s a shortfall and the sale proceeds don’t cover the loan amount, the lender is prohibited from accessing other assets in your SMSF, but may call on a guarantor to make up the loan shortfall.

Tax losses

If you incur tax losses which arise because the after-tax cost of the property exceeds the income derived from the property, the loss will be quarantined in the fund, meaning tax losses cannot be offset against the taxable income earned outside the fund.

Equity in the property

If the property appreciates in value while it has a Super Fund Loan, you cannot use the property equity for other loans. In other words, the equity built up over time cannot be used to purchase other properties.

Related party loans

If you’re taking a loan from a related party, it’s important to ensure the loan is clearly documented. Failure to properly document the loan may result in the loan amount being treated as a contribution to the SMSF resulting in a possible breach of the contribution cap.

Costs of purchasing a property in an SMSF with a Super Fund Loan >

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Disclaimer: This information has been prepared by Aurora Finance Group as a guide only. You should not act solely on the basis of this information because it has been generalised and tax laws apply differently to different circumstances. As tax and related laws change frequently, there may have been changes to the law since this information was prepared. None of the comments in this page are intended to be advice, whether legal, financial or professional. Do not act on this information without first obtaining specific information about your particular situation from either Aurora Finance Group or other superannuation professionals.