Can I borrow from my superannuation fund?
There are significant advantages to having a property in a Self Managed Super Fund (SMSF) with the most obvious being the tax rate for income derived in your super fund being taxed at a considerably lower rate than income tax (namely 15%) as well as the choice to control your investments and your future investment strategy.
SMSF's can borrow funds via what has been defined by Superannuation legislation as a "Limited Recourse Borrowing Arrangement "(LRBA) which describes a loan/arrangement which has limited recourse for the lender against the borrower in the event of default, to the single asset purchased using the specific LRBA – thus protecting the other assets that sit inside the SMSF.
Each asset purchased using an LRBA must be housed inside what is known as a "Bare Trust."
More Australians are turning to their Self-Managed Superannuation Funds as a financing option. According to statistics released by the Australian Taxation Office (ATO), lending through a Superfund has risen from $1.4 billion borrowed in June 2011 to over $21.8 billion by the same month in 2016. Is an SMSF loan a good choice for you?
Benefits of borrowing money through your SMSF
Before 2007, if you wanted to purchase assets through your SMSF, you could only do so if there were sufficient funds available. With the changes to the rules in 2007 and clarifications in 2010, 2011 and 2012, you can now borrow money for these purchases.
One of the benefits of these changes is diversification because you don't have to use a large portion of your funds to purchase a single asset. As an example, if you have $100,000 available in your SMSF, you can use a portion of these funds as a deposit on real estate and another portion as a deposit on shares, borrowing the balance from a financial lender.
Another substantial benefit is the tax advantages of investing in property via your SMSF, potentially saving you thousands of dollars. This means that if you hold the asset in your SMSF until you retire, your fund could potentially enjoy the benefits of zero capital gains tax on that asset.
Many Australians budget for their retirement using Self Managed Super Funds (SMSFs), because they want more control over how their superannuation is invested. Since 2007, you can borrow money through your SMSF to invest in assets, such as real estate, shares and managed funds, but only if you adhere to strict rules.
Rules concerning SMSF borrowing for asset acquisition
When you borrow money for your SMSF to invest in assets, you can only do so if you borrow the money under strictly limited recourse borrowing arrangements (LRBAs) and adhere to many rules. Here are some of the more notable rules:
Single acquirable asset
Your SMSF can only purchase what is called a 'single acquirable asset' using this borrowed money. Generally, this means that you can only purchase one property with the loan or one block of identical shares in the same company and purchased at the same time. For each property or block of shares, you have to take out separate loans through your SMSF.
When you purchase a single acquirable asset using borrowed money through your SMSF, you cannot improve the asset until the loan has been repaid. You can repair and restore the property, but not renovate it to increase its resale value.
Held in a trust
The asset, as mentioned above, must be held in a specific holding trust until the loan is repaid. Security for this borrowed money is the asset itself, which is secured using an LRBA. The LRBA protects all other assets in the SMSF, so for example, if the loan defaults, the lender can only access the purchased asset for recompense, they cannot access any of the other assets held by the SMSF.
Other rules state that the property cannot be lived in, rented to or purchased from a fund member or any related parties. Your SMSF can, however, purchase your business's premises and then your business would pay rent to your SMSF.
Before borrowing money and investing in residential, commercial or industrial property via your SMSF, it is important to talk to a financial advisor. This is because you need to ensure that the asset purchase is consistent with the investment strategy and risk profile of your fund.
Another consideration is that your SMSF will pay the loan, so there must be sufficient funds available to meet these loan repayments. Don't forget to have an exit strategy as well, which might include life insurances, in case something unexpected occurs.
Purchasing assets using LRBAs is a practical strategy to build wealth for your retirement. However, you must be sure that you work within the rules and ask for advice if needed.
What Is Limited Recourse Borrowing?
Most loans obtained through an SMSF are structured as Limited Recourse Borrowing Arrangements or LRBAs. Any investment bought with funds from the Super is held in trust so that the borrower may access it in the future.
The term "limited recourse" is used because, if the loan goes into default, the lender can only seek compensation through the asset that the loan was used to purchase. They cannot go after any other assets currently held by the Superfund.
What Can I Buy with a Superfund Loan?
What can an LRBA be used to purchase? The general guideline is that it can be used to buy a single asset or a collection of similar assets. Each asset must hold the same market value. The beneficial interest earned from the investment goes to the SMSF trustees; however, legal ownership remains with the holding trust.
A majority of money borrowed through a Superfund is used to buy property, both non-residential and residential. This lending option allows the property to be purchased with a lower tax rate than you would get when buying on your own. If the Superfund goes into pension phase, then the property can be sold tax-free. If it is sold during the accumulation phase, then the property is eligible for a discounted capital gains tax.
One thing to remember when investing in residential property is that the trustee and/or any member of the trustee's family cannot live in the property. There must not be a direct benefit for the trustee or any relatives.
SMSF Interest Rates
A 2016 report released by Canstar provided an overview of SMSF loan interest rate averages, which included:
- Variable – 5.65%
- 1 Year Fixed – 5.42%
- 2 Year Fixed – 5.32%
- 3 Year Fixed – 5.38%
- 5 Year Fixed – 5.62%
What if I Don't Have Enough in My Super to Buy property?
There is an option available for those who do not have enough in their SMSF to buy a residential property. You can use a Tenants in Common, or TIC, arrangement. This permits you to borrow from both your Superfund and your home. For example, if you are interested in a property that costs $400,000, you could use the TIC to borrow $200,000 against your home and the remainder from the Superfund.
Circumstances that legally allow early access
Severe financial hardship
A member is eligible for access under severe financial hardship if and only if they are unable to meet reasonable and immediate living expenses. They must also have been receiving government financial support continuously for 26 weeks, including the time they applied for early access.
In both managed funds and SMSFs, members are allowed withdrawal of $1,000 (unless the balance is below this amount) to $10,000 if they are experiencing severe financial hardship. However, only one withdrawal is allowed in any 12 months. The actual allowable amount is taxable as a normal lump sum payment.
Members may apply for a withdrawal on compassionate grounds if they or their dependents need financial assistance to pay for medical or death-related expenses, such as burial or funeral expenses. The money may also be used for expenses related to home and vehicle modifications to address severe disabilities.
A member can also apply for early withdrawal if they are solely responsible for paying the mortgage and is about to lose their home. In this case, a member is only allowed access to 3 months' worth of repayment and 12 months worth of interest on the loan balance.
Withdrawals based on temporary incapacity may be allowed if a member temporarily needs to stop working due to a physical or mental disability.
This is only allowed for members who are not on sick leave (i.e., receiving benefits from the company due to their disability). The money should come from insured- or employer-funded contributions and given as an income stream.
Members who become permanently disabled and have stopped working due to their disability are allowed early access to their super benefits without cashing restrictions.
However, the member must prove that they are truly unable to work due to their disability, even if their education and experience qualify them.
Terminal medical condition
Members diagnosed with a terminal disease are allowed early access to their funds without restrictions. However, they must present certifications from two medical professionals that their condition will most likely result in death within 24 months. One of the certifications must come from a specialist in the diagnosed disease.
Does the ATO have an article, SMSF and Lending, on their website warning trustees about the dangers of lending an SMSF?s funds to the wrong person. This includes yourself, your own business, someone who advises you or a family member or friend.
Unfortunately, an all too common occurrence is the practice adopted by some people of withdrawing funds from their SMSF to "temporarily" help keep their business afloat when cash flow is tight. This is, in fact, the most common breach, accounting for over 25% of contraventions reported to the ATO by fund Auditors each year and is illegal.
Has your SMSF loaned money? If so, you need to make sure the loan terms comply with the law and are in the best interests of your funds' sole purpose test, which is to provide for your retirement.
The essential fact to know is that the Trustees of SMSFs cannot lend money to members of the SMSF or their relatives. However, trustees can lend to related parties of the SMSF, subject to the 'in-house asset' rules. The SIS Act limits investments in 'in-house' assets (which includes loans to related parties) to 5% of the total assets of the SMSF, based on current market value.
If someone is recommending you set up an SMSF and then to lend them or related party money for a development or business deal, you have to ask yourself in whose best interest are they working? It might be time to scrutinise the small print and legality of this "great opportunity".
So when would a loan agreement not be seen to be in the best interest of your SMSF? An example would be where you have given discount loan rates. In addition to putting your member's benefits at risk, your SMSF could be found to be non-complying and would, therefore, not qualify for concessional tax rates, or since July 2014 the ATO also can apply penalties on each trustee of up to $10,200 per infringement.
So you should consider your fund's investment strategy and determine whether the investment is appropriate and that any acceptable loans are on commercial terms.
Regardless of how badly you need short-term funding or how much you trust the person you are considering lending to, you need to stop and think or get professional advice. Don't be in a rush or be embarrassed about taking the time to check the legalities. Later is often too late to get your funds back and hindsight can be a cruel tormentor.
Can my SMSF lend me money?
No. Your SMSF cannot lend you or any of your relative's money. Making this type of loan must be avoided: it's not a way of legally accessing super early via an SMSF.
Section 65 of the SIS Act prohibits superannuation funds, including SMSFs, from providing financial assistance to members or their relatives.
The trustee or an investment manager of a regulated superannuation fund (SMSF) must not:
lend money of the fund to:
- a member of the fund; or
- a relative of a member of the fund; or
give any other financial assistance using the resources of the fund to:
- a member of the fund; or
- a relative of a member of the fund.
Breaching this provision could lead to an administrative penalty of 60 units ($12,600 per trustee) as well as disqualification from being a trustee of an SMSF and/or civil and criminal penalties.
Can my SMSF loan money to my business?
In general, loans to a business operated by members of an SMSF is prohibited and can result in the following administrative fines:
- Lending to members and relatives – 60 penalty units
- In-house assets – 60 penalty units
Currently, a penalty unit is $210, therefore each breach is $12,600 per trustee and penalties must be paid by the trustee personally (or on behalf of the corporate trustee) and not paid by the SMSF.
The ATO has more information on how they deal with non-compliance on their website.
There are however certain loans to a related party business that can be made under strict conditions that will not breach these tight rules provided they are correctly put in place. Having your SMSF make a small loan to your business may be a way of legally accessing super early via an SMSF.
The key restrictions are:
- The loan is made to a company or a trust with a corporate trustee (not to a sole trader business or partnership)
- The amount of the loan is less than 5% of total fund assets (based on market value)
- The loan is on arms-length commercial terms
- The loan is allowable under the trust deed of the SMSF and is included as part of the investment strategy of the SMSF
- The loan does not breach the sole purpose test
In many cases, a loan of less than 5% of the assets of the SMSF may not be a significant amount. For an SMSF with a $1 million balance, this only equates to $50,000, which may not be enough for a business owner to survive through extended business disruption.
One key risk with a 5% loan is what happens when the market value of assets of the SMSF drop, and the loan increases to greater than 5% of the assets of the fund. Where the value of the loan to the related party (i.e. the in-house asset) exceeds 5% of the assets of the fund at the end of the financial year, the trustee (s) of the SMSF must put in place a written plan to rectify the excess by the end of the next financial year.
For example, if a loan is made of $50,000 in April 2020 (based on the market value of total SMSF assets of $1 million), however, the value of all assets drops to $900,000 as at 30 June 2020, before 30 June 2021 the trustees must reduce the loan amount to under 5% again. I.e. the $50,000 would need to be reduced to less than $45,000 to prevent the investment from being considered an in-house asset.
In addition, the loan must be allowable under the SMSF trust deed, as well as included as part of the investment strategy of the fund meaning both of these documents need to be reviewed and updated where necessary.
The sole purpose test is also important. Essentially, the sole purpose of an SMSF is to pay retirement or death benefits to members or member beneficiaries of the fund. If a loan is being made to a related party company or trust, and then that money is subsequently paid out to the members of the SMSF or used to benefit them directly in any way, the sole purpose test is likely breached, and the trustee (s) may face significant penalties and compliance action from the ATO.