Self managed super funds open up a whole new world of investment opportunities for your retirement savings, including direct property.
But what if you simply don’t have enough money in super to buy property?
Traditionally, you may have had to consider borrowing the balance yourself and then becoming joint owner of the property with your super fund. Perhaps this would have been set up through a trust structure to give you flexibility later on.
However, since 2007, SMSFs have been permitted to borrow money directly to help purchase investments such as property. For this to be allowed, there are a number of strict criteria that need to be met. For example, it must be established that the lender has no recourse to other assets of the SMSF in the event of default.
In addition, specific legal documentation must be in place relating to the ownership of the investment. A special type of trust — known as a bare trust — must be set up to hold the investment on behalf of the super fund until the loan is extinguished. If this is not structured correctly, the fund may breach investment rules.
But if all of the requirements are satisfied, borrowing through your super fund can open a whole new range of opportunities.
How it can work
We will use the example of Grant Architects to demonstrate how this works and can benefit small business owners.
Owners Andrew and Bettina Grant are currently leasing their business premises. They want to buy the premises but with their current home mortgage, they don’t have the available money to do so.
Andrew and Bettina both have superannuation accounts with a combined balance of $130,000. They are interested in a smart way to use these savings to purchase the premises (valued at $300,000) as soon as possible.
Can their SMSF borrow?
In this example, one of the benefits to Andrew and Bettina of investing through an SMSF is that they can use their existing superannuation as a deposit on the purchase of the business premises. This is especially useful if they have limited equity in their own names, such as through the family home.
Here, the SMSF has borrowed from the bank to make up the difference between the Grants’ existing super and the purchase price of the premises. Over time, the SMSF will use rental income, plus super contributions received from Andrew and Bettina, to repay the debt to the bank.
On these types of loans, banks are not likely to lend up to 80% or 90% of the property value, as with normal investment loans. It is more likely to be around 60% to 70%.
Is it better to borrow personally if you can?
Most property investors like the idea that any excess of expenses over the rent received can be deducted against other income. In other words, negative gearing can be a key factor in a wealth-building strategy using debt.
Within the SMSF environment, the tax benefits of negative gearing are not so obvious. The excess deductions cannot be claimed by the individual members, only by the fund itself. This outcome should be weighed against the advantages of SMSF borrowing, as well as having sufficient deposit as noted above.
Like Andrew and Bettina, the decision you make depends on your particular financial circumstances and arrangements. Your financial adviser can help in implementing the most appropriate structure for you.