Super and more specifically Self Managed Super Funds are complicated and always changing. At the moment we’re hearing a lot of industry chatter around leveraging super savings to invest or buy property.
SMSF borrowing arrangements and investment rules and regulations are complex. Before jumping in, 542 Partners recommend seeking financial, tax and/or legal advice to ensure any investment strategy is right for you.
What is an LRBA?
SMSFs can buy assets such as shares and property by using cash in the fund and borrowing the rest. This can enable the SMSF to acquire assets it currently doesn’t have enough money to purchase outright. Provided the governing rules allow for it, SMSFs can borrow to invest by using what’s called a ‘limited recourse borrowing arrangement’ (LRBA).
The risk of borrowing within your SMSF
The main risk of borrowing within your SMSF is being unable to meet your SMSF’s loan obligations. Reasons for not being able to make repayments can include:
Change in personal circumstances
The death, disablement or divorce of a member is likely to require payment from the fund, which can result in your SMSF having to sell the asset or risk defaulting on repayments.
The value of your investment can fall for a number of reasons, such as a general fall in market prices, or a fall in the value of your SMSF’s property.
The rules that govern SMSFs and superannuation in general change regularly. These changes could impact what the SMSF can own, whether and how it can borrow, the tax payable by your SMSF, and more.
Advantages of borrowing within your SMSF
Potential for increased returns
Superannuation exists for the purpose of providing members with an income in retirement. Smart investment strategies can improve your SMSF’s returns over time.
A well-diversified portfolio can reduce risk and improve returns over time. It can also assist with making your SMSF’s portfolio more liquid; i.e. a wider range of assets means it can be easier to sell some assets if your SMSF needs cash quickly.
Interest and other borrowing expenses are generally tax deductible to your SMSF, which can reduce any tax payable within your fund. If your borrowing is positively geared (i.e. rental income exceeds interest and other borrowing expenses), superannuation tax rates are capped at 15%, which is generally lower than personal income tax rates (on income above $18,200).